Monday, June 30, 2008

Spiced-Up Idea - attractive stock for long term investor

Idea Cellular's merger with Spice Communications augurs well for the former. The stock looks attractive for long-term investors

IDEA CELLULAR'S decision to merge Spice Communications with itself will go down in Indian corporate history as one of the most significant consolidation moves in the domestic telecom space. As stated in the June 16, '08 edition ofET Investor's Guide, the deal is likely to benefit Idea by making it a bigger player in the fiercely competitive space of mobile communications. Given the synergies of the merger, Idea can prove to be a good bet in a falling market.


Idea has agreed to pay Rs 77.3 per share to acquire the complete promoter stake in Spice. It will also pay noncompete fees of Rs 19 a share to the Spice promoters. This ensures that Spice will not venture into the mobile communication business for at least the
next three years. The total tag for the deal comes to Rs 2,720 crore. Apart from this, Idea, along with Telekom Malaysia International (TMI), a prominent stakeholder in Spice, will make an open offer to buy 20% additional stake from existing Spice shareholders. This will cost nearly Rs 1,070 crore, though the payment procedure is not yet clear. After the merger, TMI will gain 5% stake in Idea, in exchange for its existing 39.2% stake in Spice. Later, Idea will issue preferential shares to TMI at Rs 156.96 per share to TMI, thus aggregating Rs 7,294.4 crore. Post-issue, TMI will hold close to 20% in Idea.


Through this deal, Idea has not only acquired the business of Spice, but has also made arrangements to get funds for its future business requirements. On a net basis (after considering cash outflow to buy Spice promoters' stake, a subsequent buyback offer and cash inflow from stake sale to TMI), it will see a capital inflow of over Rs 3,500 crore. This is opportune at a time when the turmoil in global markets has made it tough for corporates to raise finances on favourable terms.


For Idea, the biggest benefit is Spice's existing subscriber base. The deal

boosts Idea's current subscriber base by 17% to 306 million. This also translates into an increase in market share from 9.6% to 11.2%. Moreover, Idea gets an entry into the telecom circles of Karnataka and Punjab, where it doesn't have spectrum as of now. According to experts, setting up operations in a new circle requires a breakeven period of nearly three years. Spice's operations — though not profitable at the net level due to higher depreciation and interest costs — are cash positive with operating margin of 26%. Given this, acquiring the operations of Spice makes sense. Idea has a capex plan of over Rs 10,000 crore, which reflects its aggressive strategies for future expansion. The capital to be infused by the deal will help Idea to pursue these plans. Currently, Idea has more efficient operations than Spice, given per-user capital expenditure. We expect Idea to retain its efficiency, post-merger, resulting in higher subscriber growth and improved profitability.


The deal is expected to increase Idea's equity from Rs 2,635.4 crore to Rs 3,232.6 crore. The dilution in equity and the fact that Spice's operations are still losing money on a net basis will depress Idea's EPS in the next few quarters. But this shouldn't deter long-term investors.


At a CMP of Rs 97.5, Idea attracts the lowest per-subscriber enterprise value (EV) of
Rs 10,261 among top three listed mobile operators. Its EV/ EBITDA is 11.3. This excludes impact of the merger. The deal makes Idea more expensive on these parameters as postmerger, its EV/subscriber will rise to Rs 11,033, while EV/EBITDA will rise to 16.9. Given this, the deal appears to have come at a higher price. But we expect Spice's operations to turn around in the next 2-3 quarters. This will substantially add to Idea's overall performance in future. TMI has agreed to acquire more shares of Idea at Rs 156.96. This indicates a 61% premium over the current price and reflects the kind of growth TMI expects from this venture. Long-term investors can use the opportunity provided by the recent market fall to accumulate Idea's shares.

Beta: 0.76

Institutional Holding: 10.2%

Dividend Yield: Nil

P/E: 24.7

M-Cap: Rs 25,

CMP: Rs 97.5


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