Telecom stocks have started generating substantial returns for investors and attracting increasing interest. Meanwhile, for telecom companies, IPOs are proving to be a reliable source of financing. Industry experts share their views on the key growth drivers for telecom stocks, the preferred financing route and the possibility of more IPOs in the future…
How are telecom stocks performing?
Amit K. Ahire: It has been observed that companies that have pan-Indian operations and an ability to garner larger subscriber additions have performed well. The ability to provide NLD and ILD operations gives a further fillip to the growth of the company. Going forward, an increase in subscriber base along with the players’ ability to differentiate service offerings will determine the growth of the company.
Nitin Gupta: Telecom stocks have been attracting phenomenal attention from investors. During the last year, stocks of companies like Bharti Airtel, Reliance Communications and Tata Teleservices Maharashtra Limited outperformed the Sensex. Bharti and Reliance outperformed the Sensex by huge margins, generating returns of 100 per cent and 52 per cent respectively in the last one year. The latest market entrant is Idea Cellular, which came out with an IPO price of Rs 75 per share. It has already registered a return of over 50 per cent in a span of less than two months.
Romal Shetty: Telecom stocks like Bharti Airtel and Idea Cellular have been performing extremely well, even better than the benchmark indices. Bharti’s stock is worth around Rs 800 today as opposed to Rs 400 a year ago. This is a 100 per cent increment. So, it is evident that they have been performing extremely well.
Prianka Singhal: Bharti Airtel has been an outstanding performer, with price appreciation of 73 per cent relative to the Sensex over the past year. Reliance Communications has appreciated by 30 per cent (relative to the Sensex) over the same period. Due to robust demand (and hence growth), the scenario has remained unmarred by global factors and the Indian telecom sector is grabbing investor attention.
What are the key drivers of the growth in telecom stocks?
Amit K. Ahire: At the end of February 2007, the mobile subscriber base stood at 162.5 million, up from 98.8 million at the end of March 2006, an addition of 63.7 million subscribers during this period. This strong growth in subscribers is helping improve revenues and subsequently, profit margins. Going forward too, the mobile subscriber base is expected to continue to improve. CRISIL Research expects the mobile subscriber base to reach 353 million by the end of March 2011. The growth in subscriber base will be driven by a decline in the cost of service, falling costs of mobile handsets and an increase in coverage by telecom operators.
Nitin Gupta: The key growth drivers of telecom stocks are the following:
Furthermore, recent transactions, particularly the Vodafone-Hutch deal, have provided an aggressive benchmark for the valuation of telecom companies.
Romal Shetty: From an industry perspective, the main driver is volume growth. The subscriber base is expected to reach 500 million by 2010. This is due to several reasons such as price stabilisation, and favourable regulatory changes like reduction in roaming tariffs.
Second, large integrated telecom companies like Bharti Airtel and Reliance Communications enjoy the advantage of having built up their capex. This, in turn, means that they will benefit from further efficiencies in their opex, which will then positively impact their margins. Initially, there may have been some reduction in the companies’ margins as they were opting for capitalisation. However, slowly, the capitalisation phase will reduce and the margins will start increasing over the next couple of years. So, if you look at this trend in terms of stock prices, they should go up. From the companies’ performance point of view, the stock prices should go up by another 100 per cent during the next couple of years.
Third, telecom equipment manufacturers are setting up base in India. This is a direct indication that the Indian telecom market will continue to grow. This will also lend stability to telecom stock prices. Earlier, equipment manufacturers such as Nokia and Ericsson had assembly units in India but not any manufacturing facilities.
However, currently, they know that in order to survive in the Indian market, they must reduce prices. Local manufacturing enables these companies to indigenise certain components and offer goods at competitive prices.
Moreover, infrastructure sharing among leading operators is very important. This will lead to further lowering of operating costs and add to operators’ margins.
Earlier, companies had to set up their own infrastructure. However now, the government has allowed sharing of towers and infrastructure. This will be beneficial for operators and should translate into further growth of telecom stocks.
Prianka Singhal: The accelerating subscriber additions, month on month, are the major attraction. Besides, India is still far from saturation with the teledensity currently at around 17 per cent compared to countries like China, Sri Lanka and Pakistan, which are at around 30 per cent, and more developed ones like the UK, the US, South Africa which have above 70 per cent teledensity. Moreover, increasing competition coupled with cuts in regulatory charges is expected to result in a further decline in tariffs (already the lowest in the world). This will increase affordability.
On margins, we feel that despite increased competitive pressures, the EBITDA margins at 40-41 per cent levels are sustainable. The party seems to have just started for telecom companies.
What are the prospects for IPOs in the telecom sector?
Amit K. Ahire: As mentioned earlier, the telecom sector is expected to grow at a fast pace. However, the important thing to be noted is telecom is a scale business. Telecom operators with a pan-Indian presence and integrated operations such as national and international long distance networks will fare better compared to others. Therefore, small players with a presence in a few circles will always be at a disadvantage compared to others.
Nitin Gupta: Most of the big telecom service providers are already listed. The year saw Idea Cellular launch its IPO successfully, with the issue being oversubscribed 57 times. The stock is currently trading at Rs 114, which is a return of over 50 per cent on its IPO price. Given the level of institutional holdings in most of the telecom companies, one can expect that the prospects of IPOs in the telecom sector are favourable.
Other than operators, one can expect that some players in the telecommunications ancillaries/infrastructure space, including equipment manufacturers and content providers, may witness some IPO activity.
Romal Shetty: IPOs could emerge as the desired route of financing for telecom companies, particularly because this routing faces fewer regulatory roadblocks. Idea Cellular’s IPO, for example, has done very well in terms of returns. Some telecom IPOs will definitely do well because of the attraction of the fastgrowing telecom markets. However, the company must have a sound basis and solid plan of what its future is going to be. There are two IPOs coming up: Spice Telecom and Flag Telecom. Flag has huge expansion plans across the world. So, it will definitely attract fairly good valuation. Spice Telecom, on the other hand, is backed by Telekom Malaysia. Consequently, once these IPOs hit the market, they will probably generate a lot of investor interest and attract good valuation. However, this need not be the case with all telecom IPOs. It largely depends on the company itself.
Prianka Singhal: Bharti was the sole telecom company of its size and scale to be listed on the stock exchange for quite some time (five years). Reliance Communications got listed in March 2006 while Idea was listed in March 2007. Spice has filed a draft red herring prospectus and will launch its issue any time soon.
What is the desired financing route for telecom companies?
Amit K. Ahire: Government-owned companies such as BSNL and MTNL are debt free.Telecom is a capital-intensive business and in order to meet the growing subscriber base, players need to investheavily in increasing their network infrastructure. Long-term loans raised by the private companies included term loan from banks, external commercial borrowings (ECBs) and foreign commercial convertible bonds (FCCBs). Short-term loans included bank loans and vendor financing. Based on their financial position, the scale of operation and funding requirement, we expect players to decide on their funding pattern.
Nitin Gupta: The desired route of financing for telecom companies has historically been a combination of debt and private equity, particularly in the early stages of their growth cycle. Operators including Bharti, Tata Teleservices and Idea Cellular have at critical growth junctures raised funds through private equity. These three operators have then moved on to tap the public markets after reaching critical mass and a certain level of maturity in the business model. Operators are, however, now increasingly looking at other options including AIM listings and FCCB issues to raise funds.
Romal Shetty: IPOs could emerge as the desired route of financing for telecom companies, particularly because this routing faces fewer regulatory roadblocks. Foreign financing is always under the scrutiny of the government. The Hutchison-Vodafone transaction is a case in point. Many companies in which there is foreign investment will start exploring the IPO route due to fewer regulatory roadblocks. IPOs also make sense because the market is currently favouring the telecom sector.
For long-term sources of financings, companies typically utilise bank credits. On the other hand, for short-term sources of financing, companies can use internal accruals. Too much dependence on external sources is seldom affordable for companies.
Typically also, heavy investments of Rs 40 billion or so cannot be financed by external sources. In such cases, companies can go in for a rights issue or internal accruals.
Prianka Singhal: Vendor financing is one commonly followed route to finance capex. Lately, with the booming equity markets, IPOs and private placements have become an attractive option.
What has been the international experience with telecom stocks? Do you see a possible depreciation in the value of telecom stocks in the future, as has been the case in some saturated markets?
Nitin Gupta: Internationally, stocks that have been overvalued and/or valued on the basis of business models that were not too robust have seen significant erosion of value. The valuation multiples tend to decline as the businesses enter into more mature phases and the growth starts tapering. That should happen in India as well, as the high multiples currently reflect the high growth potential. However, it is too early to conclude whether one would witness any possible depreciation in the value of telecom stocks as the industry continues to offer new areas of growth driven by convergence, content, valu-added services, and emerging technologies such as 3G, Wi-Max, etc. Furthermore, Indian companies are expanding their geographical presence by bidding for licences and companies abroad.
Romal Shetty: In most European markets, mobile penetration has reached 90-100 per cent. Telecom stocks in the West have gone through the boom-and-bust cycle, especially during the dotcom era. However, currently, there has been some consolidation and stabilisation in these markets and things are picking up. Besides, some telecom stocks such as WorldCom fell because of scams. So, it is not likely that Indian telecom stocks will have a meltdown. However, some regular price checks will keep on occurring in terms of overall stock market valuation and foreign institutional investors (FIIs). FIIs have become critical in the Indian stock market. In India, the turning point of saturation will come when the telecom penetration ratio has reached 40 per cent. It will not reach 90 per cent as there is a segment of society that cannot afford telecom services. Even if they purchase a mobile phone they may just use the phone for incoming calls and may not contribute to a company’s revenues. Consequently, I don’t expect telecom stocks to fall in value for a couple of years. However, companies must be careful in terms of financial reporting. In the case of WorldCom, for instance, the company had capitalised all its expenses and opex. So the company displayed huge profits when it was actually under strain. Hence, strict financial reporting is very important. In India, auditing is far stricter in terms of the guidelines a company has to follow.
Every company has the scope to do some “creative accounting” but this is especially prominent in telecom companies because of the nature of their capex and opex investments.
Prianka Singhal: I have not looked at international telecom stocks in detail. However, as far as any slowdown in growth is concerned, it doesn’t seem likely for at least another two-three years. As stated before, with low teledensity, still falling tariffs and declining handset prices, there is no reason for worry. Hence, there is no depreciation in the fundamental value of telecom companies.
