India Broadband

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The personal computer has turned 25 years old this August. The PC has changed the way we live and think. It has now become more of a communication device than something that was expected to replace the calculator on a very grand scale. But at 25, if you are a PC, you will not be a happy PC.

The mobile phone, which is much younger than the PC, has achieved much more in the last five years that the PC was able to achieve in the last 25.

And the markets are responding. Companies like Reliance Communications (RCom) and Bharti Airtel Limited are enjoying higher valuations as compared to many other industries. Over the last one year, the share price of Bharti has gone up by almost 37.45% compared to 9.57% of MTNL. The share price of RCom, which started trading from March 2006, has given a negative return of 8.37%. During the same period, the Nifty has moved remained flat but on a yearly basis, it has moved up by 35%.

RCom and Bharti account for 42% of the total market share of the industry and it shows in their valuations. RCom enjoys a P/E multiple of 121 times, which is very high when compared to 36.76 for Bharti. This is the kind of valuation that the market has given to the retailing industry. Many feel that RCom is like a retailing stock and with convergence coming into the picture, the company will have to move like one in the retailing industry where return to the shareholders will be driven by high volumes.

The valuations are attractive for RCom. As of now, enterprise value per subscriber (EVPS) for RCom works out to Rs 15,561 against Rs 34,661 for Bharti.

“Considering EVPS, valuations are currently cheaper for RCom. It is a turnaround story. Moreover, RCom has a strong presence in B and C circles which are growing fast”, says Phani Shekhar, IT and telecom analyst at Angel Broking. “Besides this, RCom’s strategy of catering to masses than classes will help the company in strengthening its base in the B and C circles,” he adds.

On the OPM front, Bharti’s operating profit margins works out to 35% while for RCom the same works out to 21%. The difference exists because Bharti has the first mover advantage in the industry and has also broken even much ahead of RCom. Again, RCom operates on the Reliance group principle, namely ‘high volumes and lower margins’. This allows the company to grab a higher market share at a much faster rate.

What works for telecom?

Higher oil prices, rising interest rates, inflation are some of the worries that directly and indirectly dampen the outlook for most sectors of the economy.

The growth of sectors such as manufacturing, FMCG and automobiles will be largely determined by these factors. Though sectors like pharma and banking are considered as defensive answers, they lack higher growth rates.

The Indian telecom sector is one amongst the few, which has attributes to take leeway from hovering macro concerns and provide higher growth.

Says Surendra Singh, analyst at Anand Rathi Securities, “Typically, all other sectors have cyclical effect due to changing interest rates, oil prices, inflation and consumer demand. But sectors like IT or telecom show a linear growth rate and payoffs are better in the long run. Telecom is one sector which may outperform in the long run compared to many other sectors of the economy”.

During FY06 the NLD (National Long Distance) volumes have grown by more than 50%, whereas ILD (International Long Distance) grew by about 45%. The long distance volume is primarily driven by increasing mobile penetration, wider coverage and reduction in call prices. The Indian telecom sector is expected to grow at 30% over the next 5 years. However, analysts feel that the visibility of higher incomes is only in long the run.

With the mobile subscriber base of more than 100 million, India is the fifth largest country in mobile usage after China, US, Japan and Russia. As the government of India is contemplating this figure to touch 250 million by December 2007, the telecom companies are expected to grow at a higher growth rate. The rural teledensity of 1.86% and the entire country’s teledensity at about 13% is very low. The penetration in the villages and small towns will keep the party going in the long run.

The MTNL-BSNL merger

The MTNL-BSNL merger is still stalled on account of various issues. Post-merger, the new company will have about 90% of the fixed-line market and around 19% of the wireless market, with a total subscriber base of over 20 million users.

Says Sourabh Gupta, analyst, Pranav Securities, “The merger will definitely be considered positive for MTNL shareholders and give more leverage to MTNL and its subscribers.”

Currently, both these companies share networks and allow free roaming across networks. However, post-merger synergies will be created in terms of operational efficiency and existing asset base spread across the country. This will also have an impact on increased competition between the telecom companies.

Capex

Higher growth will mean increased expenses on capacity expansion plans. The telecom companies are expanding their reach and network to tap the higher market shares. Initially, most of the cash generated from the business will be used for financing higher capex required to fund the aggressive expansion plan. Bharti has a plan to invest about $13 billion over the next five years of which 70% of will be allocated towards expansion of domestic telecom business.

Bharti v/s RCom

According to Q4FY06 results, RCom’s wireless segment contributes 56% to its topline, while Bharti mobile services segment accounts for 71% of its total revenues. However, it is likely that Bharti’s growth in revenue for coming quarters would come from mobile services segment, while for RCom with its leverage on metro fibre optic network and large long distance it would come from the global segment.

RCom is quickly increasing its broadband presence. It is estimated that RCom’s revenues will grow at a CAGR of 18% till FY11 on the back of its growth in broadband and global segments as against 15% for Bharti. The number of buildings connected to RCom’s network has increased by three times over a period of around nine months to touch one lakh figure.

Though there’s a lot of talk about RCom switching over to GSM technology from CDMA, the capex required in CDMA to support more traffic is lower than that in GSM. This gives it an edge over the GSM players. Moreover, RCom offers cost efficient handsets that give the company an edge over other players in the market.

With almost same amount of subscriber base, Reliance has about half the market cap of Bharti. Which in simple words means, two companies in the same industry having equal number of customers and same amount of turnover are having different market cap.

Bharti has an annual sales turnover of Rs 11,228 crore, which is more or less same in the case of RCom estimated at about Rs 11,200-11,500 crore. The market cap to sales of Bharti is 6.59 times compared to 2.80 for RCom. Bharti’s average revenue per subscriber (ARPS) per month is about Rs 470 compared to Rs 412 of RCom.

If the ARPS of both the companies remains the same, it would take Bharti about 80 months to achieve the revenue equal to market cap per subscriber, compared to 33 months for Reliance.

Amongst the Asian peers, the Indian companies enjoy higher valuations. The estimated EV/EBDITA of Reliance and Bharti are about 8.3 and 9.2 respectively, which is higher compared to Asian average of 5.1 times. The average PEx FY07 of major Asian telecom companies is at 12.3 compared to P/E multiple of about 22x for Reliance and Bharti.

As the mobile takes the place of the PC, the Indian telephony market will witness one of the highest subscriber bases in the world. For the good old PC, this may be a distant dream.