Idea Cellular

Deven Choksey, KR Choksey


Idea Cellular : Reco Price Rs. 125.35

On EV/EBIDTA basis, Idea is trading at 21.5x which is at a discount to
TTML and a premium to RCom and Bharti. We believe Idea looks attractive
considering its entry into new circles and improvement of margins in the
existing ones.

Idea Cellular is a part of the US $ 24 billion Aditya Birla Group and a
leading GSM mobile services operator with licenses to operate in 13 telecom
service areas in India. The company has operations in Delhi, Himachal Pradesh,
Rajasthan, Haryana, Uttar Pradesh (W) & Uttaranchal, Uttar Pradesh (E), Madhya
Pradesh & Chattisgarh, Gujarat, Maharashtra & Goa, Andhra Pradesh and Kerala.
With the planned expansion into Mumbai, Bihar & Jharkhand.

Idea's footprint will cover nearly 70% of India's telephony potential. Idea
Cellular had 16.13 Million subscribers as on June 30, 2007, and had a market
share of 15.4% as on June 30, 2007 in its 11 service areas of operation. We
think Idea looks impressive due to the following reasons:-

Higher subscriber addition

We expect that the company will see a robust growth in its subscriber base in
the coming months in both new as well as existing circles. Moreover it is
expected to be allotted spectrum in Mumbai in the coming months.

Improvement in EBITDA margins

The EBITDA margins are expected to improve both in the existing and the new
circles. As more and more subscribers will be added and company will enter into
new circles, revenue flow will also be higher.

Hiving off tower business

Following the footsteps of Bharti and RCom, Idea Cellular has also decided to
hive off its tower business into an independent subsidiary. The Board of
Directors (BoD) has approved the demerger plan. So value unlocking is on the
cards.

Key Developments

Hiving off tower business

The Board of Directors of the company has approved the demerger of its tower
business into an independent subsidiary for possible transfer of passive
infrastructure which would lead to substantial value unlocking going forward.

Financial Performance

In Q1 FY08, Idea Cellular’s net profit grew by 259% to Rs 308.5 crore and
revenues were at Rs 1477.2 crore showing an increase of 64% on year on year
basis. This growth was mainly on account of robust subscriber addition. EBITDA
margins stood at 34.7% which also improved on a year on year basis from 33.7%
which was largely on account of improvement in network and marketing expenses.

Industry Scenario

While India is now the world’s fastest growing telecom market, our tele-density
continues to be lowest at about 20%, taking into account both wireline and
wireless phones. It is clear that India has a long way to go before we catch up
with the rest of the world or even with other emerging markets. It is expected
that telephony will continue to grow at the present rate of 6 to 7 million
additions per month over the next several years to reach the 500-million
connections mark by the year 2010.

Further growth in the subscribers is likely to come from circle 'c'. Telecom
companies have geared up to achieve the target growth in the subscriber numbers
and are expected do a capex of Rs 60000 crore in the coming years. Few major
developments that are likely to happen in the sector are:-

• Consolidation and M&A in the sector

• Listing of tower subsidiaries

• Launch of 3G services,IPTV,DTH and WIMAX

• Mobile number portability

• "Do-Not-Call Registry"

• Entry of global players

Spectrum Crunch: - Besides, almost each telecom company is facing acute shortage
of spectrum which is the indispensable resource for this sector. This problem of
spectrum crunch might hinder the growth targets of the companies and also cause
deterioration in the quality of service (QoS). Spectrum is yet to be vacated by
the defence ministry.

Though the government is keen to carry out the bidding for the additional
spectrum, COAI (association of GSM operators) has strongly opposed it and taken
the stand that the current policy is based on subscriber base is very clear.
They have even hinted to file legal proceedings against the govt. However, AUSPI
(association of CDMA operators) have opposed the current policy and is of the
opinion that GSM players have already been allotted the extra spectrum.
Department of Telecom (DoT) has formed a committee to look at this issue and
come out with a report. Seeing the deficiency of spectrum a study regarding the
efficient utilization of this

scarce resource will also be conducted.

Tower business hive off

These days almost every telecom operator is hiving off its tower business into
an independent subsidiary. Seeing the growth in the subscriber base passive
sharing of the infrastructure is a viable option especially when the growth has
to come from circle “C” where ARPU is comparatively lower. Total tower
requirement is estimated to be at 330000 towers by FY10. Such a model has
enormous potential to succeed in India because there are 7-8 operators in India
as compared to Europe and China where there are only 2-3 operators. Moreover it
is better for an operator to start tower business because their payback period
is comparatively lower.

The company has planned to hive off its tower business for possible transfer
of passive infrastructure. It would result in significant value unlocking. The
company had 13,160 cell sites as of Q1FY08 compared to 10,114 cell sites at the
end of Q4FY07. Around 4500 towers are on sharing basis. Out of 8.662 towers
about 4,900 are roof top towers and 3,700 are ground based. They have a tenancy
ratio 0f 1.3x. Company is expected to increase its cell sites to 20000 by FY08.

Aggressive method of recognizing revenue

Idea recognizes entire processing charge from Lifetime prepaid schemes as
revenue upfront, while RCom and Bharti amortize the same over 48 months and 24
months, respectively. Thus, Idea’s ARPU, revenues and margins, to that extent
are inflated. In Q1FY08 more than 30% of net additions were from new lifetime
prepaid scheme. We believe that the policy of booking entire processing fee as
revenues upfront would have contributed almost Rs6 to ARPU.

EBITDA margins increase by 100bps to 34.7%.

EBITDA grew by 69% Y-o-Y. The EBITDA margins in its ‘established’ circles
including Delhi, Maharashtra, Gujarat, Andhra Pradesh, Madhya Pradesh, Haryana,
Kerala and Uttar Pradesh (W) expanded by 40bps Q-o-Q to 38 percent. Losses in 3
new circles have come down to Rs 24.6 crore (-40% of revenues) from Rs 330 m
(-76% of revenues) in last quarter. Company saw reduction in network and
marketing expenses as percentage of sales by

160 bps. However access charges increased slightly. PAT increased 259% Y-o-Y due
to margin expansion, lower depreciation and interest expense.

At CMP, Idea is quoting at P/E multiple of 44.8x based on TTM basis June 07. EV/Subscriber
and EV/EBIDTA for Idea is Rs22630 and 21.5x respectively on TTM basis June 07.

Risks: The risks that could hinder the earnings growth of Idea in time to
come are as under:

- Inadequacy of spectrum required for future subscriber additions may hamper the
growth process of the company and may even deteriorate the quality of service

- Competitive structure of the industry poses further threat to the company’s
vision and it may even hit the operating margins substantially in order to carve
a niche in the market.

- Telecom is a highly regulated sector and as such needs many approvals for
undertaking a new project. Moreover there is generally a lot of pressure from
NGO’s in case of a minor increase in fares. Such oppositions and delay in
projects may also cause harm.

- Mobile number portability, if allowed might increase the churn rates.

- If the company enters new circles, incremental revenues will be less than
the expenditure done by the company because marketing and license fees will have
to be incurred.

Growth: The growth for the company in the coming years is likely to be fueled
by the following factors:

- Further penetration into the Indian markets would lead to huge subscriber
additions per month.

- Entry into the new circles subject to allotment of spectrum will fuel the
growth prospects.

- Inorganic growth may be an option to consolidate its position in the
Industry.

- Issue of NLD and ILD licenses to Idea will boost the revenues.

Idea is currently trading at P/E multiple of 44.8x on TTM basis June 07 which
is at premium to RCom but at discount to Bharti. On EV/EBIDTA basis, Idea is
trading at 21.5x which is at a discount to TTML and a premium to RCom and Bharti.
We believe Idea looks attractive considering its entry into new circles and
improvement of margins in the existing ones. However if it enters new circles
its expenditures would spiral up and will have to face tough competitions from
its arch rivals Bharti and Rcom. Hence long term investors can buy the stock.

Disclaimer: As per SEBI requirements it is stated that,Kisan
Ratilal Choksey Shares & Sec Pvt Ltd., and/or individuals thereof may have
positions in securities referred herein and may make purchases or sale thereof
while this report is in circulation.