Comeback Call :revival of Indian Telecom Companies

The tide has once again turned in favour of telecom companies, reeling under the impact of intense competition and rockbottom tariffs. Most frontline operators have raised tariffs in the past few weeks which should gradually help stabilise their existing 2G operations. Besides, the lure of 3G services is strong given the rapidly rising sales of smart phones and tablets. Ranjit Shinde & Parul Bhatnagar spot the companies which are better positioned to benefit from the renewed momentum

    It will hardly be a surprise for those who invested in the telecom growth story two years ago and stayed invested thereafter to feel a sense of deja vu. For, after losing market value for the past two years in the wake of stiff competition and pressure on profitability, telecom companies are once again back on the radar of investors. 
ET Intelligence Group takes a closer look at the changing revenue pattern of the sector and factors that would impact these changes to identify the companies which are well placed to take advantage of the change in fortunes. 
This time around, what has caught investors' fancy is the spate of tariff hikes undertaken by telecom operators in the past few weeks. Observers consider this as a sign of an end to the long drawn tariff war among new and existing telecom players. In addition, a slew of products and services, including smart phones, tablet computers, mapping and location finding solutions, and e-book readers, are expected to increase the need for connectivity considering their growing popularity. These factors also indicate that the extensive dependence of Indian telecom operators on voice and basic text messaging as a source of revenue when compared with their overseas counterparts is likely to reduce in favour of data-driven services. And since such services are value driven, they tend to offer better margins compared to pure voice-based services. 
This brings us closer to a more optimistic scenario in future compared to the sluggish performance of operators in the past. Over the pst two years, frontline telecom players, including Bharti Airtel, Reliance Communications and Idea Cellular, reported falling profits due to intense competition among existing players and new incumbents. Average revenue per user (ARPU) per month fell by 10-15% during the period; each minute on the network also became cheaper by similar magnitude. 
This impacted the growth in operating profit. For instance, Bharti's domestic revenue increased at a CAGR of 8% during the three years ended June 2011. In contrast, its earnings before interest, depreciation, amortisation and taxes (EBDITA) rose by just 1%. This also took a toll on the stock market performance of telecom players. Between FY08 and FY11, Bharti and Idea lost 13% and 18% of their market capitalization, respectively, while for RCOM, the fall was steeper at 79%. 
Against this backdrop, the recent announcements by most operators to increase their tariff rates across circles have stoked hopes of a revival in the sector. For investors, it spells an end to the era of cut-throat competition though the exact benefit of higher tariffs will take time to reflect in the financials of companies. 
While the existing 2G services are showing signs of stabilising, the newly-launched 3G services are expected to spread rapidly given the fast rising usage of smart phones and other gadgets. This may help valuations of telecom operators rise once again after a two-year lull. A stand-out indicator that valuations may surge again is the recent decision of Piramal Healthcare to invest in the country's second-largest operator by revenue, Vodafone India. Piramal spent $640 million (approximately Rs 2,840 crores) for buying a 5.5% stake in Vodafone. This values the Indian operations of the British telecom giant at $11.6 billion (over Rs 51,800 crore). In addition, Piramal expects a compounded annual return of 17-20% on its investment in the next two years. This values Vodafone India at over $16 billion or very close to what the British parent paid to Hutchison Essar in 2007. 
Though the sector is once again on the cusp of a turnaround, the trend may not be secular at least initially with a select few participants likely to benefit the most. To help readers identify the right companies to bet their investment on, we have done a detailed analysis of listed telecom players with a focus on what to expect from each one of them.…

THE country's largest telecom player by revenue and subscribers appears to be the best bet in the sector. A formidable market share in metros, wider reach in remote areas and a footprint overseas are the major strengths of the company. 
Thanks to its leadership position, Bharti enjoys a unique command over the market. No wonder then that the company was the first among its peers to raise tariffs for its pre-paid customers, brining an end to the two-year long sluggish trend in mobile call rates and prompting others to follow suit. 
Bharti was also the first to adopt a total outsourcing solution and identify new markets for its services overseas. These measures have helped the company grow business without compromising on profitability. Today, the company enjoys one of the best operating margins in the business. 
With its high penetration and over 90% of active user base, Bharti is expected to take advantage of its recent tariff hikes and the launch of 3G services. Also, its African operations have gained momentum. In the next four-six quarters, investors may be in a position to see the benefits of Bharti's past investments.

A PAN-INDIA expansion over the past two years through both the organic and inorganic route has helped Idea Cellular grow its revenue share at the fastest pace among the top five domestic telecom players. The company has a share of over 12% in total sector revenue at the end of the June 2011 quarter, a 170 basis point jump in two years, according to data released by the Telecom Regulatory Authority of India (TRAI). 
A sharp focus on improving reach and efforts to build a strong brand are keys to Idea's success. The company also boasts of over 92% active users relative to total reported subscriber base. 
While the company has maintained a higher momentum in its topline, profits have been hit due to losses from operations in the nine new circles. What has worsened the scenario is soaring interest costs for servicing the loan taken for 3G licences and launching the service. The company has started launching 3G services across various circles. A higher active user base should help the company penetrate existing customer accounts further. This is expected to stave off the burden of higher interest outgo.

THE state-run telecom operator seems to have lost out to the private sector players in the past few years. MTNL has been unable to report profits in the past six quarters. Its subscriber base rose at a tepid rate of over 6% in the last one year in comparison with a strong double digit growth between 22% and 36% reported by its larger private sector players. 
A proposed merger between BSNL and MTNL may offer benefits of synergies but it is not certain when such integration will take place. The stock does not hold much promise in the medium term in the backdrop of a firm hold of bigger private sector players.

RECENT reports that the Central Bureau of Investigation (CBI) has stated that there was no evidence of the alleged involvement of three executives of Reliance Communications (RCOM) boosted its stock which otherwise had been battered. However, it is too early to conclude since the public prosecutor has hinted at evidence relating to charges of corruption against the executives. The imbroglio is expected to impact its stock performance. 
Apart from legal tangles, RCOM also faces challenges on the operational front. Unlike its peers, including Bharti Airtel and Idea Cellular that reported a double-digit growth in revenue, RCOM's revenue dropped by nearly 5% between FY09 and FY11. Its net profit fell in each of the last eight quarters given competition and higher interest outgo due to a higher debt burden. 
A gross debt of Rs 33,158 crore as of June 2011 calls for steps to restructure debt. The company has tied up with Chinese banks for funding to reduce its debt, but investors will have to wait for a few more quarters to see a significant reduction in loans. Given these factors, investment in RCOM could be highly risky at the moment, despite its lower valuations.

THE Tata Group company has so far been unable to report a net profit despite a gradual improvement in its share of total sector revenue over the past two years. The company is also struggling at the operating level with expenses shooting past its revenue. In the June 2011 quarter, it posted a loss at the operating level. 
In the past few months, the company's growth in the share of total wireless subscribers has remained sluggish due to competition from some of the new operators. According to TRAI data, its subscriber share has fallen by over 80 basis points to 10.3% in June 2011 from the year ago. Considering this, a turnaround in its operations is not expected any time soon.

MUMBAI-BASED Tulip Telecom is an enterprise data connectivity service provider. The company has grown considerably over the past several years gaining a market share of over 30% in the VPN segment. 
On the financial front, Tulip has posted a compounded annual growth rate of 35% in its topline and over 40% in its bottomline over the past five years. It has posted double-digit revenue growth consistently over the past several years and expects to clock a revenue growth of 20-24% yearon-year in FY12 on the back of growing wireless connectivity and increasing business momentum from its fibre rollout. The government vertical, which currently forms a small part of the company's overall revenues, is also expected to be a key growth driver. 
Moreover, the upcoming data centre in Bangalore is expected to add Rs 1,000 crore of annual revenue in the next three years. For FY11, Tulip has reported an operating profit margin of 28.2%, substantially higher than the level prevailing during FY06-09. On the back of higher realisation on the fiber network, the company is expected to post similar growth momentum, going ahead. Among these positives, however, increasing debt on the books with debt-to-equity ratio of 1.53 remains a key concern for the stock. However, a probable stake sale in data centre and an anticipated divestment of Qualcomm investment could ease the debt on the books.

THE Bangalore-based company is a telecom products manufacturer. Its product kitty includes radio frequency products (RF) and antennas. The company has grown substantially over the past five years with topline and bottomline improving at a CAGR of more than 50%. 
The company's subsidiary, Kavveri Telecom Infrastructure, offers in-building coverage solutions to cellular operators on lease rentals. Given the high debt burden on the books of the telecom operators and their willingness to reduce operational expense, Kavveri expects to gain from its contract manufacturing business. 
Inline with its inorganic growth strategy, the company plans to make acquisitions in Europe. It is keen to expand business in Europe, Africa and Latin America. Currently, exports form just over 20% of its total revenues. 
Given the backdrop of increasing demand for contract-based business and growing technological need across verticals, the company is expected to fare well in the coming quarters.