Stock Pick- Telecom

TELECOM STOCKS-->
From 220 million to 500 million
Sandeep Singh
Posted online: Monday , June 18, 2007 at 1407 IST
Updated: Wednesday, June 29, 2005 at 1257 hours IST

When an industry is ravaged by competition-forced price cuts, when it sees the entry of the world’s largest player, the last thing to expect is a surge in share prices of most other players. Yet, that’s what been happening to the listed telecom stocks in India, which have shrugged off a drop in roaming rates and ISD call charges, and the takeover of Hutch by Vodafone. The market’s vote of confidence comes primarily from one number: subscribers added.

The sectorThe landline segment might have gone cold, but the mobile segment continues its scorching mobilisation drive, adding about five million subscribers every month. That’s about 60 million subscribers a year. To put it in perspective, as of April 2007, the country had 212 million subscribers. In other words, if that pace sustains, the industry should double its subscriber base in about two-and-a-half years; the better ones, probably, even quicker.
Industry players say that it should be a walk up to 500 million, and is likely to be covered in the next three years. Says Mahesh Uppal, a telecom consultant: “There is enough scope for growth in urban and rural areas for the next three to four years, after which natural limits to growth will set in.” Adds Sachin Neema, head of research, India Infoline: “Subscriber additions will taper off, sooner than is being projected. Going forward, though, value-added services should provide a boost.”
The creamy layer of subscribers — the high-usage, cost-oblivious — has been captured, and now it’s down to penetrating the crust, which is more price-conscious. In general, each new subscriber from small towns like Bareilly or Bhatinda brings in a fraction of the revenues a new user in a metro brings in. As a result, while the addition to subscriber base is robust, the average contribution of each user, as represented by average revenue per user (ARPU), is falling. For GSM operators (Bharti Airtel, Hutch-Essar, BSNL, some of Reliance Communications), ARPU is down from Rs 366 in March 2006 to Rs 316 in December 2006; for CDMA operators (Tata Teleservices and most of Reliance), it’s down from Rs 256 to Rs 196 over the same period.
The companies don’t mind taking such knocks in this race for subscribers. All subscribers are valuable additions for phone companies as, in time and with higher incomes, most of them will only increase their phone usage. With that vision, companies are expanding their footprint and pumping in big money to build infrastructure like towers and networks. Some are doing it more efficiently — and with better results — than the others. And that’s where, valuations permitting, your money as an investor should go.
The companiesThe telecom services industry is basically six players: Bharti, Reliance, Hutch, BSNL, Tata Teleservices and Idea. All either have a pan-India presence or will have one in the foreseeable future. Of these, only three — Bharti, Reliance and Idea — are listed. The Tatas do have a listed entity, but it covers only Maharashtra and Goa, while MTNL, the other listed player, is struggling in its Delhi and Mumbai landline business and making only modest additions to it mobile business.
The stock to buy today is Bharti. It’s adding more subscribers than anyone else and is, therefore, even able to offset the high base effect. During the 13-month period between March 2006 and April 2007, the industry added 80 million subscribers, or a growth of 61 per cent. Bharti, Tata and Idea bettered that growth, but this has to been seen in the context of where they have grown from.
Idea led with 97.6 per cent, but it was on a small base (7.4 million to 14.6 million). Bharti, despite having the largest base of the four, grew the second fastest at 94.9 per cent, adding 19.9 million subscribers to go to 40.8 million. Reliance, by comparison, added 10 million, or 49.4 per cent, to increase to 30.3 million. Because of its success and Reliance’s relative lack of it during this period, the gap between Bharti and Reliance, which was closing in March 2006, opened up once again.
In terms of spread and infrastructure, Bharti and Reliance lead the pack. More subscribers means they are able to absorb their fixed cost better, and maintain margins. Where Bharti takes the edge over Reliance is in its subscriber profile, where it has benefited hugely by being one of two first-movers, the other being Hutch. Both companies have a higher percentage of post-paid subscribers, who use the phone more than pre-paid users. ARPUs of GSM operators are about 60 per cent higher than those for CDMA operators. Says Uppal: “The main reason for this gap is the affluent customer base GSM operators have because of their first-mover advantage.”
In 2006-07, Bharti had an operating margin of 40.1 per cent and a net margin of 22.7 per cent — the best in the industry. Reliance was a close second (38 per cent, 20.5 per cent). Idea is showing the after-effects of being in the business building stage — operating margin of 35.1 per cent, which gets whittled down at the net level to 9.9 per cent. Bharti and Reliance are also rolling out massive capital expansion plans, but their larger user base gives their business a touch of maturity. If they are able to add subscribers, as they should, they would be safer picks.
Recently, the Bharti management said it was targeting a 25 per cent market share and a subscriber base of 120 million — three times current levels - in three years time. Even with the pitched competition, it can get close to that, perhaps even manage it. That makes Bharti the telecom stock to buy, even at its current tall valuations. At a price of Rs 807, the Bharti stock is valued at a PE of 38.1, which is lower than Reliance (41.8) and Idea (105.5). Given the probable tripling of subscriber base in three years, and the stickiness of customers in this business, which gives a good margin of comfort in economic downturns, that’s still a good call to make.

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