Facts about Mumbai that necessitate its transformation into an IFC

Mumbai-ites are ingenious operators be it their incredible food distribution business of dabbawallahs or their travel via overloaded trains that carry more passengers with greater frequency and for longer hours than comparable mass transit systems in the rest of world.

Mumbai, renamed from Bombay under pressure from nationalists, was once the home of India's thriving textile industry. Today its most famous industry is Bollywood, which produces 200 films a year. Once a manufacturing city, Mumbai is now primarily a services-dominated economy, as factory jobs are vanishing to cheaper locations elsewhere in India.

What keeps the metropolis dynamic is money. Its two stock markets raise capital, fuelling India's super-charged growth (8% a year since 2000). And its financial sector adds to India's vibrancy.

Mumbai's banks process twice as many cheques as those in New Delhi. Some 14% of the national bank deposits are found in Mumbai. A staggering 80% of India's mutual funds are registered in Mumbai, and almost all transactions involving financial institutions, and over 90% of merchant banking transactions are structured in Mumbai. Its two stock exchanges account for 92% of India's stock market turnover.
Mumbai contributes 38% of India's taxes, and gets little in return to remove its infrastructure bottlenecks. Its contribution to the state and national exchequer amount to £4.6bn; state-funded capital expenditure in the city annually amounts to a mere £11.5m.

A megalopolis like Mumbai therefore cannot be ignored and an IFC between Singapore and Frankfurt is a must given the increased financial deepening in Asia and that place can be filled by Mumbai alone.

Spice Telecom IPO : unless an acquisition target, thou shall not benefit

Spice Communications

Small player trying to survive
Only takeover news can add spice to its poor track record and limited growth story

Promoted by Dilip Modi of the B K Modi group, Spice Communications provides cellular services in Punjab and Karnataka. Telekom Malaysia will hold a 39.2% equity stake post-issue compared with 40.8% of the Modi group. The company was the second largest cellular services provider in Punjab and the fifth largest cellular services provider in Karnataka, measured by the total number of subscribers with a combined market share of 14.49% in these two states (Punjab: 23.9% and Karnataka: 7.5%) end March 2007. The subscriber base was 3 million (2.05 million in Punjab and 0.95 million in Karnataka) with network coverage of 537 towns in Punjab, covering approximately 55% of the state population, and 229 towns in Karnataka, covering 33% of the state population end May 2007.

Spice Communications has pending applications for licences to provide cellular services in additional 21 circles throughout India. The company was recently awarded a national long distance (NLD) licence and international long distance (ILD) licence by the Department of Telecommunications and it intends to initially set up base infrastructure for a capacity of 30 million minutes per month across 15 locations in India.

The current initial public offering (IPO) is to raise Rs 464 crore at the lower band (Rs 41) and Rs 520 crore at the upper band (Rs 46). The net proceeds from the issue are to be used for part repayment of long-term debt, for payment of NLD and ILD licence fee, for meeting related capital expenditures to set up base infrastructure for NLD/ILD amounting to Rs 63.60 crore, for paying vendor(s) for network equipment and other capital expenditure amounting to Rs 177.63 crore, and for general corporate purpose and public issue expenses. Spice Communications has issued 2.49 crore of equity shares at a price of Rs 45 to certain investors pre-IPO and raised Rs 111.93 crore.

Strengths

• Has received NLD and ILD licences and proposes to offer data transmission services and voice transmission for calls originating and terminating on most of India’s and global telecom networks. It will be basically taking capacity on lease rather than setting up its own network. This will improve the operating profit margin.
• One of the objects of the issue is to repay part of debt, which is likely to reduce the interest burden.
• The Indian telecom industry is one of the fastest growing in the world adding nearly six million subscribers a month. The mobile subscribers base is estimated to increase to approx. 210 million by the year ending March 2008 (FY 2008), from the current level of 167.44 million subscribers end April 2007. Factors like falling handset costs, attractive tariffs and extensive reach have reduced the entry barriers for new subscribers and, thus, expanded the markets available to telecommunication service providers. The presence in the country’s richest state, Punjab, is likely to translate into volume growth.

Weaknesses

• In the absence of pan-India presence like other integrated operators, unable to provide seamless roaming services and is forced to share its revenue with other operators with whom it has roaming arrangement for its subscribers. Though licences in other circles have been sought, the current state of financials will hamper expansion in other circles in a major way in foreseeable future.
• Of the last five completed financial years, there were net losses in three years on account of low operating profit margin compared with the industry, high interest and depreciation. Losses have been incurred even in FY 2007. On account of continuous losses, the net worth has eroded. Accumulated losses stand at Rs 684 core (higher than the current issue size of around Rs 500 crore).
• Being a regional service provider, there is significant competition from larger integrated players with pan-India presence and greater financial, technical and marketing resources. In the past, key corporate clients were lost, particularly in Karnataka, primarily due to lack of coverage in certain geographic areas. Not been able to sustain its first mover advantage in both the states it operates.
• The Modi group’s track record is not encouraging.

Valuation

Spice Communication has made net losses in the six months ended December 2006 and year ended June 2006. However, it has been making profit at the cash level. The company will not be listed on NSE as it does not meet the financial track record prescribed by NSE for new listings.

At the price band of Rs 41 - Rs 46, the EV/EBITDA works out to 20.9 – 22.8, respectively. While Bharti Airtel, the largest integrated player in the sector with a pan-India presence in GSM (in all 23 circles), trades at EV/EBITDA of 21.5, and Reliance Communication, with CDMA presence in 21 out of 23 circles and GSM presence in eight circles constituting a pan-India presence in all the 23 circles, is trading at EV/EBITDA of 18.4. Idea Cellular, with operations in 11 circles, trades at EV/EBITDA of 22.6.

On the basis of FY 2007 consolidated revenue, the market capitalisation to sales works out to 8.5 for Bharti Airtel, 7.3 for Reliance Communication, 7 for Idea Cellular, and 3.4 for Tata Teleservices (Maharashtra). It is 3.7-4.1 for Spice Communications. The EV per wireless subscriber for Bharti Airtel, Reliance Communication and Idea Cellular is about Rs 41102, Rs 35382 and Rs 23434, respectively. For Spice Communication, it is Rs 13887 – Rs 15113. But one should also factor in that Spice Communications is operating in only two circles and has a low subscriber base/market share.

The blended average revenue per user (ARPU) of Spice Communication stood at about Rs 370 in the six months ended December 2006 against Rs 427 for Bharti Airtel, Rs 338 for Idea cellular and Rs 328 for Reliance Communication in the quarter ended December 2006. The industry average is only Rs.332. The minutes of usage (MOU) is also decent at 468 minutes per subscriber per month compared to the industry average of Rs.425 albeit its limited presence in two circles. The positive is that the MOU has increased from 385 to 468 in a span of two years.

Spice Communication is one of the suitable candidates for takeover. Earlier attempts have reportedly failed due to pricing issues. The company is not a growth story as it is neither capable of growing organically nor inorganically in a significant way. Ultimately, it will have to get itself taken over by a strong player. That’s the only thing that can add spice to its share price. There are strong rumours that Idea Cellular may acquire Spice Telecom as the former has no presence in Karnataka and Punjab and is looking at increasing the number of circles from its existing presence in 11 circles.

Allied digital IPO

Founded in 1995 by Amit Shah, a first-generation entrepreneur with 30 years experience in the Indian IT industry, Allied Digital Services (ADS) is a provider of IT infrastructure management and technical support services. Operating across a network of 92 locations in 25 states with a team of around 1250 employees countrywide, the company follows a direct approach.

ADS operates through six strategic business units (SBUs) spread across the services and solutions space. The solutions segment includes information technologies solutions (SBU-1) including IT infrastructure, storage solutions, information security and data security solutions, enterprise management solutions and telecom solutions. The second SBU comprises networking/communication Solutions. The third SBU provides integrated solutions to set up security & safety devices, asset tracking devices, intelligent building management system and energy management solutions. The fourth SBU’s services cover software solutions in the enterprise management system (EMS) and enterprise resource planning (ERP) for manufacturing; retail; banking, financial services and insurance (BFSI); and telecom.

In the services segment the fourth SBU provides information technology services including test and repair/service centre, technical BPO, incident-based support, annual maintenance contract (AMC), facilities management services, enterprise management services and infrastructure/professional services. SBU-6’s services include remote management services (RMS) including network operation centre (NOC) offering enterprise IT helpdesk, remote desktop management, and server and network management. The security operation centre (SOC) offers 24x7 information security surveillance services.

Solutions contributed 79% of the revenue and services 20% in the year ending March 2007 (FY 2007), Services contributed about 50% of the earning before interest, tax, depreciation and amortisation (EBITDA). The top client contributed 12%, top 5 clients 34% and top 10 clients 47% of the revenue. International business accounted for only 6% of the operating revenue.

The net proceeds of the present issue would be utilised for setting up a global service delivery centre comprising a 250-seater technical BPO, IT service delivery centre, remote management service centre, software solution unit, data centre and centre of excellence. Other uses of the funds would be for upgradation and expansion of existing infrastructure such as increasing the warehouse space, expanding geographically, and setting up the NOC/SOC business facility. ADS would also go for strategic acquisition. It has identified three companies: one an Oracle services provider in India addressing India, the US and the Middle East; a security services provider in India addressing India and the Middle East; and a technical BPO services provider in Canada addressing US and Canada.

Strengths

• ADS is collaborating with e-Cop to enter remote management services through the NOC/SOC initiative. This is still not a competitive segment as it is in the nascent stage. Its partnership with e-Cop, the leader in SOC with more than 90% market share in the Far East market, will be a big positive. The SOC facility would be operational by July 2007. There is possibility of transfer of work from e-Cop to the partnership due to competitiveness of Indian operations.
• Due to its direct-customer and neutral-vendor approach and national presence across 92 locations and 25 states, ADS enjoys a strategic advantage to capture the fast growing market opportunity.
• Through its acquisitions, ADS will expand clients and geographically, enabling it to cross-sell services and solutions.
• Currently, ADS has an order book of Rs 107.81 crore. Of this, Rs 54.70 crore is annuity revenue arising from services contracts and Rs 53.11 crore from the solutions business. These would be executed within 8-10 months.

Weaknesses

• ADS is operating in a highly competitive market. This could affect its cost advantages, and reduce its share of business from clients.
• Growth is dependent on manpower. The industry suffers from high attrition rate.

Valuation

From FY 2004-FY 2007, the operating income of ADS recorded a CAGR of 58.5% and net profit zoomed from Rs 32 lakh to Rs 22.93 crore due to focus on infrastructure management services, storage and security services.

At a price band of Rs 170-Rs190, FY 2007 EPS on post-issue equity works out Rs 13.3, and P/E 12.8-14.3. The Sector PE works out to 26. Definite listing gains on the anvil as the issue has already received a robust response with over subscription exceeding 60 times.