Although Spice Communications Ltd made an impressive debut on the stock markets this July, listing at a premium of over 30%, it had since underperformed the market consistently. By end-October, Spice had underperformed the Sensex by 40%, with its share price falling as much as 23% from the listing price of Rs 60.65.
But things have changed dramatically this month, with the stock gaining as much as 30% at a time when both the Sensex and the company’s larger peer, Bharti Airtel Ltd, have risen by just a little over 4%. Spice announced on Wednesday that it would sell 875 of its more than 5,000 telecom towers to a tower operating company. The company told business news channel CNBC-TV18 that it would earn a profit of Rs500 crore from the sale. It also announced that it had borrowing facilities worth $810 million (Rs3,191 crore) for its expansion plans. This would considerably ease the company’s funding requirements, especially given its plans to expand operations in its existing two circles.
The company’s pre-IPO (initial public offering) placement in June and then the IPO in August had bailed it out from a cash crunch. Prior to that, it had negative reserves which exceeded its entire equity capital of Rs552 crore. Besides, it had a high debt of more than Rs1,200 crore. After the IPO funding, its net worth improved to Rs1,184 crore and its debt reduced to Rs886 crore.
But Spice’s cash generation continues to be low, and with some of its old debt getting due for repayment, the access to additional funds through the borrowing facilities and the sale of the tower business couldn’t be more timely. The markets’ sudden enthusiasm for the company’s shares, therefore, is understandable. At current levels, however, the company gets a hefty valuation of over 23 times its trailing 12-months Ebitda (earnings before interest, tax, depreciation and amortization). In comparison, Bharti Airtel trades at about 20 times last 12-months’ Ebitda. This is unusual, considering that Spice operates in just two circles at present, and is still running losses after stripping off other income. In fact, Bharti’s net profit margin of over 25% last quarter was even higher than Spice’s Ebitda margin.
The markets seem to be betting on a dramatic increase in Spice’s profitability, on the back of its expansion and resultant benefits of scale, and from a reduction in its interest burden. That argument now rings truer after the unlocking of part of the company’s investment in telecom towers.
Mahindra and Mahindra Ltd (M&M) is a rare company with an exposure to two relatively undervalued sectors: automobiles and information technology, the latter through its subsidiary Tech Mahindra. That’s the reason why the stock is trading below its January 2007 level. Recently, however, M&M has benefited both from the rally in auto and tech stocks, with an additional benefit from the unlocking of value as a result of the imminent listing of its subsidiary Mahindra Holidays and Resorts. Yet another trigger has been Navistar International’s recent acquisition of General Motors’ medium-duty truck business, whose products will now be available to M&M, because of its joint venture with Navistar. All these factors have led to the stock gaining over 7% in the past week and over 16% in the last one month.
The company is already a leader in the utility vehicle segment. Non-Scorpio utility vehicle sales were up 29.8% in November, and the launch of the utility vehicle Ingenio is expected to boost the company’s volumes substantially in FY09.
It is also planning to introduce the Scorpio in the US and has appointed 200 dealers in that country. However, sales of Logan, which is manufactured by its joint venture with Renault, have not done well in November.
Volumes in M&M’s tractor segment too have been flat in November. However, tractor sales have been down in the dumps for quite some time and the news is already in the price. As a matter of fact, it’s very likely that the nadir has already been reached in this segment and higher agricultural production, combined with a probable turn in the interest rate cycle, will mean higher tractor sales in future.
But the auto business forms only about half of the company’s valuation. Recent sum-of-the-parts valuation exercises by broking firms put the fair value of the core auto business between Rs410 and Rs490 per share, and the subsidiaries—including its real estate, financial services, IT business and its stake in Punjab Tractors—between Rs350 and Rs480 per share. The stock’s target price ranges between Rs885 and Rs939, depending on the broking firm issuing the recommendation.
With such a high proportion of the company’s valuation dependent on its subsidiaries, the stock’s recent outperformance owes much to higher stock prices for its listed subsidiaries, including its financial services and real estate subsidiaries.
Tech Mahindra, which accounts for around half the total valuation of M&M’s subsidiaries, has moved up around 13% in the past month, but its performance has been hobbled by concerns about the restructuring going on in two of the company’s main clients—BT and AT&T—which account for three-quarters of the company’s revenues. But it’s the Mahindra Holidays IPO that should drive the stock in the near term.
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