When the board of Reliance Communications Ltd (RCom) decided on hiving off its tower business in November 2006, the entire company was valued at less than $18 billion (Rs79,600 crore). Now, the tower business itself contributes $12 billion (Rs47,280 crore) to RCom’s total value. Last year, the company sold 5% in the tower company at a valuation of $6.75 billion. Its majority stake, therefore, reflected a value of $6.4 billion.
On Monday, after the tower company filed for an initial public offering (IPO), RCom’s market value rose by another $3.9 billion. Post-IPO, Reliance will have a 85% stake in the company. Back-of-the-envelope calculations show that the markets expect Reliance Infratel Ltd, the tower company, to get a valuation of at least $12 billion.
Indeed, the markets may be willing to pay an even higher valuation. Recently, Bharti Infratel Ltd, the tower infrastructure subsidiary of Bharti Airtel Ltd, raised funds at an enterprise valuation of about $11 billion. Reliance Infratel aims to have a much wider network of towers. Besides, new entrants in the wireless space who have recently received spectrum are potential customers for tower infrastructure companies. When the tower business was demerged early last year, the possibility of a large number of tenants was not known. Further, the coming together of India’s three largest GSM operators to form Indus Towers signifies that the business of leasing towers would not be a fragmented one. As a result, the tower business may be one that enjoys some pricing power and hence reasonable return ratios.
But that is not a given. With the onset of new competition, the profitability of Indian telecom companies is expected to fall. They are already facing the pressure of falling realizations and minutes of use due to higher sales in rural areas and among low-income users.
The pressure on tariffs and profitability could get accentuated once number portability is introduced. In such a scenario, wireless operators may not be liberal with vendors, including tower companies. This was one of the reasons Kotak Securities had assigned an enterprise value of $4.4 billion for Reliance’s tower business about two months ago. Current prices leave no room for such concerns.
Bhel’s execution risk
It’s not enough to have an order book bulging at the seams; much also depends on the speed of execution. That’s the message brought out by the Bharat Heavy Electricals Ltd (Bhel) results for the quarter ended December. Both sales and net profits have been well below expectations. Net sales have increased by just 14% over the year-ago period, while operating profit rose a mere 7.7%. Higher other income saved the quarter, propping up net profit, which grew 16% year-on-year. But that’s not the kind of growth you want from a stock that trades at 24 times fiscal year 2009 estimated earnings.
Bhel’s market leadership, government ownership and technical ability make it one of the frontline companies that have benefited from the boom in the power sector. The question is: Do the third quarter results cast some doubts about its future performance or is it a one-time hit? That’s a question the power ministry, too, has repeatedly raised as it has blamed Bhel for the delay in setting up power projects in the country.
Edelweiss Research points out that margins in the company’s power segment, which accounts for three quarters of total revenues, fell by 340 basis points, which “can be attributed to slower execution of projects, thereby resulting in lower profit booking.”
The other reason for the pressure on margins has been higher wage costs. These increased by 46% over the year-ago period. Getting quality staff has become difficult in the manufacturing sector—companies such as Larsen and Toubro Ltd, for example, have made no secret about this. Part of the increase in wage costs, however, is due to provisions made for a wage hike.
Order intake continues to be strong, with new orders of Rs10,900 crore in the December quarter, and an order backlog of Rs78,000 crore, or more than three years’ projected revenues. But the quarterly execution rate, or the sales in a quarter compared to the backlog at the end of the previous quarter, has been falling.
Nevertheless, analysts believe the doubts over Bhel’s ability to supply supercritical boilers are overdone and they point out that the company is also expanding capacity. But the December quarter results have highlighted the issue of execution risk.
Despite several order wins in recent times, including its emergence as the sole bidder for the turbine and generator package as well as the boiler for NTPC Ltd’s Barh-2 project, the Bhel stock has taken a battering in recent times and is down 30% from its 52-week high.
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