BackIs irrational exuberance driving Idea Cellular shares?
As investors rush to buy Idea's shares, question arises whether it can overcome the odds to extract significantly higher value from its new spectrum
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Idea Cellular Ltd’s market capitalization has risen by ₹ 15,500 crore ($2.5 billion) since the beginning of the spectrum auctions in early March. But that’s not all. The company’s final bid amount of ₹ 30,100 crore was about 40-50% higher than what most analysts had estimated. As a result, incremental debt vis-a-vis Street estimates has also ended being higher by over ₹ 9,000 crore ($1.5 billion).
All put together, Idea Cellular’s enterprise valuation has risen by as much as $4 billion in the past month. What started off as a relief rally—the relief being that the event risk of the spectrum auctions was coming to an end—has clearly gone too far.
About four-fifths of the spectrum purchased by Idea Cellular is estimated to be for renewals, or in other words, for maintaining service at pre-auction levels. According to an analyst with a multinational brokerage firm, since most of the auction purchased will be used to maintain operations at current levels, there’s hardly any case for a sharp re-rating. Besides, the massive (3.6 times) jump in Idea Cellular’s net debt means that it will have little leeway to spend in new areas such as 4G, or to strengthen data services by investing in its network. This will naturally hurt its growth prospects vis-a-vis competitors.
Nomura’s Asia (ex-Japan) telecom analysts wrote in a note to clients, “We struggle to understand the new potential now versus a few months back." One view on the Street is that the spectrum purchases, although expensive, have helped incumbents such as Bharti Airtel Ltd and Idea to further consolidate their positions. And that eventually, this will be reflected in higher tariffs and hence higher-than-earlier-expected profits. Nomura’s analysts, however, point out that despite reduced competition, average tariffs have declined by 3% in the first nine months of the current fiscal year. “The price increase rhetoric has been around for a while we note, but implementation hasn’t been straight-forward", they say.
What’s more, in the excitement about getting past one event risk, investors seem to be ignoring the other major risk for the sector—the entry of Reliance Jio Infocomm Ltd. While the company’s launch of 4G services is delayed considerably, analysts believe its eventual entry will be disruptive and can hurt data revenue estimates of incumbents.
After Idea Cellular starts amortizing the new spectrum and starts accounting for interest expenses—the full impact of which will be visible in fiscal year 2016-17—net profit is expected to take a sharp hit. Nomura’s analysts expect net profit to fall by 35% in FY17 vis-a-vis FY15 levels, despite an estimated 30% increase in operating profit during the same period. Lower earnings and a bigger balance sheet size essentially mean lower return ratios—hardly a case for increased investments.
Still, investors have rushed to buy Idea Cellular’s shares. This raises the $4 billion question whether Idea Cellular can overcome each of these odds to extract significantly higher value from its new spectrum.
The writer doesn’t own shares in the above-mentioned companies.
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