Idea incurred huge capex primarily in acquiring spectrum with the assumption that data will drive growth. Then, Reliance Jio pulled the rug from under its feet
Idea Cellular Ltd’s December quarter results highlight the precarious position the firm is in. Its operating profit is no longer sufficient to cover depreciation charges and interest costs; cash profits aren’t enough to meet enhanced capital expenditure (capex) needs, and debt has gone out of whack.
In the past few years, Idea has incurred huge capex—primarily in acquiring spectrum—with the assumption that high growth in data services will generate adequate returns. Reliance Jio Infocomm Ltd has, as it were, pulled the rug from under its feet. A merger with Vodafone India Ltd can help fill portfolio gaps, besides providing succour to its stressed balance sheet, although Idea’s financial performance hardly puts it in a place to demand “equal rights" in the merged entity. According to analysts, Vodafone is better off because of a higher proportion of high-end subscribers.
The cut-throat competition in the market has resulted in year-on-year declines in both Idea’s voice and data revenue growth. Revenue fell by 3.8% year-on-year, vis-à-vis a 1.9% decline in the case of Vodafone. Earnings before interest, tax, depreciation and amortization (Ebitda) fell by as much as 5.5 percentage points compared to the September quarter. Net profit margin was in any case wafer thin in Q2, and it isn’t surprising that the company reported losses in Q3.
Idea doesn’t give details of cash flows, but cash profit (profit plus depreciation) of Rs1,230 crore was way short of the capex of Rs2,000 crore. It’s little wonder that the firm’s indebtedness has become unwieldy. It reported a net debt of Rs49,140 crore, which works out to 5.67 times annualized Ebitda. Analysts at JM Financial Institutional Securities Ltd point out that the effective net debt is Rs51,300 crore, including accrued interest.
According to an analyst at a multinational brokerage firm, the performance in the March quarter is likely to be far worse, considering that usage of Jio’s free services has picked up. Idea’s management said in a call with analysts that the pace of subscriber addition at the new entrant (Jio) was lower in January as compared to November and December. Still, with an increasing number of subscribers using free services, demand for paid services of competitors will naturally be on the wane.
True, things will be different when Jio starts charging for its services; although it may be barely better for companies such as Idea to start breathing easily. The big challenge in the current environment is that companies can’t afford to go slow on capex, even though profits are declining and balance sheets are already stretched.
In this backdrop, deleveraging through sales of assets such as towers is an imperative. Of course, that won’t be sufficient and it appears that a merger with Vodafone may be the best bet for the company. While there are a number of ifs and buts about the merger’s prospects (bit.ly/2kosoKt), it’ll be a pity if the proposed deal falls through because Idea’s dominant shareholders demanded their pound of flesh. After the Q3 results the writing is on the wall—Idea is much more vulnerable than Vodafone.