Reduce rating on Idea Cellular: Spectrum buys will make Idea’s financials messier

IDEA has signed an agreement to purchase Videocon’s 1800MHz spectrum in Gujarat and Uttar Pradesh-West circles. These are 2x5MHz blocks each, and are conditional on approvals.

The purchase price is R33 bn, or ~$500m, which seems expensive. Videocon acquired this spectrum back in 2012 for roughly R13 bn. But more relevant is the recent March-2015 auction, and these prices are almost double the final auction price then. The implied price for 5MHz in Gujarat was R12 bn and UP-W was R5 bn. It is not clear why such a premium—perhaps it is due to spectrum contiguity.

The objective as per IDEA is to be able to launch 4G services and this spectrum is valid until 2032. These 2 circles account for 7-8% each, of its subs and revenues.

Strategically, one can’t disagree with this move. Spectrum shortage is a massive problem for everyone in India, and without this, 3G or 4G and even 2G is a challenge, especially as there is more regulatory scrutiny on quality of services too and the R-Jio launch is still ahead. This should see IDEA solidify some of its spectrum and market positioning.

But the problem is that the company financials become even messier in the near to medium term. And we don’t think this is the last time we will see spectrum purchases—this will be an ongoing process for Indian telcos. IDEA’s current net debt is around $6 bn, or 4x Ebitda, so that will rise. And this spectrum also falls under the deferred payment structure, so interest expenses and amortisation too will rise. So near term, there could be more EPS cuts (8-10%) we think.

We maintain Reduce on IDEA for concerns highlighted in the recent report. Again we don’t disagree with this move strategically and telcos unfortunately don’t have other (cheaper) alternatives, but the problem will be its stretched balance sheet which could be an issue in the event competition heats up ahead.

More elimination, than consolidation: Smaller operators have struggled in India in recent years anyway and have scaled back operations to select circles. So this doesn’t necessarily mean that competition becomes rational. In fact, when telcos are spending so much on spectrum etc, they will need more customers to justify this, or hope to see higher ARPUs, which hasn’t been easy either. As of now, IDEA has just 2.2MHz in Uttar Pradesh-West and 1.6MHz in Gujarat, and with this, it will be expanding its LTE spectrum footprint to twelve circles. See table for details.

4While the amount of consideration is ~R33 bn, we note the two parties are currently going through a due diligence exercise, which could lead to some fine-tuning.

4IDEA will take over Videocon’s deferred spectrum payments for these circles, amounting to R4.8 bn.

4The deal is subject to the DoT’s approval, and will be completed post the ongoing due diligence mentioned above.

4IDEA can start using this spectrum 45 days from “the date of joint intimation”, which could be sometime ahead.