Financial Statement Analysis

!dea CellularAn !dea can change your life

Abhimanyu Naik

Telecom IndustryOne of the fastest growing sectors in IndiaIndia reached the target of having 300 million

telephone subscribers, becoming the second largest telecommunications network in the world after China

India is adding around 8.5 million to 10 million new mobile subscribers to the network each month, emerging as one of the fastest growing telecom markets in the world.

Growth Drivers

Mobile Telecom IndustryUrban India enjoys a whopping 57% mobile

phone penetrationRural India has an abysmal 6.4% penetration Highly competitive market with lowest tariffs

and very high minutes of usage per subscriber even, when compared with most developed markets

Mobile Telecom Industry (Cont.)

The Indian wireless subscriber base has grown by 37 times in the last six years, implying a CAGR of 82%.

The staggering growth rate has been achieved on the back of aggressive network coverage by the leading operators and innovative tariff plans.

The key drivers for the industry are: falling equipment costs, leading to lower capex/subscriber, network coverage, falling handset prices which lowered entry barriers for subscribers falling tariffs.

A number of new players are entering the market and more private operators are becoming pan-India players

Margins will continue to remain under pressure The industry will enter a consolidation phase in the next 12

to 18 months

Idea CellularOne of India's leading GSM mobile service

operatorsStarted as a Joint Venture between the Tatas,

Aditya Birla Group and AT&TIDEA has licenses to operate in 13 circles

comprising states of Mumbai, Delhi, UP, Uttaranchal, Haryana, Rajasthan, Madhya Pradesh, Chattisgarh, Gujarat, Maharashtra (excluding Mumbai), Goa, Andhra Pradesh, Bihar and Kerala

IDEA's footprint covers approximately 70 per cent of the national market for mobile telephony

Idea Cellular had 24 Million subscribers as on March 31, 2008, and had a market share of 9.4% in 2007-08

Idea Cellular Services

Business StrategyIdea Cellular generally focuses on the student

community by offering freebies along with its services. In contrast, its major competitor Bharti Airtel focuses on introducing new services to offer to its customers.

Idea Cellular has been consistently gaining market share on account of its excellent execution skills and improving network coverage in the operational circles.

Idea Cellular has also enhanced its brand imagery by a wider positioning. Earlier, Idea was primarily viewed as a youth brand. The current celebrity endorsements have targeted a much wider base with special emphasis on the rural subscribers.

Competition

Accounting Policies Explained

Revenue RecognitionMobile Telephony Services and Sale of Handsets:

recognized net of rebates, discount, service tax, etc. on rendering of services and supply of goods respectively

Life Time Prepaid Connection: Violation of Matching Principle

Recharge Fees: recognized as revenue as and when the recharge voucher is activated by the subscriber.

Conservative Approach

Unbilled Receivables: Revenues recognized from the bill cycle date to the end of each month. Billed in subsequent periods as per the terms of the billing plans.

Ratio Analysis

ProfitabilityGPM has come down but NPM has

increased by 35%. NPM of Idea 11.44% to 15.50%

Depreciation & AmortizationCharged on a straight line basis on all

fixed assets as per the life of the assetThe network equipments and other

infrastructure costs are depreciated over 10-13 years, their estimated life

The current 2G technology would become obsolete in a few years due to the evolution of the 3G technology

Current depreciation is less than ideal and as such results in an increase in net profit (EBIT) and reporting inflated earnings

IntangiblesLicense Fees paid earlier in order to obtain the

spectrum, prior to the revenue sharing model. The license fees needs to be amortized and is done on a straight line basis over the period of the license.

Software, which is not an integral part of hardware, is treated as intangible asset and is amortized over its useful economic lives as estimated by the management between 3 to 5 years.

Bandwidth/Fibre taken on Indefeasible Right of Use (IRU) is amortized over the agreement period.

Customers DefaultCustomers who default for more than 3 months are

considered doubtful. Provisioning made for the same.

Provision for Interconnect Usage Charges (IUC) is made for dues outstanding for more than 180 days.

Debt Equity Ratio

IDEA Airtel Reliance Industry

2008 2007 2008 2007 2008 2007 2008 2007

Total Debt-Equity Ratio 1.32 0.92 0.38 0.54 0.77 0.41 0.35 0.21

Interest Coverage 3.04 2.47 12.47 15.81 3.99 6.30 4.52 7.04

Asset Utilization, ROE Improved utilization of assets in achieving higher

profitsEarning Power up from 9.5% to 13% indicating more

efficient operational business performance

Liquidity Analysis

In 2007 : Current Ratio = 1.15 In 2008: Current Ratio = 0.60

Quick Ratio has gone down from 1.14 to 0.59

Idea Cellular

2008 2007

Current Ratio 0.60 1.15

Quick Ratio 0.59 1.14

Working Capital

ParticularsMarch 31st, 2008

March 31st, 2007 Particulars

March 31st, 2008

March 31st, 2007

Current Liabilities     Current Assets    Sundry Creditors 16854.57 16108.74 Inventories 276.15 179.1Book Bank Overdraft 2255.71 665.03 Sundry Debtors 1985.93 1524.77

Advances from customers4054.32 2565.34

Cash and Bank Balances4970.55 18197.28

Deposits from customers557.44 570.08

Other Current Assets520.66 757.4

Other liabilities1621.88 1054.58

Loans and Advances7986.73 4040.57

Interest accrued but not due92.71 17.61

Total15740 24699.1

Total 25436.63 20963.8

Telecom industry firms invest heavily in fixed assets for the long term and have little or no inventory

Idea cellular shows that it has a negative working capital

This may be alarming in most companies but not in service intensive companies.

Working Capital (Cont.)Working capital has shifted from Rs 3735.3

million to Rs -9696.61Utilization of excess cash in 2007 (largely

from the IPO) to the license fee paid in Jan 2008 for obtaining license of ten circle licenses.

The Increase in sundry creditors due to increased capital expenditure incurred as part of pre operating cost.

Increase in Investments from Rs 138.31 million to Rs 5699.31 million

Strategy: To increase returns of the firm by not maintaining large amounts of idle cash.

DuPont Analysis

ROE up from 10.84 in FY 2007 to 21.8 in FY 2008

IDEA Airtel Reliance

2008 2007 2008 2007 2008 2007

PBIDT/Sales(%) 33.7 33.8 41.72 40.70 35.95 36.95

Sales/Net Assets 0.53 0.51 0.96 1.07 0.33 0.36

PBDIT/Net Assets 0.18 0.17 0.40 0.43 0.12 0.13

PAT/PBIDT(%) 0.46 0.34 58.10 55.51 48.64 51.11

Net Assets/Net Worth 2.57 1.85 1.33 1.47 1.82 1.71

ROE(%) 21.09% 10.84% 39.53% 43.04% 11.40% 10.92%

ARPU, Tariffs, Demand Density

Metros and next big cities reaching saturation limits

Idea has obtained UAL in many circles to become pan-India operator

Will have difficulty in garnering Market share in major cities

Rural India and SEC B&C cities offer great opportunities

But ARPU will be low in smaller towns/villages due to demographics

Add to it TRAI regulations on tariffs and fierce competition

Hence ARPU for Idea will lower further and hence needs to watch out

Cash Flow Analysis

Net Cash from Operating ActivitiesIncreased significantly in the last 3 yearsDoubled in the year ending March 31, 2007

over the previous year due to launching of commercial mobile services in Rajasthan, UP (East) and Himachal Pradesh

Growth of approximately 57% in Cash from Operations during the year 2007-2008.

The constantly increasing cash flows from operations demonstrate the growing levels of operational efficiency that the company has achieved in the last three years.

Net Cash from Investing ActivitiesGrew 10 times in the year ending March 31, 2007

over the previous yearThe company entered into ten years pact with

IBM to integrate its IT infrastructure and signed a $500mn contract with Nokia to expand its network. The company also signed a $343mn contract for GSM expansion with Ericsson.

 In the year ending March 31, 2008, it became 2.6 times the previous year.

The company invested heavily in the formation of Indus Towers, a joint venture with Bharti and Vodafone to provide infrastructure services to all operators. The company holds 16% stake in Indus Towers.

Net Cash Flow From Financing ActivitiesThis showed an enormous increase in the year

ending March 31, 2007 because the company made Initial Public Offering , which was oversubscribed.

The company also entered into a Long Term Financing Arrangement of Rs. 42,240mn with IDBI for refinancing of all existing debt and part financing of capital expenditure requirement.

In October 2007, the company entered into an agreement of additional Rs. 32,000mn with IDBI. This is mainly for capital expenditure requirement for launch of services in Mumbai and Bihar.

Spice Acquisition

Deal Chronology

Benefits to IdeaImmediate access to subscriber base, market

share gains and operating profitability

Spice, a well-entrenched operator in its two circles of operations

Benefits to Idea

Benefits to IdeaGaining access to spectrum in the 900

MHz band, enabling lower capex and opex

TMI as a strategic investorcomes with significant experience in

emerging market operations in countries like Sri Lanka, Pakistan, Malaysia, Indonesia and Bangladesh

has strong experience in operating 3G networks in other markets

Issues with the DealViolation of clauses on intra-circle merger and

mobile licence conditions.DoT revised merger and acquisition guidelines in

April 2008 that disallow intra-circle mergers (merger between two operators in the same service area) for three years from the date a licence is granted.

Idea has licences for the two Spice circles effective January 25, 2008. Also, Idea Cellular has licences for the Delhi, Andhra Pradesh, Haryana and Maharashtra circles where Spice also holds licences in these circles effective January 25, 2008.

Violation a "substantial equity" clauseUnder this clause, one service provider cannot have

more than 10 per cent in another in the same circle.Spice has stated if the merger does not take place

within a year, it would be willing to surrender its new licences for the Maharashtra, Andhra Pradesh, Delhi and Haryana circles, as required by policy.

Idea has also announced that it may consider surrendering licenses in the two circles where Spice operates

But DoT will not return the money which has already been deposited to acquire the licence

Issues with the Deal

Valuation – Discounted Cash Flow

Free Cash FlowThe industry is assumed to be growing at

an enormous rate till FY 2020Terminal growth rate of 5% is assumed

post-2020The number of subscribers and ARPU is

estimated from FY 2009 to FY 2020Implied revenue is obtained by multiplying

estimated number of subscribers with estimate ARPU

Capex and Working Capital are estimated using the Capex/Sales and WC/Sales ratio

Other AssumptionsMarket return and beta are calculated using

Nifty returns and the stock price of Idea Cellular on NSE

Cost of Equity is calculated using CAPMWACC obtained is 10.7%The intrinsic value of Idea Cellular stock is

estimated to be Rs. 103.Hence we think the stock is UNDERVALUED

So we give it a BUY rating

WHAT AN !DEA Sir Jee