Do not subscribe to Spice Comm IPO: ASK Sec

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Spice Communications is open for subscription with its initial public offering, IPO of 1,13,11,111 equity shares to raise around Rs 523 crore in the upper end of the price band of Rs 41-46 per share. The IPO closes on June 27.

The issue will constitute 16.39% of the fully diluted post-issue equity share capital of the company.

ASK Securities report on Spice Communications IPO:

Company overview

Spice Communications, promoted by the Modi group, is a regional telecom operator providing GSM based mobile services to its principal markets, Punjab and Karnataka. The company sports a combined market share of 14.5% in these circles, and services a subscriber base of ~3 mn (as on May 2007). Having been in operations for nearly a decade, Spice has built a strong brand and is ranked second in Punjab and fifth in Karnataka in terms of subscribers.

In both these markets, Spice operates out of the 900 MHz frequency band. It is now amidst strengthening its existing presence in its principal markets and plans to increase its footprint as well as offer more services-ILD/NLD etc. Telekom Malaysia, the second largest telco in Asia-Pacific region, holds a 46.89% stake in the company, the balance being held by the Modi group - Modi Wellvest.

Investment positives

Incumbency benefits in terms of spectrum

Being among the first private sector telcos in its circles, Spice has the advantage of having been allotted spectrum in the 800-900 MHz range (as compared to the 1,800-1,900 MHz range). This gives it the 'lower-capex-per-subscriber' advantage. However, scarcity in the 800-900 MHz range limits the advantage.

Likely candidate for takeover

Given its weak financials and lack of economy of scale, Spice is a clear take-over target. This could change business dynamics, thus a positive. As we understand, Spice had often been in talks with various operators to sell-out in the past, but valuation has been the key reason for talks to fall through.

Investment concerns

Two circle operations not scalable

Spice operates in just two circles - Punjab and Karnataka. While profitable, this business model will eventually lose out to the all-India integrated players like Bharti Airtel and Reliance Communications.

A weak balance sheet that may require further equity funding

Spice's balance sheet is relatively weaker than its peers - negative net worth of Rs 1,342 million and higher gearing of 2.2x compared to 0.5x for Bharti and 0.7x for Reliance Communications. While the IPO proceeds would suffice its capex requirement until FY08, we believe the company may have to raise further equity funds by FY09.

Denial to NSE listing likely to affect liquidity

Since Spice Communications has been posting a negative net worth over the past five years, it has been unable to fulfill NSE's listing criteria that mandates - positive net worth for a minimum of three years preceding the issue. This could affect stock trading liquidity.

Increasing competition to pose a challenge

Sustaining market share amidst increasing intensity of competition is, and will continue to, pose a challenge for all operators. As observed in Exhibit 5, Spice's incremental market share in both the circles have shown a sharp variance over the past five years; and going forward the battleground is only going to become tougher.

Valuation - Rs 29/share, Do Not Subscribe

We have valued Spice Communication using relative valuation approach based on EV/EBITDA metric. Using Bharti as a proxy, we have derived Spice's valuation by giving it a 30% discount to the leader Bharti. We believe this quantum of discount is the minimum, when one considers:

Geographic spread is limited: Spice is confined to two circles vis-à-vis Bharti that has a national footprint in all 23 circles.

Operational efficiency suffers due to lack of economy of scale: Spice's 23% EBITDA margin compares poorly with that of Bharti, which is at 40.6%. This is a function of lack of economy of scale - our primary worry for Spice's model.

Small subscriber base: Spice's subscriber base (at 3 million as on May 2007) is being one-fourteenth that of Bharti's.

Weak balance sheet: Spice's negative net worth, higher gearing of 2.2x and relatively lower return ratios as against that of Bharti's.

We arrive at fairvalue Rs 29/share. We recommend Do Not Subscribe.