Allow mkt to discover price, reauction spectrum: JM Fin

Sanjay Chawla of JM Financial explains to CNBC-TV18 that the price of the spectrum has to be discovered by the market and the government needs to cut the reserve price, increase the amount of the spectrum and conduct an auction again.

Chawla adds that, in his view, Idea Cellular will outperform Bharti Airtel until the government does a rethinks on the auction and if there is hike in tariff by the telecom industry. Below is the edited transcript of the analysis on CNBC-TV18. Q: Is the market reading the situation correctly? Should we understand that the government's key take-home will be that it was unrealistic with its reserve price at the telecom auction?
A: That's absolutely correct. And that has obviously been reflecting in the stock prices over or the last several days. Ever since the data on earnest money deposits was released by the DoT, the markets started pricing-in an unsuccessful auction and that's how it exactly turned out to be. It was badly designed with the biggest flaw being the exorbitantly high reserve price along with limited quantity of spectrum available for auction as well the limits on the spectrum that could be acquired by the existing operators.
Due these flaws, the auction ended with no bids for four circles which were obviously the most expensive, accounting for almost 50 percent of the national reserve price for spectrum. In 17 of the 18 circles where the bids were received, the auction actually ended at the reserve price itself and in15 of the 18 circles, the amount of spectrum that was eventually sold was less than the minimum amount of spectrum which was on offer. So by all these metrics, this was an unsuccessful auction and it is not surprising at all that the market has been rightly pricing it in the stocks. Q: Do you really expect that there will be a cut in the reserve price or a re-auction? Do you think the government will actually have the courage to price spectrum lower?
A: First of all, I don't think there is anybody else to blame for the unsuccessful auction than the government itself. The government was fully vindicated by the Supreme Court in the Presidential Reference that the policy is the domain of the government. So it was well within their right to design the auction properly. It was not Supreme Court or CAG which gave them a reserve price. It is the outcome of the TRAI, the DoT, the Telecom Commission, the EGoM and the Cabinet. The entire blame, in our view, lies with the government.
Another fault of the government was the undue obsession with the reserve price rather than with proper discovery of the market price. The Supreme Court mandated a proper discovery of the market price of the spectrum. And if the auction has ended at the reserve price in 17 of the 18 circles with no takes for four circles at the current reserve price, it is obvious that the reserve price was high. And even if the government had set a zero reserve price, it was possible to discover the market price of the spectrum which is what we have maintained for the last six months.
Now in terms of the road ahead, clearly the government has painted itself into a corner as there were no bids in four circles because of the high reserve price. So government will have to cut the reserve price to sell spectrum in those circles. But that is not going to be easy as the auction at the other 18 circles, in our view, was not at the market-discovered price but at the administrative price. So there was no auction as such. In our view, it was a sham auction.
The best recourse for the government would be to actually scrap the auction, cut the reserve price across the board, put in more spectrum in the kitty and combine it with the 800 Mhz spectrum which had no takers at the current reserve price and put it for auction where the market will discover the price. Q: Where do you think the risk-reward is most favorable at this point in time considering that we have seen the relief rally play out in the past two-to-three days?
A: If you look at the performance in the last couple of weeks, Idea has been a big outperformer, up almost 15-17 percent and it has outperformed Bharti. Very rightly so, because any reduction in spectrum prices benefits Idea more than Bharti in terms of percentage cheer upside but that rally in our view in terms of the unsuccessful auction which we have seen that has now been priced-in as far as Idea stock is concerned. From here onwards we see more upside for Bharti incrementally, our target price is also Rs 290 for Bharti and if you build in some upside from the unsuccessful auction, the target price could touch Rs 310-320.
For Idea, at Rs 95-96 the stock is already pricing in the unsuccessful auction. From here onwards, obviously the next potential upside could occur if government were to do a bold rethink on the whole spectrum pricing issue. Then all the stocks will benefit on that aspect as well and probable tariff hike could provide further leg to the upside.  We believe that Idea can only outperform Bharti if the government conducts a serious rethink on the spectrum price and if there is a tariff hike. Q: What would your reserve price estimates be? Do you have any target?
A: The market is the best judge of the value of spectrum and it's about time that all of us gave up second guessing the market. The reserve price needs to be kept as low as possible to ensure there is significant level of interest in the auction and let there be a proper market price discovery as was the case back in 2001 when the 1800 Mhz spectrum was auctioned. But clearly from where the reserve prices are currently it requires a drastic cut, maybe 70-80 percent cut, to be able to attract serious interest in any auction in Delhi, Mumbai and Karnataka circles. Q: Any thoughts at all in terms of what investors should look for in the other stocks that you didn't speak about such as Reliance, Tata Tele and Tulip?
A: Though we don't have a formal rating on these stocks, these stocks have other problems particularly emanating from litigation in the Supreme Court. One, there is confusion as to whether Tata Tele's GSM spectrum should be cancelled as part of the February 2 verdict of the Supreme Court. Two, RComm is fighting a case against dual technology policy of the government issued in 2007 by which they were given GSM spectrum. So, these stocks have got more leverage to those issues and also ofcourse to a more benign pricing environment in the market. There is more sensitivity to regulatory decisions in the near-term.