Den Networks way too expensive. It’s better to avoid

One of the enduring laws of the stock market is that the number of initial public offerings hitting the market is directly proportional to the state of the market. And that explains the spate of IPOs recently.

The latest company to take advantage of the bull run is Den Networks Ltd. Started in July 2007, this Delhi-based company is now a leading cable television company with a pan-India presence. Within a short span of 2 years, it has spread its reach to 1 crore households across 77 cities, mainly by buying out smaller cable TV operators. The company has acquired majority stake in as many as 65 MSOs (multi-system operators) to expand its network across nine states.  Investors are well advised to stay away from this expensively priced IPO. To know why, read on.

Objects of the issue
Den is planning to raise around Rs 390-410 crore this week through its IPO, which is priced in the band of Rs 195- 205. Out of total proceeds, it plans to deploy around Rs 210 crore for the development of its digital cable television infrastructure, around Rs 25 crore to grow its cable broadband business and Rs 40 crore for repayment of certain loans.

Valuations
At Rs 195-205, the issue is very aggressively priced. This is a company which made a loss of Rs 1.67 per share in the last financial year and a loss of Rs 4.32 per share the year before that. Analysts expect it to make a profit per share of Rs 1.1-1.4 this financial year.
Even at the upper end of those expectations, the price-to-earnings ratio of the company stands in the range of 139-146. This is calculated by taking the prices Rs 195 and Rs 205 and dividing them by the expected profit per share of Rs 1.4. In comparison, the 30-share BSE Sensex quotes at a P/E ratio of 20.91.

The company’s consolidated revenue in the last financial was Rs 719.35 crore with net loss for second straight year at Rs 15 crore.

Since the company is yet to make a full-year profit, using the P/E ratio may not be a fair way of comparing valuations. So let’s use the revenue to post-issue market capitalisation ratio. This works out to 3.76, assuming that the company is able to issue shares at the upper level of Rs 205. The total market capitalisation of the company will stand at Rs 2,704 crore, if its able to issue shares at the upper level of Rs 205.

This ratio for Wire and Wireless, the only listed entity in a comparable line of business, stands at 1.3 times. Wire and Wireless’ revenues last financial year were Rs 308.26 crore, whereas its current market capitalisation is at around Rs 399.7 crore. This means Den Networks is 2.9 times more aggressively priced than Wire and Wireless. Having said that, Wire and Wireless is also a loss-making business.

Opportunities
The number of cable households in India is expected to increase to 13 crore by 2013 from 9 crore at present. Furthermore, currently only 20 lakh households receive cable services based on digital technology. The key driver for Den’s growth would be the demand for better visual quality which is provided by digital service. Also, increased reach through inorganic route by acquiring local service operators would provide much-needed consolidation and subsequently, larger subscriber base. Furthermore, digital service would reduce the huge under reporting by local operators. The broadband and internet services would add to the revenues of Den, which may constitute 15-20% to its overall revenues in next 2-3 years.

Challenges
The cable business has got tough competition as the industry is quite fragmented. It will take Den Networks 2-3 years to upgrade its network to digital mode. Till such time it gets totally digital network infrastructure in place, Den would have to bear the menace of local cable operators under-reporting revenue which is sufficiently high occurrence. Also, Den would have to convince its subscribers to take pay channels in order to get better revenues, which is still a big ask for local operators. Furthermore, cable operators are facing stiff competition from big DTH players such as Tata Sky, Reliance’s BIG TV, Dish TV and Bharti Airtel, who have aggressive reach.

There are other regulatory issues such as CAS extension and a pricing limit above which subscribers can’t be charged.

Investors may be better of avoiding the IPO of Den Networks, considering the complex nature how this cable service provider derives its revenues, intense competition it faces from big DTH players and the highly expensive price range. Those looking for exposure to this line of business are best advised to take a re-look at the stock after it lists.