Hughes Tele.com (India): Below average

Score: Below average

Krishnan Thiagarajan

With risks outweighing the merits and the stock likely to suffer from equity overhang, investments in the company at this stage can be avoided.

HUGHES Electronics and ALLTEL Corporation, US, are the key promoters of the company lending strength to this project. As a complex broadband project, their technological expertise, management quality and telecom operating and project implementation experience are expected to help support this long gestation and capital intensive project.

MTC is expected to be the most attractive market in the country. With huge growth potential and low teledensity in the Maharashtra circle as a whole, Hughes Tele.com will enjoy the ``first mover advantage'' in a project of this kind. Through a business model which aims to deploy high bandwidth optical fibre catering to corporates/commercial establishments, Hughes aims to rapidly ramp up its current 27,000 lines which are in service over the next couple of years. Using the ``grid strategy'' and complementing it with a comprehensive suite of value-added business products and services, the company aims to `lock'-in commercial/corporate customers and corner a significant marketshare in a service starved basic services market. These two strategies are expected to erect an entry barrier for other players.

Risks

Competition from basic service providers: As the Government is considering the opening up of the basic services market to additional private players in consultation with TRAI, the prospect of the Maharashtra circle attracting more players remains fairly high. Since the target markets and client segments for those players are likely to be more or less the same as Hughes Tele.com, the competition levels are expected to be intense. As infrastructure providers such as BSES, Railways, Power Grid Corporation, GAIL and others are in the process of wiring up the entire nation (including Maharashtra), the prospect of leasing optical fibre bandwidth at highly competitive prices may become a reality in the near future. The competitive advantage in that case for Hughes will stem largely from its ``portfolio of broadband offerings'' and ``service quality''. In turn, this advantage too will depend on the kind of private players who enter the basic services segment and their suite of product and service offerings. As the most attractive market segment, it is expected to attract players with ``deep pockets'' and ``staying power'', specially in a blossoming market segment such as Maharashtra.

Competition from ``cable TV and ISP'' players: All the major cable TV operators, in particular, ZeeNet (part of the Zee group) and IndusInd Media and Communication (part of the Hinduja Group) are examining the ``broadband hybrid fibre coaxial'' strategy to target the Mumbai market in a big way. Even though concentration of these players will be on residential subscribers who have cable TV access, the current pricing structure of cable modems and competitive economics will drive them towards examining options for providing ``value-added services'' to corporates/commercial establishments. The heightened competition levels only force down tariffs leading to lower margins for all the existing players, including Hughes Tele.com. Similarly, the competition from standalone ISP players is also likely to be fairly stiff.

Association with the Ispat group: The poor track record of the Ispat Group, one of the promoters of this venture, is expected to be a damper for investors from an investment perspective. Although the joint venture agreement between Hughes and Ispat provides for the appointment of all the three key executives (CEO, CTO and CFO) by the Hughes group, the association with the Ispat factor may be a negative for this IPO.

Long gestation capital-intensive project: According to the offer document: ``In a capital-intensive project such as this, the break-even of cashflows takes place approximately four-five years after the commencement of commercial production. Financial institutions in India have approved the scheme of financing of telecom projects which includes funding of cash losses during the project implementation phase''. Although the exact break-even level has not been specified in the offer document for this project, the risk associated with a break-even of cash flows over an extended period cannot be ruled out. In a technology-intensive industry, two-to-three years can dramatically alter the technology landscape. Innovations on the access front, either in the cable TV or cellular industry, can suddenly make them more attractive relative to ``broadband services from basic service providers''. The long gestation period in projects like this can prove to be a key risk factor.

Regulatory environment: Though the government is committed to the reforms process, the roadblocks placed by the telecom unions and other vested interest may either slowdown the deregulation process or impose conditions which are too onerous on the private sector players. This may affect their fortunes in the long run. The tariff structure, which is being reviewed by TRAI, on a regular basis may be reduced further for local calls, thereby putting further pressure on the margins of basic service providers in the long run.

Free float: The free float (including the stock which is held by institutional investors) will be so high that it may affect the price formation and discovery process. This factor may even pave the way for risk averse institutional investors to contemplate an entry into the stock in the post-listing period.

Capital-intensive project

HUGHES Tele.com (India) is making with an initial public offering to part-finance the estimated project cost of Rs. 3,485 crores for the expansion of the company's existing wireless and wireline telecommunications infrastructure. The company's business plan for this project aims to finance the construction of fibre optical cable network, digital switches, integration with existing network for provision of broadband telephony and wireless services, Internet and Advanced Intelligent Network (AIN) services, web-based application services and total business telecom services.

ICICI, which appraised the company's basic telephony project, has sanctioned a rupee debt underwriting facility of Rs. 854.3 crores, including long-term debt of Rs. 350 crores.

Facts: The following are the facts as extracted from the offer document:

Hughes Tele.com (India) was granted a license by the Department of Telecommunications (DoT) to operate basic telecommunication services in Maharashtra telecom circle (including Mumbai) and Goa. The licence fees of Rs. 532.54 crores paid by Hughes Tele.com for the period between September 30, 1997 and July 31, 1999 was converted into entry fees following the migration from the fixed license fee regime to the revenue sharing arrangement with effect from August 1, 1999.

Under the revenue sharing arrangement, Hughes Tele.com (alongwith the other licensees) will pay license fees as a percentage of gross revenues. The licence fee percentage is to be fixed by the Government in consultation with the Telecom Regulatory Authority of India (TRAI).

The promoters of Hughes Tele.com are Hughes Electronics Corporation, US, ALLTEL Corporation, US, and Ispat Industries.

Hughes Electronics businesses include DIRECTV, one of the major digital multichannel entertainment service providers based on the number of subscribers, and PanAmSat, the owner and operator of the largest commercial satellite fleet in the world.

As of December 31, 1999, the total revenues of Hughes Electronics were $5.5 billions (or Rs. 25,366 crores), with loss at the operating and net level. It made a net loss of Rs. 291.30 millions (or Rs. 1,328.91 crores). ALLTEL Corporation, US, is a US based information technology company that provides wireline and wireless communication and information services. As of December 31, 1999, ALLTEL had revenues of $ 6.3 billion (Rs. 28,750 crores) and net income of $ 783.63 million (Rs.3,574.92 crores).

Ispat Industries, the third promoter, is engaged mainly in the steel-flat products business. For the year-ended March 31, 1999, its revenues were Rs. 1,398.56 crores and post-tax earnings Rs. 25.08 crores.

According to the terms of the joint venture agreement, Hughes Electronics has the right to nominate the chief executive officer, chief financial officer and chief technology officer of the company. All the three key posts have been filled on directions from Hughes Electronics.

The Maharashtra Telecom circle (MTC) is considered to be one of the most attractive basic service circles. Maharashtra's per capita income is estimated to be nearly 50 per cent higher than that of India as a whole. The State produces 20 per cent of India's GDP. The population of MTC is in excess of 24 million and as on December 31, 1999, there were more than 4.10 million telephone lines in Maharashtra, of which 2.10 million were in Mumbai. Historically, MTC has been the largest revenue-earning circle for DoT and MTNL. For 1999, the combined MTC revenues for DoT and MTNL were approx. Rs. 4000 crores.

Hughes Tele.com intends to be among the first telecom provider in the MTC to offer its customer significant benefits of the broadband network by investing in the fibre optical cable network capable of supporting the high bandwidth application of predominantly business subscribers by using the ``fibre to business'' architecture. The fibre optical connections right up to the premises will provide the customer high bandwidth of several mega bits per second to support ``voice, multimedia and real-time data communications''.

The initial network roll-out and marketing effort is focussed on three major segments -- large corporate and commercial customers, public calling offices (PCO's) and multi-line residential users. The planned network rollout is based on a ``grid'' strategy. A grid is defined as a geographical catchment area containing a mix of business and residential subscribers. Using parameters such as economic attractiveness, subscriber demographics, density and geographical spread, the company has developed various grid classifications.

The company plans to wire these grids by deploying optical fibre simultaneously through these grids. In this manner, the company proposes to convert the base of existing subscribers in these buildings to the company's network. Thereafter, the company's multi services broadband data-centric architecture will provide web applications such as high speed internet access, virtual private networks, security services, web hosting, e-mailing, newsgroup, chat, multimedia conferencing, and so on.

The company, which serves the three markets of Mumbai, Navi Mumbai and Pune aims to offer its products and services to additional customers in nine additional markets in the MTC by March 2002.

For the year-ended March 31, 2000, on total revenues of Rs. 63.81 crores, Hughes Tele.com had incurred an operating loss of Rs. 116 crores and net loss of Rs. 270 crores. Hughes Tele.com has projected a total income of Rs. 185.76 crores, EBITDA (operating profit) of Rs. 19.79 crores and net loss of Rs. 221.03 crores for the year-ended March 31, 2001.

Industry Class :Telecommunications -- Basic

Issue Type :Equity -- Book-built portion

Offer price :Rs. 13-14 per share

Application amount :Minimum of 1,100 shares based on the floor price

Project Cost :Rs. 3,485.4 crores

Debt:Equity :1.24: 1

Offer Opens on :August 29

Offer Closes on :September 5

Promoters :Hughes Electronics Corporation, US/ALLTEL Corpn.,US/Ispat Industries and others

Lead Managers :Kotak Mahindra Capital

Listing at :BSE/NSE