Diversification story

IPO REVIEW

CDMA phone manufacturer XL Telecom is banking on solar systems and ethanol businesses to boost its bottom line.

Hyderabad-based XL Telecom, a manufacturer of CDMA phones is trying to hitch on to the wireless telecom boom that has seen the demand for handsets double from 17.8 million in 2003 to 42 million last year.

With a 30 per cent annual growth in the number of handsets, volumes could touch 156 million by 2008. Of this, 41 million are expected to be CDMA phones.

The company, in association with Kyocera, is one of the four CDMA handset manufacturers in the country and has an assembling unit with an installed capacity of 3 million handsets per annum.

Competition for XL Telecom comes in the form of Korean majors Samsung and LG and to a lesser extent from Nokia.

In addition to handsets, the company also makes switching mode power supply systems (SMPS) which are used by telecom operators. XL's other businesses include solar photovoltaic systems and ethanol.

To improve its presence across the country and expand its facilities, XL Telecom is going the equity route to raise Rs 50-60 crore between Rs 125-150.

The proceeds of the issue will be used to create a surface mounting technology (SMT) line facility to manufacture PCBs used in mobile phones and to expand the module making capacity of its solar photovoltaic division. So far, the company had been importing the handset parts and assembling them, and wants to reduce its dependency on its foreign suppliers.

While Kyocera will continue to supply it with designs and products, the company wants to strengthen its manufacturing base. Unless the company can build its own R&D base it will have to rely on its foreign collaborators for new designs and products which is a major risk.

Any decision by a foreign collaborator to set up a manufacturing base or aggressive pricing by foreign majors can dent the company's earnings.

The second issue which is common to commodity businesses are the wafer thin margins. Currently, the company is surviving on a 5 per cent operating margin from orders that are primarily sourced from BSNL.

XL has expanded its customer base and has included Tata and Reliance Communications on its roster. While Tata and BSNL are smaller players, Reliance Communications with a 75 per cent share in the CDMA business could drive down XL's margins further, though volumes could improve.

Though the telecom business has helped the company post a Rs 400 crore turnover for the year ended June 2006, the company is focussing on its photovoltaic and ethanol businesses to shore up its bottom line.

Solar photovoltaic systems
After its initial setbacks on the supply of solar photovoltaic systems to BSNL for its village public telephone requirements, the company has tied up with a Spanish company to market its products in Europe.

The company claims that it has a minimum commitment of 3 MW per year from the Spanish company for the next three years and at current prices, this will work out to Rs 200 crore a year. The revenues will however get reflected only in FY08.

Ethanol
The company's ethanol division has a capacity of 1.5 lakh litres per day and has achieved a Rs 59 crore turnover from sales to oil marketing companies (OMCs). Going by the five per cent mix in petrol (which is already being implemented in nine states), the demand for ethanol is estimated at 667 million litres in 2007.

Thanks to the bumper sugarcane harvest, sourcing of molasses might not be a problem this fiscal but the company will have to ensure supplies of the raw material to make the final product.

Sugar manufacturers could prove to be a tough hurdle to overcome for XL since their cost of manufacturing a litre of ethanol at Rs 12-13 is cheaper than XL's Rs 16. Despite the higher cost of manufacturing, XL Telecom has been able to offer the OMCs a price of Rs 19.50 a litre which is lower than the Bajaj Hindusthan's reported Rs 21.50 per litre.

Valuations
Though there are companies that have a presence in telecom equipment, design and solutions segment such as Shyam Telecom, there is no peer which is in the same business. 
 

FINANCIALS
(Rs crore)	FY06	FY05	FY04
Net Sales	395.29	296.91	213.94
Y-o-Y growth (%)	33.13	38.78	235.64
Operating profit	18.45	23.84	14.95
Y-o-Y growth (%)	-22.61	59.46	90.45
OPM (%)	4.67	8.03	6.99
Net profit	10.67	5.94	2.48
Y-o-Y growth (%)	79.63	139.52	64.24
NPM (%)	2.70	2.00	1.16

At the higher end of the price band XL would trade at 8.63 times its estimated FY07 earnings (June ending) and 7.19 times at the lower end. While the issue seems to be reasonably priced considering the growth prospects, investors will have to wait till FY08 to see a spurt in earnings.

Issue opens on December 4
Issue closes on December 7