Onmobile+global+ipo+note 23.01

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OnMobile Global

Strong ‘growth’, but less ‘value’

Harit Shah Tel: 022 - 4040 3800 Ext: 345 E-mail: [email protected]

OnMobile Global (OMGL) is a leading provider of telecom value-added software products and services in India. The company was incorporated September 2000 by parent company, OnMobile Systems, Inc (OMSI), which is a start-up company of Infosys Technologies, India’s second-largest software company.

Issue Open: January 24, 2008 Objects of the Issue Issue Close: January 29, 2008

Particulars Purchase of equipment Working capital requirements Repayment of loan General Corporate Purposes Total

Issue Details Face Value: Rs 10

Amount 180.5 5.0 35.0 242.8 463.3

Estimated schedule of deployment FY2009 FY2010 FY2011 55.5 60.0 65.0 5.0 0.0 0.0 35.0 0.0 0.0

Source: Company RHP

Rationale for our ‘Avoid’ view Present Equity Capital: Rs48.8cr Post Issue Equity Capital: Rs57.4cr Issue size (shares): 1.09cr* Issue size (amount): Rs463.3cr** Issue Price: Price Band of Rs425 – 450 Promoters holding pre-issue: 72.4% Promoters holding post-issue: 57.5% * Including 22.9lakh shares as offer for sale by promoters ** Assumed at the lower end of the price band

Book Building QIBs

At least 60%

Non-Institutional

Up to 10%

Retail

Up to 30%

Post Issue Shareholding Pattern Promoters Group

57.5%

MF/Banks/Indian FIs/FIIs/Public & Others

42.5%

January 23, 2008

We have compared OMGL with Tanla Solutions, a company operating in a similar line of business but with greater focus on global markets. However, it should be noted that Tanla’s business model is slightly different from that of OMGL. While Tanla has a primarily service-oriented business, OMGL’s business model is product-led. It is clear that on most operating metrics, Tanla comes out on top visà-vis OMGL. Consider, Tanla’s EBITDA Margins, Asset Turnover ratio and Return Ratios stack up better compared to OMGL. Tanla earns higher percentage revenue share per transaction than OMGL as the former operates mainly in developed markets like the UK and Ireland, where mobile operators get a lesser share and the usage of mobile value-added services (VAS) is also much more. OMGL’s Return Ratios will also be lower than Tanla’s on account of the significant rise in its Book Value post the IPO. Exhibit 1: Comparative Analysis Parameters Revenues (FY2007, Rs cr) EBITDA Margins (FY2007, %) Fixed Asset turnover ratio (FY2007, x) RoE (%)* RoCE (%)* P/E ratio (x)**

OMGL 137 45.8 2.4 15.6 13.1 40.0

Tanla Solutions 222 49.8 4.2 26.6 31.2 21.7

Source: Company RHP, Angel Research; * RoE and RoCE calculated on expanded equity capital post the Issue on annualised 1HFY2008 numbers for OMGL; for Tanla, we have taken our FY2008 Estimates for comparison purposes; ** P/E ratio has been calculated on fully diluted equity capital post the Issue at the lower end of the price band (Rs425) for OMGL on annualised 1HFY2008 Net Profit; for Tanla, it is calculated on our FY2008 Estimated EPS at the closing stock price as on Wednesday, January 23, 2008.

On the valuation front, the OMGL Issue comes at a significant 85% premium to Tanla, based on annualised 1HFY2008 numbers and our FY2008 Estimates respectively. This is despite the fact that OMGL’s Operating metrics do not compare favourably with Tanla. OMGL’s business model should command better metrics than Tanla being product-based, while Tanla operates through a Services model. But this is not the case. Hence, we believe that this premium is not justified, even after taking into account higher growth rates going ahead. 1

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Company Background OnMobile Global (OMGL) is a leading provider of telecommunications value added software products and services in India. The company was incorporated in India in September 2000 by its parent company, OnMobile Systems, Inc (OMSI), which was an incubated start-up company of Infosys Technologies, India’s second-largest software company. A lion’s share of OMGL’s revenues comes from the Indian telecom market. The company also has a fast-growing international business portfolio in the Emerging markets of Asia. OMGL’s products and applications are delivered by its carrier customers to their end-user subscribers. These products include ring-back tones, voice portals, ringtone downloads, contests, music and missed call alerts, among others. Thus, the company enables a better user experience. OMGL clients include India’s Top-six mobile service operators, viz. Bharti Airtel, Reliance Communications (RCOM), Vodafone-Essar, BSNL, Tata Teleservices and Idea Cellular. Through these operators, the company had a market reach of over 232mn mobile subscribers in India as on September 30, 2007. OMGL also has over ten international telecom operators in over eight countries with clients including SingTel Optus in Australia, Sheba Telecom in Bangladesh, Maxis in Malaysia, Bakrie Telecom and PT Indosat in Indonesia. As on June 30, 2007, OMGL had a market reach of over 81mn international mobile subscribers. Exhibit 2: Financial Performance (Rs cr)

Sales

Net Profit

(%)

EBITDA margins (%, RHS)

150

65

120

55

90

45

60

35

30

25 15

0 FY04

FY05

FY06

FY07

Source: RHP, Angel Research

OMGL works principally on a revenue-share model. The company has long-standing relationships with its clients and operates through revenue-share arrangements. Service deployments involve complex hardware systems and software applications embedded within the carrier’s network infrastructure and integrated into its billing, customer care and other core network systems. The company constantly makes investments in research and development (R&D) to keep its products relevant. OMGL was ranked as the top value-added services (VAS) company in FY2007 by Voice & Data magazine. The company’s Net Revenues have grown at a CAGR of 82.7% over FY2005-07, to touch Rs136.7cr in FY2007. OMGL has grown its Net Profits at a CAGR of 57.9% over the mentioned period to Rs34.9cr in FY2007. For 1HFY2008, OMGL clocked a Topline of Rs112.5cr and Bottomline of Rs30.5cr, reflecting strong growth. Industry Overview The Indian Telecom Industry has been one of the best examples of the success of the Indian government’s reforms programme. The sector has grown at a scorching pace over the past few years, aided by enabling regulations, heightened competition resulting in across-the-board lowering of telecom tariffs, higher disposable income due to India’s strong GDP growth rates and greater coverage of India’s landscape by mobile service operators.

January 23, 2008

Earlier, the telecom sector was a government-controlled monopoly, wherein just 3 players viz., MTNL, VSNL and the Department of Telecommunications (the earlier name of BSNL), provided 2

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telecom services in the country. MTNL was licensed to provide fixed basic telecom services in Mumbai and New Delhi, while BSNL was licensed to provide services to the rest of the country. BSNL also provided national long distance (NLD) services. VSNL, on the other hand, provided international long distance (ILD) services. However, in 1994, the sector was opened up to competition and cellular licenses were issued, as the government woke up to the need to develop robust telecom infrastructure in the country, necessary to aid high GDP growth rates. Initially, due to the prohibitively high cost of licenses, telecom services were expensive and saw few additions to the mobile subscriber base. At the end of FY1998, there were a mere 880,000 cellular subscribers in the country, with over half of them being from the Mumbai and Delhi circles. However, things changed dramatically with the advent of the National Telecom Policy (NTP) 1999, which envisioned a shift in the license fee payment mechanism, from a fixed regime to a revenue-sharing regime. Other initiatives such as the allotment of the third and fourth cellular licenses, the unified access licensing regime, implementation of the Calling Party Pays (CPP) regime, making incoming calls free and consistent initiatives to reduce regulatory costs to telecom operators also resulted in a quantum jump in the cellular subscriber base. Exhibit 3: Mobile subscriber base - India calling! (Mn) 180 160 140 120 CAGR 89.5%

100 80 60 40 20 0 FY02

FY03

FY04

FY05

FY06

FY07

Source: COAI, AUSPI, Angel Research; figures include fixed wireless phones (FWP)

At the end of December 2007, the total mobile subscriber base stood at 229.3mn, with GSM subscribers standing at 172.2mn, while 57.1mn subscribers were CMDA customers. At these levels, mobile teledensity in the country stands at around 21%, leaving as yet strong scope for growth going ahead. The Indian Data / VAS market – To grow by leaps and bounds Data services revenues of the Indian Cellular Industry stood at US $858mn at the end of 2006, according to industry analyst firm, Gartner. This implies a strong CAGR growth of 84.5% over 2002-06. These revenues are estimated to continue to grow at a healthy CAGR of over 45% annually to hit a size of US $5.6bn by 2011. Revenues from data services, as a percentage of mobile operators’ Topline, have also shown a positive trend. Consider, in the latest quarter, VAS revenues as a percentage of sales of Bharti Airtel’s Mobile Services Business stood at 9.8% (including person-to-person SMS revenues). Excluding SMS, VAS revenues stood at 5.2% of Mobile Services revenues. This has seen a slight increase over a couple of fiscals back, where the respective figures were 7.4% and 1.6%. The company’s VAS revenues have grown at an outstanding CAGR of 118.2% over FY2003-07, from just Rs85cr in FY2003 to Rs1,921cr in FY2007. Thus, there is significant growth potential for mobile data services in the Indian markets. It should be noted that in more advanced, developed telecom markets such as the UK, data services account for a much more significant part of wireless revenue. For example, O2, a major operator in the UK, records data revenues of as much as 33% of its sales, reflecting the strong scope for growth in this segment. January 23, 2008

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There are two major factors driving growth of the VAS market in India. Firstly, consumer demand is increasing for services such as ring-back tones, ringtone downloads, multimedia messaging service (MMS), music, games, mobile internet and video. Secondly, with mobile operators clearly facing pressure on their average revenues per user (ARPUs), the need for increasing VAS revenues becomes all the more paramount. VAS revenues enable telcos to increase revenues with very little incremental capex, thus enabling ARPU sustenance. International telecom markets Apart from India, global telecom markets such as Indonesia, Thailand, Pakistan, Bangladesh, Malaysia and Sri Lanka are also witnessing rapid growth. For example, GrameenPhone, Bangladesh’s largest mobile operator, grew its subscriber base by 100% for the fiscal year ended March 31, 2007. Maxis, Malayisia’s largest mobile operator by population penetration, grew its subscriber base by 18% in 2006, while Sri Lanka Telecom saw a 111% increase in its mobile subscriber base in CY2006. In these markets, with operators’ focus being primarily on rapid subscriber growth, there is strong scope for external vendors to manage the VAS segment. Investment Positives Fast-growing Indian Telecom VAS market The Indian Telecom Industry is the fastest-growing in the world, adding over 8mn users a month for the past several months. With continuously falling minimum subscription costs, increasing affluence, expansion of coverage area and the introduction of a greater number of low-cost but feature-rich handset models in the market, the industry is expected to sustain the pace of net adds in the near future. According to Gartner, the Indian cellular subscriber base is expected to grow at a CAGR of 26.6% over CY2006-11E. According to our estimates, the Indian mobile subscriber base will grow at a CAGR of 38.9% over FY2007-10E to hit 432.0mn, reflecting the strong growth expected. The Indian VAS market, on the other hand, is growing at a faster rate than the mobile subscriber additions. Gartner estimates Indian data service revenues to grow at a CAGR of 45.7% over CY2006-11E to achieve a size of US $5.6bn. Thus, significant growth is expected going forward. Exhibit 4: Indian Cellular Industry data service revenues – Strong scope for growth (US $mn) 5,637

6,000 4,465

5,000 CAGR 45.7%

4,000

3,385

3,000

2,466 1,609

2,000 1,000 74

147

2002

2003

324

580

858

0 2004

2005

2006

2007E

2008E

2009E

2010E

2011E

Source: Company RHP

January 23, 2008

The twin drivers of growth – Consumer demand and declining ARPUs The strong growth in the Indian mobile VAS market is expected to result from two key drivers. Firstly, there is ever-increasing demand for such services by consumers. Globally and in India also, handsets are becoming more feature-rich and the software component is increasing to improve phone data capabilities. Consumers are increasingly using cell phones not just as a means of communication, but more as an integral part of their daily lives. Services such as music, entertainment, games and information are being increasingly used and accessed through cell phones. Mobile commerce services such as banking and payment of utility bills through mobile phones are also witnessing growth, given the convenience factor. Thus, with this integration of mobile phones into consumers’ daily lifestyles, the demand for VAS is witnessing strong growth. 4

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Further, ARPUs for Indian telecom operators are constantly on the decline. The Indian Telecom Market is arguably the most competitive in the world and given the strong growth expected and latent demand yet to be tapped, operators are constantly introducing cheaper schemes and call rates to grab a greater share of the pie. This is leading to a consistently falling trend in ARPUs. Increasing revenues from VAS is thus a very important requirement for telcos to arrest this decline. As a result, operators are constantly introducing newer schemes to get a greater proportion of their revenues from VAS leading to the ever-increasing demand for these services from the operators’ end. Exhibit 5: Industry ARPUs – On a declining trend, driving VAS demand (Rs/user/month) GSM

400

CDMA

350 300 250 200 150 Mar-06

Jun-06

Sep-06

Dec-06

Mar-07

Jun-07

Source: TRAI

A leader in the Indian VAS market, with strong client relationships OMGL has been ranked as the top VAS company in India in FY2007 by Voice & Data, a leading publication for the Telecom Industry in India. The company has strong client relationships with each of the Top-six Indian mobile service operators, viz. Bharti Airtel, RCOM, Vodafone-Essar, BSNL, Tata Teleservices and Idea Cellular. Thus, through these six operators, OMGL has a market reach of over 211mn mobile subscribers, which is the combined subscriber base of these operators as on December 31, 2007 (excluding BSNL CDMA subscribers). Apart from telcos, OMGL also counts media giants like AOL and Star as its clients. Exhibit 6: Operator-wise marketshare (%) 30 24.1% 25 17.9%

20

17.4% 14.3%

15

9.5%

9.2%

Tata Teleservices

Idea Cellular

10 5 0 Bharti

RCOM

Vodafone-Essar

BSNL

Source: COAI, AUSPI, Angel Research; Note: The figures include fixed wireless phones (FWP) and exclude the CDMA subscribers of BSNL and MTNL.

January 23, 2008

OMGL’s business model is product-based. The company’s service deployment process involves hardware and software applications that are embedded within the operator’s network and are integrated with its billing and other systems. Thus, OMGL’s products power the delivery of mobile VAS to its carrier client’s subscribers, acting as the ‘Intel Inside’ that powers personal computers, even as the services are branded in the operator’s name (white labeled). 5

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A scalable business model While OMGL’s business model is intellectual property (IP)-led, the company operates through a revenue-share model. Thus, even as the IP of the product remains with OMGL, it drives its revenues through the highly profitable revenue-sharing model. Thus, for example, a user downloads a ring tone and is charged Re 1, OMGL will get a share of this. Given the burgeoning growth in these services, the profitability of the business is strong. As and when the company recovers its fixed costs, all revenues over and above will flow straight through to the PBT. Thus, there is significant scope for operating leverage. The company’s percentage revenue share ranges between 15% and 40%. On an average, 20-25% of revenues per transaction are earned by OMGL. End-to-end solution provider OMGL offers its clients end-to-end turnkey solutions including hardware and software platforms, application development, infrastructure management and customer support. The company provides content aggregation services through content planning and procurement from content developers such as ESPN. The company also provides software applications and platforms that power VAS usage. Thus, this suite of end-to-end services enables OMGL to act as a ‘one-stop-shop’ for its clients. Exhibit 7: OMGL - End-to-end solution provider

Content owners (ESPN, Star, Disney)

Content aggregators

Application service providers

Platform providers

Telcos (Airtel, RCOM, Vodafone, BSNL)

OMGL’s end-to-end suite of solution offerings Source: Company, Angel Research

Expanding International presence OMGL has a rapidly expanding international presence, and international revenues accounted for around 4% of the company’s total revenues in 1HFY2008. The company is present in over eight countries with clients such as SingTel Optus in Australia, Sheba Telecom in Bangladesh, Maxis in Malaysia, PT Bakrie Telecom and PT Indosat in Indonesia. As on June 30, 2007, OMGL had a market reach of over 81mn mobile subscribers internationally. The company also recently acquired a company called Vox mobili SA to expand its product portfolio in data and to get access to markets in Europe and North America. Thus, apart from the strong growth in the Indian telecom market, the company’s expansion into global developing and developed markets, where percentage revenue share tends to be higher than in India (specially in developed markets like the UK and the US), provides strong revenue visibility. Concerns Low percentage revenue share The average percentage revenue-share that OMGL earns is in the range of 20-25% per transaction. This is considerably lower than is the case in developed markets like the UK, where aggregators and platform providers typically get 40-60% revenues per transaction. In India, the telecom operator gets the maximum share of around 50-70% per transaction. Going ahead, it seems unlikely that this share will change dramatically, given that telcos would tend to have greater bargaining power, since they would be using a number of VAS providers. Thus, until consolidation pervades the industry, it is highly likely that the operators would continue to have greater bargaining power.

January 23, 2008

Continuous investments required in R&D OMGL, to keep its products relevant and compete effectively in the market place, will need to make constant investments in R&D. Even so, there may not be any guarantee of success after 6

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making these investments, as competitors may bring out better products, resulting in the company losing business. Also, with the Telecom Sector characterised by rapid technological change, any inability to keep pace with such changes could lead to slowing growth and a loss of clients. High debtor days OMGL’s days’ sales outstanding in FY2007 stood at as many as 144 days, or nearly five months of sales. This could lead to the company facing significant cash constraints, though the sales cycles in this industry tends to be long. Nonetheless, it remains one of the factors that potential investors should keep in mind before considering the Issue. Outlook and Valuation At the lower end of the price band of Rs425, the OMGL IPO comes at a P/E of 40.0x annualised 1HFY2008 Earnings. Going forward, the Indian Mobile Telecoms sector is likely to grow at a rapid rate and as per our estimates, the mobile subscriber base is likely to hit 432.0mn by FY2010E, growing at a CAGR of around 39% over FY2007-10E. The Indian mobile VAS business is likely to grow at an even faster rate, as demand from subscribers and falling ARPUs of mobile operators are likely to be the twin drivers of business growth going ahead. OMGL with its well-entrenched position in the Sector and with all the Top-six Indian mobile operators as its clients seem wellpoised to benefit from this growth. Its international business portfolio is also growing at a fast clip and we expect this business to contribute strongly as well. Thus, revenue visibility is strong and we believe the company can maintain a CAGR growth of around 50-55% in EPS over the next three years. However, we believe the company’s valuations are very demanding and even adjusting for strong growth going ahead, the Issue does not come at reasonable valuations. Given that Tanla Solutions, a company in a similar line of business, is available at more reasonable valuations even after factoring in slower growth, we believe investors are better off staying away from the issue. Investors should note that we are enthused by OMGL’s business model and believe it will record strong growth over the next few years. However, we believe the IPO is aggressively priced and recommend investors to ‘Avoid’ the Issue purely on the basis of valuations.

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Exhibit 8: Profit and Loss Account (Consolidated) Y/E March (Rs cr) Net Sales % chg Total Expenditure EBIDTA (% of Net Sales) Other Income Depreciation Interest PBT (% of Net Sales) Tax PAT % chg

FY2004* 17.3

FY2005 40.9 137.2 14.5 26.5 64.7 0.1 4.5 0.0 22.2 54.1 8.1 14.0 224.7

10.3 7.0 40.5 0.1 0.9 0.0 6.3 36.2 1.9 4.3

FY2006 82.6 101.8 35.5 47.1 57.0 0.1 8.5 0.0 38.7 46.9 14.1 24.7 76.0

FY2007 136.7 65.4 74.1 62.6 45.8 4.5 14.4 0.0 52.7 38.6 17.8 34.9 41.6

FY2008E 225.0 64.6 128.0 97.1 43.1 7.6 20.0 0.4 84.3 37.4 23.2 61.0 74.7

Source: Company RHP, Angel Research; Note: FY2008E = 1HFY2008 annualised; * FY2004 = 15-month period ending March 31, 2004.

Exhibit 9: Balance Sheet (Consolidated) Y/E March (Rs cr) SOURCES OF FUNDS Equity Share Capital Reserves & Surplus Minority Interest Shareholders' Funds/Net worth Loan Funds Deferred Tax Liability (Net) Due to erstwhile shareholders of ITFINITY Soln. Deferred Payment Liability Stock options outstanding account Total Liabilities APPLICATION OF FUNDS Goodwill on consolidation Gross Block (Less) Acc. Depreciation Net Block Capital work-in-progress Investments Current Assets, Loans and Advances Current Liabilities & Provisions Net Current Assets Total Assets

FY2004

FY2005

FY2006

FY2007

1HFY2008

2.3 3.5 0.0 5.8 0.0 0.8 0.0 0.0 0.0 6.6

2.3 17.5 0.0 19.8 0.0 1.1 0.0 0.0 0.0 20.9

2.3 42.3 0.0 44.6 0.0 2.3 0.0 0.0 0.0 46.9

3.7 160.7 0.0 164.3 0.0 3.0 19.2 0.0 0.0 186.5

48.8 173.2 0.0 222.0 30.0 2.2 0.0 25.4 0.1 279.6

0.0 11.5 1.3 10.2 0.0 0.5 8.3 12.4 (4.2) 6.6

0.0 18.1 5.8 12.3 0.5 1.0 29.6 22.5 7.1 20.9

0.0 35.6 14.3 21.3 0.0 2.6 61.7 38.7 23.0 46.9

0.0 58.1 28.9 29.1 4.3 102.4 123.0 72.3 50.7 186.5

133.9 93.2 39.7 53.5 18.9 10.5 184.3 121.4 62.9 279.6

Source: Company RHP, Angel Research; Note: 1HFY2008 = as on September 30, 2007.

Exhibit 10: Valuation Summary Y/E March EPS (Rs)* P/E (x)** RoE (%)# RoCE (%)#

FY2004 0.8 564.9 149.3 108.1

FY2005 2.4 174.0 109.6 111.8

FY2006 4.3 98.9 76.6 86.9

FY2007 6.1 69.8 33.5 32.1

FY2008E 10.6 40.0 15.6 13.1

Source: Company RHP, Angel Research; Note: FY2008E = 1HFY2008 annualised on the diluted equity capital; * EPS calculated on the expanded equity capital post the issue; ** P/E ratio calculated at the lower end of the price band of Rs425; # RoE and RoCE calculated on the expanded net worth after the IPO issuance.

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