Key Operational and Financial Parameters
After discussing the terms of the telecom sector, now we will discuss the key operational and financial parameters a financial analyst should check while evaluating a telecom sector company.
As the telecom sector is very much competitive and technology oriented, the long term growth and performance depends on the Management’s vision and credibility. Formulating the right strategy at the right time is very much important to sustain the business growth here. An Analyst should check the long term vision and credibility of a telecom company while assessing its value and projecting its future growth.
Telecom companies operate in a monopolistic environment and the only way to beat other competitors is to innovate continuously. Innovating and launching new features and new products always help to increase the subscriber base and cut down the cost. Innovation in mobile software, added features, network connectivity helps to expand the business and accelerate the growth in future. Having IPRs, Patents increases the valuation of a telecom company.
Scale of Operations and Presence
As the number of subscribers depends on the scale of presence in different regions, this should be considered as an important parameter to do valuation of a telecom company. Presence in high populated circles within a country and in the emerging economies with high growth potential are considered to be important parameters while evaluating a telecom company. Telecom sector in the developed economies have almost saturated and the growth lies in the emerging economies now.
Average Revenue per User per month (ARPU)
As we have already discussed Average revenue per user per month or ARPU is the most widely used parameter to denote the revenue generated per mobile subscriber by a telecom company. Hence it is used as an important financial parameter to denote the efficiency of a telecom company. Higher the ARPU, more efficient the company is.
As the subscriber base is the main parameter to increase the revenue, subscriber growth or net subscriber addition is also used as an important financial parameter. The net subscriber addition during a particular period is calculated after deducting the reduction in the subscriber number from the total subscriber addition during that period. The more the net subscriber addition will be, better be the revenue generation for the next period.
Operating Profit Margins
As the telecom companies invest heavily in sales and marketing activities, Operating Profit Margin is considered to be the main profitability ratio. Operating Profit Margin is calculated as
Operating Profit Margin (%) = (Operating Profit /Total Revenue) * 100
Higher Operating Profit Margin denotes better efficiency of the company in generating high profit with low sales and administrative expenses and same sales.
Debt to Equity
The telecom companies use to take high debt to fund the initial investment requirement which is normally very high. The initial investment requirement is funded by debt and the interest is paid from the income. So the Debt-to-Equity ratio is a key financial ratio which should be used to evaluate a telecom company. It is calculated as:
Debt-to-Equity Ratio = Total Debt /Total Shareholders’ Equity
Lower the Debt-to-Equity, better the financial health of the company as lower debt results in lower interest payment from the profit.
Return on Equity
Return on Equity is also as an important financial parameter to evaluate the performance of a telecom company. This is mainly due to high equity investment. This is calculated as.
Return on Equity = Profit after Tax (PAT)/Equity or Net worth
Higher return on equity denotes better profit realization for a telecom company.
To do the valuation of a telecom company’s market share mainly the Price to Cash Flow (P/CF) price multiple is used instead of P/E ratio. The reasons behind the same.
Because of very high initial investment, depreciation is higher for the telecom companies which is a non-cash expense and manipulates the earnings. Because of this P/E ratio is not used to get the share valuation of a telecom company properly.
Because of high initial investment, high depreciation and high capital expenditure book value cannot give the proper insight about the share valuation of a telecom company. That’s why P/BV is not used as a price multiple.
Sales revenue can be manipulated very easily for a telecom company and it does not indicate the financial performance properly. That P/S ratio is not used to get the share valuation of a telecom company properly.
Because of these reasons, P/CF price multiple is mainly used to get the appropriate valuation of the market share price of a telecom company.
So P/CF is used as an important price multiple to compare the share price of a telecom company with other peer group companies. Higher P/CF ratio denotes the market share price as overvalued while the lower P/CF ratio denotes the market share price as undervalued.