Air Link IPO: looking for working capital

If all goes well, a leading mobile-phone distributor may soon be heading to the bourse. The Lahore-based Air Link Communications Limited is looking to offload 90 million ordinary shares – about 60 million new shares (new issue), along with 30 million existing shares that belong to its CEO – at a floor price of Rs56 per share, as per the revised prospectus published by the PSX dated February 13. Three quarters of the shares on offer will go to the institutional investors and the remaining to retail investors.

Incorporated in 2014, Air Link Limited operates in the market of mobile phone imports, having a market share of at least 20 percent. After acquiring all assets and liabilities of its predecessor Air Link (AOP) in FY19, Air Link Limited became a major distributor of mobile phones of a variety of brands including Huawei, Samsung, Apple, TCL and Tecno. The company is looking to generate Rs3.84 billion worth of funds – about Rs3.36 billion (60 mn new shares at a minimum price of Rs56/share) from the “new issue” in this IPO and another Rs0.48 billion from a short-term financing facility.

About 77 percent of those proceeds will be injected as working capital to build inventories of mobile phones in the face of 50 percent anticipated growth in mobile phones that the company expects to sell in FY20. Beyond such business enhancement, the remaining 23 percent will foot the capital and operating expenses of developing 26 new retail outlets in FY20 and FY21, to achieve forward integration.

Companies that have something to do with the smartphone value-chain are poised for a bright future in Pakistan. With smartphone penetration at 35 percent of the population, growing coverage of 3G/4G services, and the youthful country finding ways to get linked with the on-demand economy like e-commerce, and ride-sharing, there is vast scope for smartphone sales to first-time customers as well as replacement customers.

While the company has experienced management and a strong network of partnerships with smartphone majors, potential investors will be better off evaluating the broader market within which mobile phone importers and distributors like Air Link operate. Within that relevant market, which was valued at Rs103 billion at the import stage in FY19, recent years have been a mixed bag for the legitimate players.

On one hand, the regulatory crackdown on smuggled phones, as well as withdrawal of duty-free mobile import under the baggage facility, has directly helped the official importers and distributors. This is because suddenly a third of the overall market, which was previously dominated by “grey” business, is now open for legitimate players to do business in. Only devices registered and duty-paid-for under the PTA’s DIRBS system can operate in Pakistan.

On the other hand, the massive rupee devaluation since 2018 has made smartphones extremely costly, especially the Apple and Samsung types. In the medium-end of the market, Huawei has done well through its several price points. But the demand in Pakistan’s largely low-income market mainly seems to be for low-end, budget smartphones, which yield lower profit margins for importers and distributors.

Although the FBR has been recently signaled that it is against imposing further duties on mobile handset imports, it is plausible that the government decided to squeeze some more import-stage taxes out of incoming devices in the upcoming budget. This, and a next round of currency depreciation, may further affect consumer demand.

In addition, while local assembly of smartphones will be good for the country, it may not be that good for companies like Air Link, unless they also set up a local assembly unit themselves or through a JV. While the government is working on a Mobile Device Manufacturing Policy, the few players who are already active in this market may have a head start.

Coming to the numbers, the company’s financials are a bit muddled. Since entire group business was transferred to Air Link Limited in FY19, the financials need to be carefully understood. This is important because the company that is going for an IPO has only been in operations as a company for just two years. There is not much like-for-like financial history to compare latest numbers with.

But taking the financials at face value, on the positive side, business revenues jumped from Rs2.3 billion in FY14 to Rs29.8 billion in FY19. Profit margins have also been stable in recent years, with gross margin at 13 percent, operating margin at 11 percent, and net margin at 5 percent. On the other hand, borrowings have jumped in recent years, signifying financing needs for working capital. Besides having high leverage, Air Link has been running significantly negative cash flows from operations in recent years.

The valuation of a wholesale or distribution business depends mostly on its cash flows and earnings; however, specific assumptions on those two counts are missing in the prospectus. In the end, the prospectus ends up comparing Air Link with a diverse set of local companies and a couple of international mobile phone retailers that also have electronics, automotive and grocery business. The consultant/book runner could have done a better job at explaining the rationale behind Air Link’s valuation.