Wisdomsmith on Bharti

An old Wisdomsmith post:

Markets over reacting on Bharti – Buy    

17.02.2010    

Wisdomsmith recommendation to investors:

Price	Action
>Rs  350	Book Profit
Rs 280 to 350	Hold
Rs 280	Buy

Source: www.wisdomsmith.com

The likely Zain deal has seen Bharti fall from Rs 330 levels to Rs 280 levels, a fall of 15 percent. We think this is an over reaction.

Before the deal was announced, Bharti had an market cap (mcap) of Rs 125000 crore (~28bn), and an EV of about Rs 130,000 crore (~$29n). A 15% correction meant that the mcap and entity value (EV) have fallen by about Rs 18000 crore. This is more than 2x what the market felt Bharti had overpaid for Zain.

Bharti valued Zain (the African part of it) at an EV of about $10.7bn. This was at an EV/EBITDA of 9.4x. At this time, Bhart was getting valued at about 8x.

Pre Deal	Bharti	Zen
EV (Rs Cr)	130,000	49000
EBITDA (Rs Cr)	16,000	5200
EV/EBITDA (x)	8.1	9.4

So the view was Bharti overpaid by 15 percent (9.4 divided by 8x), which is about $1.6bn or about Rs 7500 crore. So a simple view can be that the EV has fallen by Rs 10,500 crore more than it should have.

Let’s look at it from another level. After the announcement, Bharti has seen its EV come down to Rs 111,000 crore (EV/EBITA of 6.9x). Now we add to this Zain’s proposed EV by Bharti of Rs 49000 crore. This leads to a total EV of Rs 160,000 crore. We also add the two EBITDAs from the first table, to get total EBITDA of Rs 21,200 crore. So what is the EV/EBITDA now?

Pre Deal	Bharti	Bharti+Zain
EV (Rs Cr)	111,000	160,000
EBITDA (Rs Cr)	16,000	21,200
EV/EBITDA (x)	6.9	7.5

We get 7.5x.

Our question is this – Should the EV/EBITDA of Bharti fall post the acquisition? We don’t see why.

1. If Bharti had taken an undue financial risk, we would have agreed with the fall. But even if the entire deal was financed by debt, D/E rises to 1x, from 0.2 earlier. Bharti may dilute by about 15-20%, in which case D/E would 0.5x at best.
2. Look at Bharti’s business pre deal and post deal. The deal will clearly enhance addressable market, and growth rate for the combined entity. So if growth rate was going up, wouldn’t you want to bid up the valuations, rather than down?
3. The logic of Bharti overpaying uses current EBITDA. Zain’s EBITDA margin is 34 percent, much less than Bharti’s 40-41%. Bharti may be able to get it up to say 37-38%, or say 10% more than current levels.

These three factors can result in an upside of 25 percent from current prices, or about Rs 70 more from these levels. The downside is low. Even in Mar09, Bharti’s low was Rs 230, or about Rs 50 less than these levels. No reason to believe Bharti is headed that low. So more upside than downside.

Returns will be muted though, the upside could take 2 years to materialise. Bharti is too large to bust the charts now.

3G impact on telco revenue mix

How 3G changes revenue mix for Telcos

Icra is lately churning out some good reports. A report on 3G shows has this table which shows how data services start contributing significantly more to revenues once mobile companies launch 3G.  From around 15% t0 as high as 35% or so for Docomo.

In India, data is still less than 10% of Telco revenues. The table suggests data revenues can double for Telcos in 3-5 years of 3G launch. Tho havent seen numbers of likely 3G profitability. Most media discussions tend to suggest 3G is unlikely to make money in India either.

Spectrum Congestion in 2G telephony

Spectrum Congestion in Indian mobile telephony

 This is a chart from a recent ICRA report on 3G telephony. This shows subscribers per megahertz of spectrum in key mobile circles. What is interesting to note is that atleast the top 3 players are above the permissible limit of congestion.  No wonder prepaid subsribers find it hard to get through at peak hours. Telecom companies deny this, but user feedback seems to suggest that telecom companies discriminate in connecting calls for pre-pard (low ARPU) users and post paid (high ARPU) users. Try calling at peak hours from 2 phones: one pre-paid, and one post-paid, to know the difference.

This suggests that 3G licenses may get rapidly sold out, since that is one way of getting additional spectrum

Number Portability

Impact of Number Portability in Telecom Sector

Another interesting table from the ICRA report. This shows the impact of number portability in Hong Kong.  The subscriber churn was as high as 35% initially, before settling down to 16% by the fifth year.

But if number portability does come to India in the next year, the first 3 years will be another head ache for telecom companies as they try to figure out how to retain the valueable post paid customers. Another round of drop in ARPUs in the offing

Telecom – competitive mess

Conptitive Scenario in telecom circles

Incumbent telecom operators are in for a rough time. While so far there was a comfortable situation of 3 main contendors – Bharti, Reliance and Vodafone, and two challengers – Tatas and Idea (ignoring BSNL which will be systematically killed by govt, much like MTNL has been), now there is a dramatic increase in competition.

As this table from an ICRA report shows, each circle has 12 or so players now. And the two challengers have hiked competitive intensity, since they perhaps feel their path to profitability and size is more under threat.

Result – everyone will be hurt for the next 1-2 years. After that perhaps some consolidation can occur. Anyways, markets have been beating down the sector for the last 3 months. Telecom is the worst performing sector, down around 10% over 1 year, as compared to almost 100% returns by Sensex or Nifty

Essar in Telecom Retail – Inflated nos?

Essar Group said it is planning to invest around Rs 1,320 crore ($250-300 million) to set up a network of retail showrooms across the country. The investments will be over a three year period to set up around 4,000-5,000 mobile showrooms. Essar said it expects revenues of Rs 4,395 crore ($1 billion) by 2010.

Mobile telephony retail is an interested area. A few other people have plans for large national chains. But none have talked about the large nos Essar has. Essar seems to have taken a leaf out the the Reliance book. It is no secret that the Ruias have the Ambanis as some kind of role model. But so far, other than the Hutch jackpot, they have little to show.

Lets check the numbers above. Rs 1300 crore for 4000 outlets means around Rs 30 lakh per outlet. So does this mean Essar is planning to own all outlets (not the real estate, but the business itself)? That is rare. For a business like this, one would imagine franchisee route would be the way to go. In a large format like a hypermarket or even a departmental store, franchising wouldnt work, becos you need tight control on product delivery. Not so necessary in other formats. Reliance aims to own all its supermarkets, but that is not necessary. You could do a supermarket chain the franchisee route.

Also, projected revenues could be what – around 15% or more market share? That is ambitious too. Since everyone will sell mobile phones – the service provider, the hypermarket, the durable chains will sell mobiles too. Not to mention the grey market.

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Telecom Towers – another big infra opportunity

The telecom tower business seems set to offer 3rd party players a strong growth opportunity. That is what players like GTL Infra have been saying and betting upon. American Tower, the US company in this business, is also eyeing the Indian market, perhaps driven by the same thought.
Business will come from existing mobile players, who may want to outsource part of futre tower capacity, or where they may want to share infra with other telecom players. This is clear merit in the sharing argument, particularly in low traffic areas. Mobile market is increasingly moving to semi urban and rural areas. For example, the Vodafone chief said he would target rural India to get to a 100mn subscriber base by 2010 or so in India.
The govt is spending Rs 4000 crore of its own to promote infra. ET reports the bidding process has 22 active players. (see story)

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