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.

- 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.
- 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?
- 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.