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• Date: 19 August 2012
• Large Cap – Mkt Cap Rs 99,115 crores
• CMP: Rs 261
• Advice:  Accumulate in FY13 through SIP
• Target:  Mar ’14 target of 421

Summary

• We have seen a fall of share prices by 39% this year. There’s no doubt that Bharti Airtel has lost its status as a safe long-term investment and Blue Chip for investors. The reasons are obvious to mobile users – low consumer prices, intense competition, poor telecom governance, and the 2G scam. Also Airtel invested in Africa, and paid heavily for 3G & 4G licenses. 
• But Airtel remains the market share leader in Indian telecom and #5 by consumers worldwide.
• Launch of 3G, 4G and mCommerce (Airtel Money) means it has comprehensive service offerings.
• Businesses like Digital TV, fixed line, broadband, Enterprise telecom services and Passive Infra services all have synergies with the telecom core and also leadership in their niches.
• The investments in 3G, 4G and Africa operations will in time propel Airtel into a profitable global telecom business as a low cost leader with a factory approach to call volumes. 

What to do now: The period FY2013 will be a year of consolidation.

• The near term positive triggers include listing (IPO) of BhartiInfratel, exits by 4-5 competitors, auction of 2G licenses and refarming/ sale of spectrum. Airtel will see a return of Pricing power. 
• Share price fall to current levels is a market excess, and offers investors an attractive entry point.
• Long-term investors with a medium risk appetite can accumulate Airtel this year for a price target of 421 by August 2014.

Bharti Airtel – Description and Profile

• Airtel is the market leader in the Indian telecom sector. Incorporated in 1995, it is a global telecom operator ranked #5 today in terms of customers.
• Consolidated revenues are 71,505 crores (FY’12), and mkt cap is 99,115 cr. ranks it #13 in India.  Operations are spread over 20 countries and Airtel has an aggregate of 26.1 cr. customers. Of these, 20 cr. are in India itself.
• Businesses are classified as B2C – consumer and B2B – Business. The B2C are Mobile, Telemedia (IPTV, broadband and fixed line), Digital TV (DTH) and MCommerce. Africa is essentially a mobile market, and is B2C.

• Market shares are 19% by subscribers and 29% by revenue, indicating a superior ARPU profile.
• B2B services are Airtel Business (end to end telecom services) and Passive Infrastructure Services (towers)
• Shareholding pattern is: Promoters Indian 45.7% and Foreign 22.8%; FIIs 16.9%; DII 8.1%; Bodies Corporate 4.6 %; Individuals – retail & HNI 1.5 and Other non institutions 0.4%.

Industry Note

• The 2004-09 period with 2G and only 5-7 competitors looks like a happy phase from the distant past.
  • The controversial 2008 Telecom licenses brought in new players, intense competition and over Rs 50k crores of fresh investment into Indian Telecom.
  • The auction of 3G in May 2010 saw major players spend $13b (Rs 67,000 cr.). In retrospect they may have overpaid for this, as 3G adoptions has been slow after the launch.
  • Compared to this, the 4G licenses auction in 2010 raised $7.5b (Rs 38,000 cr.).
• The governance for Telecom involves TRAI, DoT, Ministry of Comm./IT and TDSAT for disputes.
• Per minute call tariff rates are among the lowest in the world. And the network expansion and 3G/4G rollouts are an ongoing capital-intensive requirement for many players.

• There are 15 operators in India – see Fig 2 for Subscriber Market Shares. Revenue market shares for Mar ’12 are Airtel 29%, Vodaphone 23% and Idea 15%.
• Most operators are not able to make operating profits. And the market is reaching a subscriber saturation point. Reports are that consolidation has started, as of these, three (Etisalat, Videocon, STel) may exit fully, and Uninor and SSTL may exit partially (Fitch).
• The total number of Indian subscribers of telecom services– wireless & wire line – is 95.1 cr. The tele-density is 78.5%. Broadband penetration is low at 1.1% (1.38 cr.).
• In Feb’12, 122 telecom licenses issued by govt. in 2008 were cancelled by the Supreme Court. Many of the players, especially newer ones, are hit as their future is uncertain, and an expensive public auction process may be used to reissue the licenses.  Airtel however is not affected directly.
• In the Mar’12 quarter, the total wireless subscriber base grew 2.83% to 91.9 cr. In terms of net additions, Idea led with 63.4 lakh followed by Uninor, Airtel and Vodafone with 61.3L, 55.8L and 27.4L respectively.
• Nearly 18 months after launch of 3G, there are merely 1.5-2 cr. subscribers, less than 2% of the GSM subscriber base of 91.9 cr. Of these Airtel has 80 lakh and Idea 26 lakh. 3G ARPU may be 90-100 Rs/ month.

Key Challenges and Strategic Responses:

1) Intense competition in Indian market due to 15 players.

• The Airtel strategic direction has changed from profitability to defending market share. This will help maintain overall revenue and growth, but signals lower profitability for a few quarters.
• Marketing & Sales activities include aggressive brand building, sports sponsorships and marketing campaigns in media.
• Bundling of Airtel’s consumer services is an opportunity. Currently this is being tapped through single payment mechanism with Airtel Money. If other synergies are tapped, this can improve product stickiness

2) Regulatory uncertainty in Telecom due to cancellation of 2008 licenses, separation of spectrum and licenses and non sharing of 3G customers among operators and a host of such issues

• Many ground rules are changing in this industry due to the initiatives by troika of Indian Govt., TRAI and DoT. This includes higher service charges, potential new charges like spectrum and license fees, excess spectrum charge, refarming of spectrum, non-sharing of 3G services among operators and restrictions in voice and internet ‘combi packs’ by TRAI.
• Airtel has joined other telecom players to vigorously defend its stance at TDSAT /Indian Courts.
• In a perverse situation, consolidation in Indian telecom is being accelerated by the licenses cancellation.

3) Heavy Investments: Airtel won a number of 3G licenses (2010) and in important circles, but at a high price. It also won 4G licenses, which it launched in 2012.

• 3G services have not initially taken off in the market as expected. Having spent large sums in the 3G auctions, Airtel is leading the push in 3G services with investments in m-Heath, m-Education, m-Commerce, e-governance, etc. and generating trials among current subscribers.
• Airtel has already launched 4G services (essentially for data) in Bangalore and Kolkata. It will launch soon in Delhi, Mumbai and Kerala.

4) Airtel acquired the African telecom assets of Zain in 2010, for USD $9 billion (Rs 49,500 cr.) in cash.

• This purchase provided entry into a high potential market and allows Airtel to start a second phase of corporate growth. (As per Airtel estimates), Africa will eventually overtake India and China as a telecom market – as population of Africa will peak at 1.8 – 2.0 billion.
• By leveraging their balance sheet and with sound financial engineering, Airtel was able to service this loan for only $200 m (Rs 1100cr.) per year in ‘10. The ‘13 revenue target for Africa is $5 billion (27.5k crores).
• However this market requires a couple of years of investments in markets for regulatory approvals, 3G rollout, network investments and marketing & sales to raise the profile of Airtel.

5) High debt due to purchase of Zain Africa, 3G and 4G, and network upgradation and expansion in all regions

• Airtel continues to be an outsourcing leader with partners for networks, IT, and support services.
• Airtel is planning on an IPO for its telecom tower unit BhartiInfratel Ltd. (BIL). This independent firm manages towers for any operator and listing this asset will help pare down debt.

6) Mobile Number Portability was perceived as a threat for Airtel. However, the first year of experience of this facility shows that Airtel is the second highest beneficiary of MNP.

Stock Valuation, Performance and Returns

• CMP is 261. In the last 8 years, the market price has appreciated at 12% per annum CAGR.  However, the share has fallen from a high of 565 in Oct ‘07 by 54%, and within last 1 year by 39% to today’s CMP. See Fig 3.
• Particularly worrying is the share price fall in August 2012, where after the Q1FY13 results on Aug 8th, the share fell by 14% in 3 days.
• The maiden dividend of 20% declared in FY09 has been kept steady at this rate for next two years.

• The quarterly sales and margins data, Fig 4, for the last 5 years is revealing:
  • The growth in Revenues is 31.1% and EBITDA too is up 25.7% CAGR over this period.
  • However Net Profit is flat, and the Profit margin has fallen in last 2 years from over 20% to 5% range.
• The EPS, Cash flow and Investments Chart – Fig 5 – shows that Cash Flow has increased 21.6% CAGR over the last 5 years. But the investments required by the business has consumed a lot of this cash.
• EPS peaked in 2010, and has fallen sharply thereafter.

• RoCE has fallen from 25% levels to 8.9% – a poor statistic; RoNW is 4.4%; Price/Book is 1.96.
• Debt / Equity is 1.36 for the consolidated entity, indicating fair leverage.

• The Price and PE Chart – Fig 6 – show that the average PE over last 5 years is 22.5.
• Current PE at 25.4 is in the Upper Quartile, at high levels, in spite of recent price fall.

• The Price and EPS chart – Fig 7 – clearly shows the EPS drop post April 2010.
• The key question is, when will this fall in EPS be arrested and resume its growth path?

Benchmarking and Financial Projections

In a benchmarking exercise, we compare Airtel with 3 other firms, Table 8.

• Airtel has healthy Sales growth, while Asset Turnover and EBITDA margins are excellent.
• The ROCE is low, and profit erosion and price fall are signs of weakness for Airtel.
• D/E is high but within the 2.0 times comfort zone
• The Airtel consolidated Financials are projected till FY 2015, Table 9.

Risks:

• Indian Telecom Regulatory and legal overhang.
• Revenue pressures from the Indian government. The govt. is looking to bridge deficits with larger revenues from Telecom industry.
• The current expectation is that M&As and exits will reduce competitive intensity in the sector. If this does not happen, it will affect profitability and margins.
• The interest rates have risen in India, increasing debt-servicing costs. Our expectations are that rates have peaked in India, and should fall going forward. Any change in this affects financial projections.

Opinion, Outlook and Recommendation

• The Telecom sector in India has achieved deep penetration, and voice services have been a language independent enabler of productivity, efficiency and knowledge. The success of Apple’s iPhone is an indication of future data services consumption, assuming the Indian market follows the developed markets trends.
• In future the sector revenues will be driven by volume and price increases, value added services, 3G adoption, internet and application usage, 4G and incremental penetration. With maturity, the telecom sector revenues will be a Consumer play, reflecting personal income growth and habits.
• Airtel is a volume leader in India, and is perceived as a technology leader with cutting edge offerings and the best network.  In Africa, the brand is slowly getting established.
• The current financial performance is a trough due to a combination of Indian telecom governance challenges, intense competition, high interest rates and investments in Indian 3G/ 4G networks and African operations.
• But FY2013 will see Airtel consolidating its leadership position in India & many African countries. In India about 6-7 players will exit or merge with other players due to investment/ profit pressures. After this, mobile call prices will rise, due to a return of pricing power. In FY14, the financial recovery will be swift & comprehensive.
• The June 2010 bottom for the Airtel share was Rs 255, has held firm so far till August 2012. There may be more consolidation at these levels in rest of FY13.
• The Mar 2014 target for Airtel is 421 based on a P/E target of 25 times and projections of financials. This is a 61% appreciation from current price levels. 

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The author can be contacted over email at punit.jain@jainmatrix.com or on www.jainmatrix.com

JainMatrix Knowledge Base:

Other reports on Telecom

• Telecom: Auctions speak louder than words – Article
• Indian Telecom at Cross-Roads – Article
• Indian Equity – Winds of Change – Article

Disclosure: It is safe to assume that if the JainMatrix website recommends a stock, the researcher has already invested in it.

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