Bharti Infratel IPO: Aggressive offering of Passive Infrastructure: Invest

SUMMARY

  • Date: Dec 6th 2012
  • Offering: Price Range Rs 210 – 240
  • Issue Period:  Dec 11 – 14
  • Retail gets an additional discount

Description: Bharti Infratel runs the tower network for Airtel, and also partners for this with Vodaphone and Idea. The business is sticky in terms of customers and has stable cash flows. The telecom sector is at an early stage of growth in India. Risks: The business is capital intensive. There is regulatory and litigation uncertainty. BIL has only recently turned Free Cash Flow positive. Opinion: BIL has the leadership and first mover advantage. The aggressive pricing may be justified by high growth, good financials, and resurgent industry. Invest for the long term, at Cut Off price.

Bharti Infratel – Description and Profile

  • Bharti Infratel (BIL) was started in 2006 as the tower subsidiary of Bharti Airtel. Revenues in FY12 were Rs 9597 crores with PAT 751 cr. Operating & profit margins are 38% & 7.8%.
  • BIL owns 33,000 towers, and holds 42% stake in Indus Towers, which has 110,000 towers. BIL thus owns 80,656 towers, a 21% share of the tower industry (and a combined 143,300 and 38%).
  • BIL, along with Indus, currently employ 2521 staff directly, and 5659 indirectly. Operations are spread across all 22 Telecom circles of India.
  • Currently Airtel owns about 86.1% of BIL, and PE firms 13.9%, see Fig 1. But Airtel will not sell any shares in IPO. So after the issue, its stake would fall to 79.4% and the PE firms will fall to 10.5%.
Fig 1 – Bharti Infratel Structure – Source Red Herring Prospectus

Fig 1 – Bharti Infratel Structure – Source Red Herring Prospectus

Why Is BIL going for an IPO?

The objects of the issue are:

  • Investments in Installation of 4,813 new towers – 1087 cr.
  • Upgradation and replacement on existing towers – 1214 cr.
  • Green initiatives at tower sites – 639 cr.
  • General corporate purpose and partial exit by investors Temasek Holding, Goldman Sachs, Anadale and Nomura – Over 1060 cr.

Soft Benefits:

  • In future Airtel can sell its shares and deleverage its stressed Balance Sheet.
  • Overall valuation of Airtel will get a boost on successful listing of BIL, since it retains 79% ownership.

Telecom Industry

  • The Indian telecom industry revenue reached Rs 1,36,100 cr. by Mar’12, and the mobile subscriber base is around 91.9 cr. Of that number, approximately 86.8 cr. are 2G subscribers and 5.1 cr. 3G.
  • The industry has gone through phases. While the 1990-’99 phase was an introduction phase, the 2000-’10 period saw massive industry and subscriber growth. We are now in a phase of hyper competition /consolidation, where operators may reduce from 12-15 to 6-8. For details, see LINK.
  • The business model is based on leasing of towers by service providers on 10-15 year contracts. There is customer stickiness and the revenue model is stable.
  • The total number of towers today is 376,000, and the Tower tenancy average rate for the industry is 1.7. BIL enjoys a higher tenancy of 1.9. The 1.7 – 1.8 range is considered the break-even point. Tenancies for independent telcos are estimated at around 1.46 times.
Fig 2 Industry Towers and Tenancy, Source Red Herring Prospectus

Fig 2 Industry Towers and Tenancy, Source RHP

  •  BIL is a pioneer in the industry as it initiated co-operation and alliances in the telecom towers industry. As a result, from being a competitive scenario, industry players were able to grow tower numbers rapidly and at the same time reduce costs of this critical infrastructure by sharing.
  • Airtel along with partners Vodaphone and Idea together having 68% of the mobile market by Revenue Market Share. They are also incumbents growing fastest. Thus BIL is in the safest position in the industry in the form of market share, growth prospects and revenue stability.
  • The key drivers for tower and tenancy growth will be: 1) Rural 2G expansion 2) new 3G capacity 3) Usage of higher frequencies 1800MHZ+ which is more tower intensive and 4) new 4G coverage.
  • Operating Costs structure of industry indicates that 50% of Opex is Energy, of which again 60% is Diesel costs. This is a risk as there is a good chance Diesel prices may be raised as it is subsidized.
  • Companies also face several barriers in the form of the complex and time-consuming approval process for the deployment of new towers, and public fear of radiation from current towers.
  • Industry players include Indus towers (109k towers), Reliance Infratel (50k), Bharti Infratel (33k), Viom Networks (42k), GTL Infra (33k), ATC (10k), Tower Vision (8k) and Ascend Telecom.
  • There are significant entry barriers for new players as the business is capital & technology intensive.

BIL financials:

  • We can see at a glance that financials are good. Revenues, EBITDA and PAT have increased at 23%, 31% and 57% CAGR over the last 3 years.  Fig 3.
Fig 3: Bharti Infratel Financials, JainMatrix Investments

Fig 3: Bharti Infratel Financials, JainMatrix Investments

  • The Free Cash flow of BIL has improved a lot from FY09, and turned positive in FY12. Fig 4.
  • Low debt-equity ratio of 0.2 times.
Fig 4: Bharti Infratel - Free Cash Flows

Fig 4: Bharti Infratel – Free Cash Flows

Key Strengths of BIL

  • Pioneering status in industry. Largest market share in a high growth industry.
  • Sharp business focus on growth and maintenance of passive telecom infrastructure.
  • Stable long term revenue visibility; High tower tenancy at 1.9 compared to industry average of 1.7
  • Low debt-equity ratio of 0.2 times, and Positive Free Cash Flows of late

Key Weaknesses/ Issues/ Challenges of BIL

  •  It’s a capital intensive business. As of now, BIL’s RoE was low at 5.3% in FY12.
  • Diesel is key input, and prices can be raised unexpectedly.
  • Industry in a financially stressed condition, due to regulatory overhang, hyper completion and stabilizing of subscriber growth. There is an ongoing consolidation in the industry.
  • While market pressures have resulted in consecutive quarter-on-quarter reduction in profits for several  companies including Bharti Airtel, a recent SC order on telecom licenses has forced operators to go slow on rollouts, reducing business for tower providers.
  • Regulatory uncertainty: BIL’s operations may be affected if certain proposed regulatory measures with respect to tower sharing among service providers, etc. are implemented.

Strategic Thoughts around this IPO

  • Telecom is a key infrastructure for a country, and the availability drives individual and corporate productivity. The benefits of mobiles are massive, and have changed our way of doing things.
  • Even today India is at an early phase of telecom usage. While raw penetration numbers indicate a saturation level, the fact is that (as per TRAI data of Mar ‘12) urban wireless penetration was 162.8% while rural wireless penetration was 38.3%, indicating:
    • New connections growth will essentially happen in rural areas, with churn in urban areas.
    • Market maturity will start with urban areas, where newer data intensive apps and smartphones will drive demand and consumption of telecom services.
  • Bharti Airtel is approaching the markets to list a firm after 10 years. The firm through this period has set new standards of business innovation, transparency, shareholder rewards and growth.
  • BIL has a unique model of passive infrastructure sharing, and cooperation among competitors.

IPO Offering Outline and Valuations:

  • Offer is of 18.89 cr. shares in price range Rs 210-240 available from Dec 11-14th.
  • This 10% dilution will collect upto Rs 4530 cr, and value the firm at 45,000 cr. market cap.
  • Market Lot – 50 Equity Shares
  • Maximum Subscription Amount for Retail Investor – Rs. 2,00,000
Valuations based on FY12 financials

PE range, TTM

 

PEG range, TTM

Forward EV/ EBITDA

Valuation per tower

Bharti Infratel

53 – 60 times

0.93 to 1.07 times

9-10.5 times

50-57 lakhs

Comments Aggressive pricing, but IPOs from leaders come at high prices Indicates fair valuation compared to growth rates Is reported to be cheap compared to global peers Is cheap compared to stake sale deals done in 2009 (78L) and 2007 (120-160L).

Fig 5: Multiple Valuation approaches

  • We can see that the Per Tower valuation has fallen significantly from 2007-09 levels. This can be explained by the current ‘hyper-competition’ phase of this industry. This may ease off in 2-3 years.
  • The reported forward EV/EBITDA value claims to be cheaper than global peers. However it should be noted that the Indian industry is very different from these, both from a development phase and a technology point of view, so this is a weak input.
  • While the PE range of the offering is high, it is justified by the growth, giving a fair PEG value range.
  • CRISIL Research assigns IPO grade ‘4/5’ to Bharti Infratel, indicating ‘above average’ fundamentals.

Opinion, Outlook and Recommendation

  • Telecom as a sector is at an early stage of growth in India. For BIL, the business model while capital intensive, generates good cash flows. Utilisation and tenancy can only improve from here.
  • The pricing, while apparently aggressive, commands a leadership premium and reflects a first mover advantage. Bharti Infratel is a good long term investment opportunity.
  • Airtel has always been a favourite among the institutions. The recent surge of Airtel stock by 36% from its Aug’12 lows is at least partially due to news of the BIL IPO.
  • With the recent uptick in the indices, BIL looks set to capture the imagination of newer investors. There may be pop on listing.
  •  Invest for the long term, at Cut Off price.
  • Check back on the website www.jainmatrix.com for updates.

JainMatrix Knowledge Base:

  • CARE IPO – they do care about shareholders – LINK
  • Bharti Airtel – This is a year of consolidation – LINK
  • Telecom – Auctions speak louder than words – LINK
  • TBZ: A Glittering IPO Offer – Invest  – LINK
  • MCX – 800 pound Gorilla of Commodities; Invest – LINK

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These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com Also see: https://jainmatrix.wordpress.com/disclaimer/

Telecom: Auctions speak louder than words

The Indian Telecom sector these days is going through a couple of nerve racking events that I will call as ‘growing up pains’.

News Updates

  • 15thNov 2012: the Telecom 2G spectrum auctions closed, with 57% of spectrum unsold due to high minimum bid prices, poor industry conditions and availability of spectrum with the older players. An amount of Rs 9,400 crores were collected from 5 firms, against the target of 40,000 crores.  The winners were Vodaphone (14 circles), Idea (8), Telenor (6), Videocon (6) and Bharti Airtel (1).
  • 10th Oct 2012: The Parthasarathi Shome committee set up by the government said retrospective amendments in tax laws targeting overseas M&A of companies with assets in India, should be scrapped. The recommendation is expected to bring major relief to British telecom giant Vodafone in its dispute with the income-tax department.
  • 2nd Feb 2012: the Supreme Court cancelled the 122 licenses issued in Jan 2008 by former telecom minister A Raja. It also directed the TRAI to make fresh recommendations for the telecom spectrum auction in future.
  • 19th May 2010: The 3G auctions ends with resounding success. After intense bidding, the auction collected 68,000 crores from 7 private and 2 govt players, about double the initial target.

Analysis:

  • The limited success of the Nov’12 auctions will have a strong impact on telecom regulation in India. Hopefully the government/ regulators will turn their attention to improving the health of the industry, reducing friction, litigation and excessive controls and restrictions.
  • Auction will continue to be the method of handover of telecom licenses and spectrum in the future. The difference is that the reserve prices, and total income from auctions will reflect realistic telecom market conditions and industry health.
  • How the market has changed completely in the last 2.5 years. The sector has gone from:
Indian Telecom Industry - Stages, JainMatrix Investments

Indian Telecom Industry – Stages, JainMatrix Investments (Click to enlarge graphic)

Action Points:

  • Bharti Airtel, Idea, Tata Comm, Reliance Comm and MTNL are listed. Of the above five, we are positive on Bharti Airtel (find report) and Idea.
  • Vodaphone is likely to have an IPO in next 2-3 years.
  • Bharti Airtel may list a subsidiary, Bharti Infratel, which owns their telecom Towers.

JainMatrix Knowledge Base:

Other reports on Telecom

  • Bharti Airtel: This is a year of consolidation – REPORT
  • Indian Telecom at Cross-Roads – Article
  • Indian Equity – Winds of Change – Article

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Bharti Airtel: This is a year of consolidation

_____________________________________________________________

  • 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.
Airtel - Business Segments, JainMatrix Investments

Fig 1 – Airtel – Business Segments, JainMatrix Investments

  • 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.
Telecom Market shares in March 2012, JainMatrix Investments

Fig 2 – Telecom Market shares in Mar’12, JainMatrix Investments (Click to enlarge)

  • 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.
Price 5 year Trend, JainMatrix Investments

Fig 3 – Price 5 year Trend, JainMatrix Investments

Quarterly Sales and Margins

Fig 4 – Quarterly Sales and Margins

  • 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.
EPS, Cash Flow and Capital Investments

Fig 5 – EPS, Cash Flow and Capital Investments

  • 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.
Airtel - Price and PE chart, TTM

Fig 6 – Airtel – Price and PE chart, TTM

  • 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.
Price and EPS Chart TTM, JainMatrix Investments

Fig 7 – Price and EPS Chart TTM, JainMatrix Investments

  • 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.

Benchmarking Analysis, JainMatrix Investments

Table 8 – Benchmarking Analysis, JainMatrix Investments

  • 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.
Financial Projections, JainMatrix Investments

Table 9 – Financial Projections, JainMatrix Investments

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. 

_____________________________________________________________

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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Indian Telecom at Cross-Roads

Feb 03, 2012 – The SC judgement striking down 122 telecom licenses from 2008 is a sharp indictment on governance in Indian Telecom. First Come First Served is a poor way to award licenses. The maximum damage may be to the new Telecom operators, and to business confidence of foreign investors. The justice process has just started with this judgement. Indian retail investors need to stay with Bharti Airtel (see report)

The headlines in all the newspapers today is about the Telecom judgement by the Supreme Court. A complex case that has been 3 years in the making. Yet most of the points do not get to the root of the issue at hand, and it is:

First Come First Serve is for Bus Stops !!

Any experienced professional will be able to tell you that any proposal for a business initiative consists of two parts – Technical ability and Financial proposal. This is true in Private sector and government; for purchases of goods,  services and projects.

The defense of Mr Raja for his deeds was a desire to introduce higher competition in the Indian Telecom market.  This itself is a bit debatable. There were 8 players in the industry in 2007. By introducing hyper-competition, he has changed the business rules for all the operators (in 2007)  overnight.

Lets ignore this aspect, and move on to the process of introduction of new players. Can a First Come First Served process give results here? Are moneybags and speed the only requirements for the new licenses? This is the work of novices. The right way is to invite technical and financial bids from corporates (and joint venture partners) who wish to enter this business. Here if you want to favour Indian firms, the right way is to set the conditions that the primary partner is Indian, and the JV must commit to have a certain 76:24 (for example) maximum partnership, and invite bids in a proper timeframe.

This aspect has been messed up and not understood by government authorities. When the subject of ‘opening up Indian skies’ came up, the government in its wisdom actually disqualified applicant firms that had foreign airlines as partners. A case of shooting yourself in the foot. All this when the biggest mess is at the government’s Air India itself. But I digress from the telecom sector.

Once the FCFS rule was in place, and the cost of licenses is so low, how do you control the number of applicants? The whole SC pronouncement is based around the arbitrary method and cut off dates chosen by Raja.

The right way to decide is a transparent evaluation of Technical & Financial bids. By experts. So that the bid winners are chosen on the basis of some merit and a better financial offer.

There are multiple parties to this SC judgement. The government (Ministers + telecom department), the TRAI and Telecom commission, the mobile operators, and consumers. How will justice prevail across all these parties? Consumers may not be much affected. They can stay if their operator survives, or use MNP to switch.

The biggest losers are the operators, and their MNC partners. Some of these took advantage of the licenses and sold it/ brought in MNC partners at huge valuations/ profits to themselves. There were no restrictions on this. Thereafter the firms may have made large investments to roll out the networks.  In the interest of business stability, these different entities need to be dealt with separately. Current players who have made investments must be given priority for new licenses.

The Ministers/ government/ TRAI and DOT have egg on their faces for creating this problem.  The New Telecom Policy should be able to provide a stable governance for this vitally important sector. By not staying on top of a rapidly evolving and important sector, the government has displayed incompetence, arbitrariness, partiality, opaque decisions and at best naivete in governance. At worst outright corruption. And First Come First Serve is for bus stops and restaurants. Not industry !!

The second largest telecom market in the world might just have the most incompetent administrators. Time for a big correction here.

In terms of the stock market effect of this scam, the only listed firms are Bharti Airtel, Idea, Reliance Comm, Tata Comm and MTNL.

The sector has underperformed in the last one year, see Figure 1.

JainMatrix Investing

Fig 1 - Telecom Sector Price Performance

The dust will take months to settle now. There will be exits (likely Telenor), counter litigation (likely older operators of Idea and Tata) and withdrawal of additional FDI.

As an Investor, I had predicted that Bharti Airtel will be least affected by the regulatory uncertainty. LINK. Investors are advised to stay with this stock.

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Bharti Airtel – Take the call

  • Date: November12, 2011
  • CMP: Rs 396; Large Cap
  • Advice: Safe long term investment
  • Target: 18 month – 800

There is an update on this report called Bharti Airtel – This is a year of consolidation (Aug 2012) available for readers. 

Bharti Airtel is a large telecom player. The market leading India business is seeing high competition, but going forward the profitability will stabilize and improve. The next growth engines are Indian 3G and the 16 country African acquisition.  Invest for the long term in this Indian – going – MNC Blue Chip.

Bharti Airtel – Description and Profile

  • Bharti Airtel is the market leader in the Indian telecom sector. Incorporated as recently as 1995, it is a global telecom operator ranked #5 today in terms of customers.
  • Standalone turnover is Rs 38,000 crores (FY’11), and the Market Cap at Rs 1,50,000 crores ranks it #7 in India.  Consolidated revenues in Q2FY12 was Rs 17,200 crore (annualized Rs 61,000 crore)
  • Other than India, Operations are spread over 18+ countries including Bangladesh, Sri Lanka and the African continent. Airtel has an aggregate of 237 million customers as of September 2011.

Businesses are classified as B2C and B2B

  • B2C operations include Mobile, Telemedia (broadband, IPTV and fixed line), and Digital TV (DTH)
  • B2B operations are Enterprise services (end to end telecom services) and Passive Infrastructure Services (Telecom towers)
  • Africa for Airtel is essentially a market for mobile services and Passive Infrastructure Services (Telecom towers)
Bharti Airtel, JainMatrix Investments

Fig 1 – The revenue proportions from business segments (click graphic to enlarge)

  • Strategic Partner – Singapore Telecom is a key Partner and investor in Bharti Airtel.
  • Equipment and Technology Partners – excellence from specialists
  1. For network and telecom equipment, the partners are Ericsson, Nokia Siemens Networks (NSN), Huawei, Alcatel Lucent, ECI, Tejas Networks and Cisco
  2. IBM is the partner for all business and enterprise IT systems, across geographies
  3. The Call Center expertise is from partners like IBM Daksh, Mphasis, Firstsource, Aegis, Tech Mahindra Teleperformance, and HGSL
  • Shareholding pattern is: Promoters 45.5%, Foreign Strategic Partner 22.8%;  FIIs 17.1%;  DII 8.7%; Bodies Corporate 4.1 %; Individuals – retail and Other 1.8%

Industry Snapshot

  • The total number of Indian subscribers of telecom services– wireless & wire line – is 88.6 crores. The tele-density is 73.97% (on 30/06/11), an increase of 4.69% over the previous quarter
  • Gross Revenue during the quarter was 46,891 crores, an increase of 3.03% over the previous quarter
  • The policy environment for Telecom is driven by TRAI, DoT and the Ministry of Communication & IT
  • There are 15 players in the telecom operator space, including PSUs. Here is a comparison of the larger players

Company

Subscribers

millions

ARPU

Rs/ month

MoU

minutes

ARPM

Rs/minute

Market Share %

3G licenses won

3G Bid

Rs Billion

Bharti Airtel

172.51

192

454

0.42

19.91

13 circles

122.95

RCom

144.51

105.8

240

0.44

16.77

13 circles

85.85

Idea

95.11

165.2

413

0.40

11.12

11 circles

57.68

Industry

885.99

93.44

329

100

7 private firms have won 71 circles among them

506

Above telecom data is from April and June 2011 quarters, from TRAI and public reports

Key challenges for Bharti Airtel and strategies being followed:

Bharti Airtel, JainMatrix Investements

  • Focus on network improvements, customer support and new service launches, so Airtel is seen as a stable, technically superior and quality service provider

2.       The draft National Telecom Policy 2011 attempts to ease conditions for M&A in the telecom sector, promote the ‘One Nation-One License’, and possibly infrastructure status for the industry

  • These policies are seen as boosts for the sector, particularly the larger players like Airtel
  • It will hasten the end of the intense competition phase and, through alliances and M&A, lower the number of players to 6-8. This can permit profitable telecom operations for most players.

3.       Airtel won a number of 3G licenses in important circles, but at a high price

  • 3G is the next big thing for Indian telecom players. Driven by a growth in smartphone sales, enabled by the telecom operators, a whole new ecosystem of content, services and functionality is being set up. This includes internet browsing, entertainment services, application stores, video calling, enterprise services, m-Heath, m-Education, m-Commerce, e-governance, etc.  These will drive usage, 3G penetration, subscriptions and ARPU, and help monetize the 3G license assets.

4.       Regulatory uncertainties on issues like Excess spectrum charge, license renewal fees, formation of 3G roaming alliances

  • By working with the industry bodies such as COAI, Bharti Airtel is defending its position on these issues. Many of these new conditions impose additional costs on the Telecom operators, which are unplanned for.

5.       Airtel acquired the African telecom assets of Zain in 2010, for USD $9 billion in cash.

  • This purchase is of a high growth franchise. 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 the balance sheet and sound financial engineering, Airtel was able to service this loan for only $200m per year in 2010.

6.       Mobile Number Portability was perceived as a threat for Airtel. However, the first year of experience of this consumer facility shows that it has not materially reduced market shares.

Stock valuation, performance and returns

  • CMP is 395. In the last 7 years, the market price has appreciated at 21% per annum CAGR.  It is below the all time high of 565 in Oct 2007. See Fig 3.
  • However, prices are on an uptrend in the last year or so. PE at 21.5 is still well below the 7 year range of 27.5

Bharti Airtel, JainMatrix Investements

  • EPS growth in the last 7 years has been 35% CAGR. Even so, we can see the trends – EPS had a rapid expansion from 2005 to 2009, but has fallen off in the last 2 years.
  • The Good News? Expectations now are that the period of falling consumer prices in telecom are over. The hyper competition phase has played out, and EPS will stabilize and start their climb once again for Airtel.
Bharti Airtel, JainMatrix Investments

Fig 4 – Price and EPS Trends

  • Sales have grown steadily at 23.4% over the past 7 years. Net profits have also appreciated at 21.3%. We can see however, that profits which were rising rapidly till 2009, have tapered down recently. This is due to industry hyper competition.
Bharti Airtel, JainMatrix Investments

Fig 5 – Sales and Profits Trends (click to enlarge)

  • Telecom is a very resource intensive business. Airtel has managed this well, and has grown the Cash generated from operations at 28% CAGR over the last 7 years. EPS growth has been higher at 35%.
Bharti Airtel, JainMatrix Investments

Fig 6 – Cash Flow and EPS Trends

  • RoCE is at 16% – healthy statistic; RoNW is 17.6%; Price/Book is 3.42
  • Debt / Equity is 0.7 for the consolidated entity. This is a comfortable level for a telecom player.
  • PEG is at 0.61 – indicates it is underpriced, and a good investment opportunity, especially given it’s Blue Chip status

Risks:

  • Poor regulatory conditions in India. The telecom sector continues to be buffeted by ad-hoc ism in policy matters, and overlapping jurisdictions of TRAI, DoT and the Ministry. The revenue short government may exert additional pressure to raise receipts, sacrificing industry growth.
  • The current policy directive is to allow M&As and reduce competition intensity in the sector. If this is not implemented, or even reversed in some way, the hyper competition environment may continue to haunt this sector, affecting profitability and margins.
  • The interest rate has risen in India. This increases debt servicing costs. Expectations are that rates have peaked in India, and should fall going forward.
  • Revenue and capital leakage into unrelated diversifications of Bharti group like Retail, Insurance, foods, etc. However this risk is fading as Bharti Airtel corporate governance standards are high, and investments are being made independently by the holding company, Bharti Enterprises.

Opinion, Outlook and Recommendation

  • Airtel essentially has two large businesses, India (mature asset) and Africa (growth).
  1. In India, the major investments have been made; the revenues are large and growing, and the high competition is expected to ease up. Over the next few quarters, all metrics will point up – Cash flow, operating margins and net profits, in addition to revenues which has held up well.
  2. In Africa, we will see Airtel slowly establish itself, move from #3, 4 or 5 in the market to #1 or 2. In country after country, it is engaging with the government, trade and consumers, to roll out its ‘minutes factory’, ‘network infrastructure sharing’ and ‘partner with the best vendors’ approach.  The 2013 target for Airtel Africa is $5 billion of revenues.
  • The recent bottom of the Airtel share was Rs 255 in June 2010. The share has been moving up thereafter and has appreciated 55% to today’s 396. The stock will continue its upward march, as it continues to deliver on stated corporate goals.
  • At current levels, Airtel share is above 20, 50 and 200 DMA levels. See Fig 7. This indicates the share is likely to continue to move up.
Bharti Airtel, JainMatrix Investments

Fig 7 – Airtel stock is above 20, 50 and 200 DMAs

  • I recommended the Airtel stock in my report in December 2010. See Link.
  • I reiterate my recommendation to Buy.  My 18 month target for this stock is 800.

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  • Check back on the website www.jainmatrix.com for updates.
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Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

Also see: https://jainmatrix.wordpress.com/disclaimer/

Bharti Airtel – CMP:331 – 2 years target 800 – Invest

Bharti Airtel is a bit of an enigmatic company. Emerging from humble origins, it has risen rapidly in the last decade to be today the largest telecom company in India by subscribers, revenues and profitability.

Leaving in its wake the famed business houses of India. It is #7 in India in market cap.

I first entered this stock in 2004; at this time, the stock was trading at a P/E of about 100. The market price was about Rs 161, and had risen from about 22 a few years before. Pretty soon, the price fell 15%.  I held on, thought about it, and then bought some more shares.

Here’s why.

Profile and the growth path

Bharti Airtel Fig 1 – In the last 1.5 years Airtel has under performed. This will change in the next two quarters.

  • Like many new industries, the mobile Telecom industry has emerged from chaos. Even today, the DoT, TRAI and Ministry of Telecom have brought to this sector little clarity, poor governance and transparency. Even so, today at least it is better regulated than 7-8 years ago.
  • In these circumstances, the story of Bharti Airtel is impressive.
  • They follow an outsourcing model and have brought on the best vendors in the world – IBM for software, and Ericsson, Nokia, and Siemens for telecom network – equipment. Today Airtel has the widest all India telecom network
  • More than good vendors, what was commendable was the engagement model with these vendors. All were hired on a SLA based revenue model, where earnings were proportional to number of subscribers and performance against SLAs. At one stroke the Enterprise – Vendor relationship changed from a tug-of war based on negotiation to one of win-win with aligned objectives. These deals in the early 2000s were admired worldwide for their superior structure.
  • Airtel thereafter was free to concentrate on the things that are core to the company – the Airtel brand, the customer experience, customer service and new business avenues
  • Airtel has added several business to its portfolio and now provides Mobile, Telemedia (broadband, IPTV and fixed line), Enterprise (end to end telecom services) and Digital TV (DTH) services – all high growth businesses related to mobile phone services.
  • When the next technology was introduced – 3G, Airtel was ready and won the largest number of circles in the very expensive auction.
  • In the 2007 – 10 period Airtel executed on a strategy to grow overseas. It has successfully launched operations in Bangladesh, Sri Lanka, (through the Zain acquisition), in Africa, totally 19 countries.

Common criticisms of Bharti Airtel, and my take on them:

Criticisms of Airtel My response
1. Airtel paid too much for the Zain acquisition in 2010, and this debt will dampen profits in the years to come They paid $9 billion, in the form of cash. However, by applying fair leverage of balance sheet and good financial engineering, they claim that debt servicing will only cost $200m per year.In fact 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
2. Airtel paid too much for 3G in the auction, and this will also hit performance Airtel paid Rs 15,609 crores to get 3G licenses in 13 circles. However, this gives Airtel access to lucrative markets such as Delhi, Mumbai, Andhra Pradesh, Karnataka and Tamil Nadu. This covers 5 of the top 6 cities of India.
3. Airtel has spread itself thin outside India in Africa and 3-4 Asian countries, this is a recipe for disasterFig 2 – Net Cash from operations has shown a steady and substantial growth In India, the penetration is crossed 50% and growth in subscribers will slow. Investments required in networks too have been made. This market is expected to grow now in terms of ARPU as consumers become affluent. Cash flow from operations is expected to increase rapidly, see Fig 2belowAirtel realized that it can now look at new markets, and roll out it’s successful Indian model elsewhere. The most logical market is Africa where mobile penetration is far less than India, and characteristics show that Airtel can develop this market and reap long-term dividends.Bangladesh and Sri Lanka are small markets, but similar to India, and Airtel found entry opportunities here also.

In fact the management of Airtel has found new challenges in these new markets after stabilizing the Indian operations.

4.       There is too high competition in India, and telecom companies here including Airtel are doomed to subpar performance for many years While there are 12-14 players in the current Indian telecom market, it is expected that this number will reduce over the next 1-2 years. This is due to a combination of heavy initial investment required for network rollout and severe pricing pressure due to competition. Inevitably the viability of the market has reduced and newer players have been unable to justify additional investments.This will be positive for Airtel also as it may snap up some of these players, and certainly will soon face less competition in this market.
5.       Just when people were getting convinced about Airtel, the share price plummeted in 2008-9 and it is now a poor stock The stock market recognized the high competition scenario and slowing growth characteristics. Hence the high P/E that players got earlier were reduced sharply and the market prices fell – for all telecom. However, see Fig 3, the EPS growth of Airtel has remained stable.
6. The Telecom sector in India is under a cloud due to regulatory problems, scams, etc. This is expected to clear up soon due to high visibility from media and political parties. In fact with valuations low and uncertainty high, it is a good time to look at an investment in Airtel.

Fig 2: Cash Flow from Operations

Fig 3: Steady increase in Airtel EPS over last 5 years.  EPS is Expected to stabilize now in 2 quarters and grow again.      

Fig 4: Development of Indian Telecom – Source TRAI

Conclusions, projections and Investment advise:

Conclusions

  • Today as the seventh largest Indian firm by market cap, Airtel is poised to show huge multi year growth, profitability and cash flow from Indian and International operations
  • As the 5th largest telecom company globally, Airtel is poised in the next 5 years to explode in terms of revenue, profits and subscriber numbers, eventually encircling the current global leaders.
  • My opinion of Bharti is that it is a fantastic company, run by some of the best and experienced telecom businessmen. They have succeeded in the Indian environment, and will not just continue on this path here, but will also translate this experience to new geographies – of Asia and Africa.
  • Hyper-competition in India has resulted in a temporary blip in performance of the industry. This is created by poor regulation and governmental interference.
  • In spite of these circumstances, Airtel has maintained a good revenue and profit performance, keeping an efficient organization, investing in required capital equipment and riding though this rough patch.
  • MNC telecoms with deep pockets have not been able to overtake Airtel, which is staying ahead.
  • Rapid yet steady increase in cash flow will be used to both lower debt levels and invest in African markets, which will increase profits. Also Airtel is the only telecom firm in India paying dividends.

Fig 5 – Airtel’s PE is far lower than the average over the last 5 years. It will return to 25-30 levels.

Projections

  • As an investor, I would say, this 1-2 year period is the opportunity to buy, for outsized returns over the next decade. In 2 years the telecom sector will recapture investor interest and Airtel will reach my price target of 800.
  • Basis for projection:  (1) stabilization of African operations (2) consolidation in number of Indian telecom players from current 14 to 8-10 leading to reduction in pricing pressures (3) successful 3G launch in 5 of India’s top 6 cities plus partnerships in others; and (4) Launch of number portability will see customers gains for Airtel (5) These will result in growth in market share for Airtel (6) Likely clarity in Indian telecom industry governance and regulation in 8-12 months, with Airtel generally benefiting.