Please refer to the disclaimer towards the end of the document.

India Equity Research

Telecom
June 02, 2010
Telecom Sector
Large potential rebound as earnings recover after Mar11
Sector Update The fall in market capitalization triggered by the
TRAI proposals
reflects a worst‐case assessment. It overlooks the robust cash flow
that can manage the burden of the 3G business as well as the
additional levy for 2G spectrum. FY11f would bear the brunt, with
up
to a 1.7% fall in EBITDA margin and 5.9% fall in net profit margin.
However, the recovery is likely to begin in FY12f with a three‐year
net
profit CAGR of 66%. This could catalyze a recovery in valuations,
leading to a potential upside of between 74% and 160% by end
FY12.
Worst may be priced in
The market capitalization of the three large telecom stocks fell by up to
21%
within days of the TRAI proposals, considerably more than the cuts to
their
earnings forecasts. The erosion in market capitalization also exceeds
the
present value of the potential erosion in net profits. This suggests that
the
worst‐case assessment of the impact of the 3G business, possible
investments
in BWA and the probable implementation of the TRAI proposals have
been
priced in.
Cashflow is robust enough to absorb burden of 2G cess and 3G
Should the recent TRAI proposals on additional levy for 2G spectrum be
implemented, providers would need to make a one‐time payment. We
estimate cash outflow of INR46bn and INR15bn for BHARTI and IDEA,
respectively. This would be in addition to the payments for 3G licenses
and
capital expenditure required to roll out 3G services. Consequently,
gearing
would rise by up to 1.1x. However, the operating cashflow of operators
is
robust enough to absorb the impact of these blows.
Low impact on EBITDA margin over the medium term
Continuance of subscriber‐linked criteria for six more months may
sustain the
downward pressure on tariffs. Also, the proposed M&A guidelines
contain
elements that may delay consolidation. Incumbents have demonstrated
their
resilience to such conditions. The change in regulatory levies is likely to
have
low impact on EBITDA margins in the medium term. However, net
profit margin
is likely to fall due to increase in interest costs and amortization.
Large potential upside as earnings likely to recover after Mar11f
The brunt of the above developments is likely to be felt in the year
ending
Mar11. We foresee a rebound in net profits starting FY12f, leading to a
three‐year CAGR of up to 66%. The forecasts may need to be
reassessed,
positively, if the TRAI proposals were to be amended. Should valuations
revert
to a ‘normal’ range, stock prices could rebound by up to 160% by end
Mar12f.
(%) 1‐m 6‐m 12‐m
Nifty ‐3 ‐1 13
Telecom Index* ‐13 ‐12 ‐38
Source: Bloomberg, Avendus research
Note* Market cap weighted index created with BHARTI,
RCOM and IDEA
Cashflows (INRbn)
‐240
‐60
120
300
BHARTI RCOM IDEA
Source: Company, TRAI, Avendus Research
Op. cashflow ‐ FY11f and FY12f
Outflow for 3G, BWA, TRAI
EBITDA margin (%)
23
29
35
41
FY10 FY11f FY12f FY13f FY14f
Source: Company, TRAI, Avendus Research
BHARTI RCOM IDEA
1‐yr forward EV/EBITDA (x)
0
4
8
12
BHARTI RCOM IDEA
Source: Company, Bloomberg, Avendus Research
Current Case A Case B Case C
Abhay Moghe, +91 022 66842857
abhay.moghe@avendus.com
India Equity Research Telecom Sector
Telecom 2
Table of Contents
Investment
summary....................................................................................................
.................... 3
Cashflow is robust enough to absorb burden of 2G cess and
3G..........................................................3
Low impact on EBITDA margin over the medium
term.........................................................................3
Tariff war may extend, consolidation may be
delayed .........................................................................3
Worst priced in, potential upside as earnings recover after
Mar11f ....................................................3
Cashflow is robust enough to absorb burden of 2G cess and
3G...................................................... 4
Incumbents may need to pay for excess 2G
spectrum..........................................................................4
3G win to increase the cash outgo
further............................................................................................5
Significant increase in gearing may call for equity
infusion ..................................................................5
Robust cashflow can absorb the burden of increased
gearing .............................................................6
Low impact on EBITDA margin over the medium
term..................................................................... 7
Change in policy may increase recurring spectrum
fees .......................................................................7
Lower license fees may partly offset this
impact ..................................................................................7
Higher interest costs and amortization may impact
profitability..........................................................7
Tariff war may extend, consolidation may be
delayed...................................................................... 9
Forces that could hasten consolidation may be
weakened ..................................................................9
Tariff war may extend, if linkage of spectrum to subscribers
persists ..................................................9
But incumbents have been resilient to competition till
now ..............................................................10
Spectrum sharing may benefit new
entrants ......................................................................................10
Worst priced in, potential upside as earnings recover after
Mar11f .............................................. 11
Stock prices have reacted faster than earnings
forecasts ...................................................................11
Earnings rebound likely to begin after Mar11; ROCEs to
stabilize ......................................................11
Erosion in market capitalization exceeds erosion in
profits ................................................................11
Low probability of complete implementation of
proposals ................................................................12
Scaling back of proposals may lead to re‐
rating..................................................................................12
Re‐rating, EBITDA growth may lead to significant potential
upside....................................................13
Annexure ...................................................................................................
..................................... 15
India Equity Research Telecom Sector
Telecom 3
Investment summary
Over the medium term, two large cash outflows for Indian telecom
providers are expenses for the 3G business and the
additional levies proposed by TRAI. We find that the internal cashflow
being generated by large telecom providers is big
enough to manage the burden of both. The TRAI proposals could pull
down FY11f EBITDA margins by up to 1.7% and net
profit margin by up to 5.9%. However, profitability is likely to recover in
the following years. The proposals tend to delay
the end of the tariff war and, thus, provide some relative advantage to
newcomers. The market capitalization of
providers may reflect a worst‐case assessment of the impact of these
proposals. It also presents an opportunity for a
significant medium‐term upside. FY11f is likely to mark the bottom and
net profits may report a three‐year CAGR of
66%. This could catalyze a recovery in valuations, leading to a potential
upside of between 74% and 160% by end FY12f.
Cashflow is robust enough to absorb burden of 2G cess and 3G
Should the recent proposals of Telecom Regulatory Authority of India
(TRAI) be implemented, the
outflow would be INR46bn for Bharti Airtel (BHARTI IN, Hold) and
INR15bn for Idea Cellular (IDEA IN,
Buy). They would need to pay more for 3G licenses and related capital
expenditure. While, gearing
would rise by up to 1.1x, the operating cashflow of operators is robust
enough to absorb the impact of
these blows. Outflow would decrease, if a part of the capital
expenditure were funded by new equity.
Low impact on EBITDA margin over the medium term
A rise in spectrum fees and fall in license fee would depress the EBITDA
margin for FY11f by up to 1.7%.
The rise in interest expense would pull down FY11f net profit margin by
up to 5.9%. Starting FY12f,
EBITDA margins may recover due to a decrease in license fees. In FY14f,
the net impact of the change in
spectrum and license fees on EBITDA margins is likely to be ‐0.6% for
BHARTI and 1.1% for IDEA.
Tariff war may extend, consolidation may be delayed
The proposals may extend the tariff war by continuing to link spectrum
to subscribers. The norms for
mergers too may be made more conservative by mandating a lower
ceiling for market share and a
larger number of providers. Data for the past five quarters reveals that
incumbents have held out well
against such forces by preserving their share of revenue even as they
lose market share in the number
of subscribers. The proposals for sharing of spectrum may provide
some advantage to newcomers.
Worst priced in, potential upside as earnings recover after Mar11f
The erosion in market value exceeds the present value of the potential
erosion in net profits. This
suggests that the worst‐case assessment of the impact of TRAI
proposals has been priced in. Net profits
for FY11f are likely to bear the brunt of the impact of these proposals,
as well as of the higher gearing
resulting from funding 3G. We foresee a rebound in net profits starting
FY12f, leading to a three‐year
CAGR of up to 66%. The forecasts may need to reassessed, positively, if
the TRAI proposals were to be
amended. Some of the proposals may not be implementable due to
physical constraints. Should
valuations revert to a ‘normal’ range, the stock prices could rebound by
up to 160% by end Mar12f.
Exhibit 1: Potential upside by end Mar12f in three scenarios for 1‐year
forward EV/EBITDA multiple
Target EV/EBITDA (x) Target EV Target mkt. (INRbn) cap. Target
price (INR) Potential upside (%)
FY13f
EBITDA
ABCABC
Net
Debt
ABC
Shares
(bn)
ABC
CMP
(INR)
ABC
RCOM 101 10.7 7.8 7.4 1,077 785 745 222 855 563 523 2 363 239 222
139 160 71 59
IDEA 65 8.7 7.0 5.1 568 457 333 109 412 301 177 4 125 91 54 49 155 86
9
BHARTI
‐ Non‐Africa 212 9.3 7.1 6.4 1,968 1,502 1,354
‐ African ops 76 5.7 433 433 433
‐ Cons. 288 8.3 6.7 6.2 2,401 1,935 1,787 578 1,823 1,357 1,209 4 448
334 297 257 74 30 16
Source: Company, Bloomberg, Avendus Research
Note: A: Lower end of highest quartile (Jan09‐May10); B: Higher end of
the lowest quartile; C: Minimum during Sep08 ‐ Mar09
India Equity Research Telecom Sector
Telecom 4
Cashflow is robust enough to absorb burden of 2G cess and 3G
Should the recent TRAI proposals on additional levy for 2G spectrum be
implemented, providers would need to make a
one‐time payment. We estimate cash outflow of INR46bn and INR15bn
for BHARTI and IDEA, respectively. This would
be in addition to the payments for 3G spectrum and capital expenditure
required to roll out 3G services. Consequently,
gearing would rise by up to 1.1x. We believe the providers may
consider funding a part of the outflow through infusion
of new equity. This would lead to dilution ranging between 7% and 20%
of the equity capital at end Mar12f. However,
the operating cashflow of operators is robust enough to absorb the
impact of these blows. The one‐time payment for
excess 2G spectrum is between 4 months (BHARTI) and 5 months (IDEA)
of FY11f cashflow. Payment for 3G is estimated
to be between 82% (BHARTI) and 129% (IDEA) of FY12f cashflow.
Incumbents may need to pay for excess 2G spectrum
Excess spectrum is defined as the total 2G GSM spectrum above
6.2MHz allocated to an operator in a
service area. BHARTI has excess spectrum of 41.5MHz, IDEA has
17.1MHz and Reliance
Communications (RCOM IN, Hold) has 1.8MHz. TRAI in its interim
recommendations has proposed the
following criteria to measure the current price of excess spectrum:
􀁦 Cost of spectrum above 6.2MHz in the 900MHz band is measured at
1.5x the 3G winning price per
MHz in the respective service area.
􀁦 Cost of spectrum above 6.2MHz in the 1,800MHz band is measured
at 1x the 3G winning price per
MHz in the respective service area.
􀁦 If total spectrum is above 10MHz in Metros or above 8MHz in other
service areas, the current price
of excess spectrum is raised by 30%.
􀁦 The current price for excess 2G spectrum will be pro‐rated for the
remaining license period, with a
minimum of 7 years.
􀁦 If the service provider chooses to return excess spectrum, the
current price has to be paid on
pro‐rata basis for a minimum of 3 years.
􀁦 The one‐time spectrum fee for excess spectrum has to be paid again
at the time of renewal of
license. The price would be calculated on the basis of the revised
benchmarks available at that time
(currently 3G winning price).
If the regulator accepts the recommendations, without any
modification, it may entail a significant cash
outgo for GSM incumbents. Our analysis indicates that the immediate
cash outgo for BHARTI would be
INR46bn and INR15bn for IDEA, while it would be marginal for RCOM.
However, GSM incumbents
would have to incur incremental cash outgo at the time of renewal of
license. Service providers may
also choose to return 2G spectrum in service areas with a 3G spectrum
win.
India Equity Research Telecom Sector
Telecom 5
Exhibit 2: One‐time cash outgo due to excess spectrum (INRmn)
‐‐‐‐‐‐‐‐‐‐ BHARTI ‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐ RCOM ‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐ IDEA
‐‐‐‐‐‐‐‐‐‐
Circles
3G winning price
per MHz (INRmn)
Excess spectrum
equivalent (MHz)
Cash outgo
(INRmn)
Excess spectrum
equivalent (MHz)
Cash outgo
(INRmn)
Excess spectrum
equivalent (MHz)
Cash outgo
(INRmn)
Delhi 6,634 4.7 10,913 ‐ ‐ 1.8 6,782
Mumbai 6,494 3.0 11,046 ‐ ‐ ‐ ‐
Kolkata 1,089 1.8 686 ‐ ‐ ‐ ‐
Maharashtra 2,516 2.6 3,708 ‐ ‐ 5.7 5,036
Gujarat 2,152 ‐ ‐ ‐ ‐ ‐ ‐
Andhra Pradesh 2,746 6.0 5,748 ‐ ‐ 1.8 1,730
Karnataka 3,160 6.0 6,614 ‐ ‐ ‐ ‐
Tamil Nadu 2,930 3.9 3,999 ‐ ‐ ‐ ‐
Kerala 625 ‐ ‐ ‐ ‐ 1.8 394
Punjab 644 2.4 541 ‐ ‐ 2.4 541
Haryana 445 ‐ ‐ ‐ ‐ ‐ ‐
Uttar Pradesh (West) 1,028 ‐ ‐ ‐ ‐ 1.8 648
Uttar Pradesh (East) 729 1.0 500 ‐ ‐ ‐ ‐
Rajasthan 642 2.6 584 ‐ ‐ ‐ ‐
Madhya Pradesh 517 1.8 527 ‐ ‐ 1.8 326
West Bengal 247 ‐ ‐ ‐ ‐ ‐ ‐
Himachal Pradesh 74 ‐ ‐ ‐ ‐ ‐ ‐
Bihar 407 3.9 1,088 1.8 256 ‐ ‐
Orissa 194 1.8 239 ‐ ‐ ‐ ‐
Assam 83 ‐ ‐ ‐ ‐ ‐ ‐
North East 85 ‐ ‐ ‐ ‐ ‐ ‐
Jammu & Kashmir 61 ‐ ‐ ‐ ‐ ‐ ‐
Total 33,501 46,194 256 15,456
Source: TRAI, Department of Telecommunications (DoT), Company,
Avendus Research
3G win to increase the cash outgo further
BHARTI won 3G spectrum in 13 circles, IDEA in 11 and RCOM in 13. This
would entail a cash outgo of
INR123bn, INR58bn and INR86bn, respectively. The winning price is to
be paid within 15 days of the
end of the 3G auctions. To comply with the roll‐out obligations
associated with the 3G spectrum win,
3G winners also have to incur additional capex over the next 22
months. This may lead to cash outgo of
INR61bn for BHARTI, INR29bn for IDEA and INR43bn for RCOM.
Significant increase in gearing may call for equity infusion
The potential one‐time cash outgo for excess 2G spectrum and 3G is
likely to be INR169bn for BHARTI,
INR73bn for IDEA and INR87bn for RCOM. Initially, this cash outgo is
likely to be funded through debt
and internal accruals. This may lead to an increase in the net
debt/equity at end Mar11f to 0.2x for
BHARTI (excluding African operations), 1.1x for IDEA and 0.7x for
RCOM. High gearing may compel
some service providers to partly fund the capital employed in the 3G
business through equity. If up to
50% is funded through equity till FY12, it may result in equity dilution of
7% for BHARTI, 22% for IDEA
and 14% for RCOM. Equity dilution may result in a decrease in the net
debt/equity in FY12f.
Exhibit 3: Impact of one‐time cash outgo on net debt and gearing
Net debt excl.
cash outgo for 2G
and 3G spectrum
Equity
(before
dilution)
Net debt/
Equity (x)
2G spectrum
related
one‐time
3G spectrum
win related
cash outgo
Net debt incl. cash
outgo for 2G and
3G spectrum
Equity (after
50% dilution
in FY12f)
Net debt/
Equity (x)
(INRbn) FY11f FY12f FY11f FY12f FY11f FY12f cash outgo FY11f
FY12f FY11f FY12f FY11f FY12f
BHARTI ‐64 ‐137 505 605 ‐0.1 ‐0.2 46 123 105 32 492 594 0.2 0.1
RCOM 224 217 421 456 0.5 0.5 0 86 310 303 414 451 0.7 0.7
IDEA 57 43 122 132 0.5 0.3 15 58 130 116 116 133 1.1 0.9
Source: Company, Avendus Research
India Equity Research Telecom Sector
Telecom 6
Robust cashflow can absorb the burden of increased gearing
GSM incumbents generated strong operating cash flow in FY10, despite
intense competition. While the
one‐time cash outgo may increase the net debt, continued strong
operating cash flow may sustain the
impact. Additionally, operating cashflow generation in the next few
years may further dilute the impact
of the delayed one‐time outgo on renewal of licenses in various service
areas.
Exhibit 4: Operating cashflow and net debt for BHARTI, RCOM and IDEA
(INRbn)
Operating cash
flow, excl. 3G
operations
Net debt excl. cash
outgo related to 2G
and 3G spectrum
Total
cash
outgo
Net debt incl. cash
outgo related to 2G
and 3G spectrum
Operating cash flow/
net debt (post
cash outgo)
(INRbn) FY11f FY12f FY11f FY12f FY11f FY11f FY12f FY11f
FY12f
BHARTI 148 149 ‐64 ‐137 169 105 32 1.4 4.6
RCOM 32 35 224 217 86 310 303 0.1 0.1
IDEA 43 45 57 43 73 130 116 0.3 0.4
Source: DoT, TRAI, Company, Avendus Research
India Equity Research Telecom Sector
Telecom 7
Low impact on EBITDA margin over the medium term
The summary impact of the rise in spectrum fees and a fall in license
fee would be a fall in EBITDA margin for FY11f—
between 1.7% (BHARTI) and 0.4% (IDEA). The additional burden
imposed by the rise in interest expense would pull
down FY11f net profit margin by up to 592‐bp. However the impact on
EBITDA margins would subside after FY11f due
to a decrease in license fees each year till FY14f. In FY14f, the summary
impact of the change in spectrum and license
fees on EBITDA margins is likely to be ‐0.6% for BHARTI and 1.1% for
IDEA.
Change in policy may increase recurring spectrum fees
TRAI has recommended a change in the recurring fees for 2G GSM and
CDMA spectrum. The spectrum
usage charge is 0.5% of the adjusted gross revenue (AGR) per MHz up
to the contracted spectrum, i.e.
6.2MHz (GSM)/5MHz (CDMA), and 1% of the AGR per MHz for
spectrum in excess of that amount. A
change in spectrum charges may have a negative impact on EBITDA
margins for BHARTI and IDEA. Our
analysis indicates that EBITDA margins of BHARTI and IDEA may be
negatively impacted by 139‐bp and
89‐bp, respectively. However, RCOM may gain from the change in
spectrum fees due to lower charges
on CDMA spectrum. The company’s EBITDA margins are likely to be
positively impacted by c18‐bp.
Exhibit 5: Impact of change in spectrum fees on EBITDA margins
(financials as of FY10)
(INRmn) BHARTI IDEA RCOM
Revenues 396,150 123,979 222,504
EBITDA 160,266 33,580 78,870
EBITDA margin (%) 40 27 35
Incremental Spectrum Charges 5,525 1,100 ‐406
Revised EBITDA 154,742 32,479 79,276
Revised EBITDA margins (%) 39 26 36
Dent on EBITDA margin ‐139‐bp ‐89‐bp 18‐bp
Impact on EBITDA (%) ‐3 ‐3 1
Source: Company, TRAI, Avendus Research
Lower license fees may partly offset this impact
Currently, telecom service providers pay recurring license fees as a
percentage of the AGR for the
wireless business. The current license fee is set at 10% in Metros and
Circle A, 8% in Circle B and 6% in
Circle C. TRAI has recommended a gradual change to the uniform
license fee of 6% over the next four
years. This is likely to reduce the recurring license fees. Hence, EBITDA
margins may improve. However,
the improvement may be partially offset by the potential imposition of
license fees on the Internet
Service Provider (ISP) and Infrastructure Provider (IP) segments.
Currently, these two segments do not
pay any license fees. After four years, EBITDA margin improvement is
likely to be 48‐bp for BHARTI,
48‐bp for IDEA and 29‐bp for RCOM. This is likely to partially offset the
negative impact of the increase
in spectrum fees.
Exhibit 6: Improvement in EBITDA margin due to change in license fees
(bp) BHARTI IDEA RCOM
Year 1 ‐29 45 ‐36
Year 2 39 73 17
Year 3 19 34 5
Year 4 48 48 29
Source: Company, Avendus Research
Higher interest costs and amortization may impact profitability
The one‐time cash outgo due to excess 2G spectrum and the 3G win
may lead to higher net debt. This
may increase interest costs and lower profitability. Also, one‐time
spectrum‐related costs are likely to
lead to higher intangible assets. This may lead to higher amortization,
further lowering the profitability.
India Equity Research Telecom Sector
Telecom 8
Higher interest costs and amortization are likely to impact net profit
margins by 492‐bp for BHARTI,
429‐bp for RCOM and 592‐bp for IDEA.
Exhibit 7: Impact of higher net debt and intangible assets on net profits
(INRmn) BHARTI RCOM IDEA
FY11f PAT 91,688 32,877 8,323
Incremental interest and amortization (after tax) 21,574 10,217 9,502
Revised FY11f PAT 70,115 22,661 ‐1,179
Impact on PAT margins ‐492‐bp ‐429‐bp ‐592‐bp
Source: TRAI, Company, Avendus Research
India Equity Research Telecom Sector
Telecom 9
Tariff war may extend, consolidation may be delayed
The proposals may provide a new lease of life to the tariff war by
continuing to link spectrum to subscribers for another
six months. The norms for mergers too may be made more
conservative by mandating a lower ceiling for market share
and a larger number of providers, among other such measures. Data for
the past five quarters reveals that incumbents
have held out well against such forces by preserving their share of
revenue even as they lose market share in the
number of subscribers. The proposals for sharing of spectrum may
provide some advantage to newcomers.
Exhibit 8: Scenarios for M&A between two segments of the Indian
telecom industry
Acquirer Target Drivers for acquisition Restrictions
GSM Incumbent GSM Incumbent 3G and 2G spectrum Market share
should be less than 30% and the cap on spectrum at 14.4MHz.
GSM Incumbent New entrant 2G spectrum Cap on spectrum at
14.4MHz and 51% promoter's equity lock‐in for 5 years.
New entrant New entrant Scale and 2G spectrum One‐time cash outgo
for excess spectrum and 51% promoter's equity lock‐in for 5 years.
New entrant GSM Incumbent Scale and 2G spectrum Cap on spectrum
at 14.4MHz and 51% promoter's equity lock‐in for 5 years.
Source: TRAI, Avendus Research
Forces that could hasten consolidation may be weakened
The revisions proposed by TRAI in the M&A regulations are likely to
delay consolidation. This is mainly
due to the following three reasons:
􀁦 Maximum market share of merged entity in terms of subscribers or
AGR is recommended to be
lowered from 40% to 30%.
􀁦 Number of service providers in a service area after a merger is
recommended to be not less than 6
compared to 4 earlier.
􀁦 51% lock‐in of promoter’s equity for 5 years or till the completion of
roll‐out obligations, whichever
is earlier.
The acquirer’s cash outgo may also increase on account of spectrum
transfer fee and a one‐time
payment for excess spectrum. Spectrum transfer fee of 5% would be
levied on the difference between
acquisition price and the value of excess spectrum. One‐time spectrum
fee may also be levied on any
excess spectrum that may result from the merger. Thus, the merger‐
related cash outgo may reduce the
valuation of the target entity.
Key recommendations that could have advanced consolidation were
relaxing the promoter lock‐in
equity and the cap on spectrum allocation. However these two factors
have not been relaxed. We have
analyzed four scenarios for M&A, key motives for acquisition and
regulatory restrictions that may apply
to the merger (Exhibit 7).
Tariff war may extend, if linkage of spectrum to subscribers persists
Exhibit 9: Trend in subscriber and revenue market share (%)
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ Subscriber market share ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ Revenue market share ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
(%) Mar09 Jun09 Sep09 Dec09 Mar10 Mar09 Jun09 Sep09 Dec09
Mar10
Bharti Airtel 24 24 24 23 22 33 34 33 32 31
Vodafone (India) 18 18 18 18 17 20 21 20 21 21
Idea Cellular 11 11 11 11 11 12 12 12 13 13
Reliance Communications 19 19 18 18 18 12 12 12 12 11
Tata Teleservices 9 9 10 11 11 8 7 7 7 9
Aircel 5 5 5 6 6 3 3 4 4 4
Other new entrants 0 0 0 0 1 0 0 0 0 1
Others 15 14 14 14 13 12 11 11 10 10
Total 100 100 100 100 100 100 100 100 100 100
Source: TRAI, Avendus Research
India Equity Research Telecom Sector
Telecom 10
In the future, 2G spectrum is likely to be allocated on the basis of
completion of 2G roll‐out obligations.
However, the TRAI has recommended continuing the current
subscriber‐linked criteria for another six
months. This may compel new entrants to gain more subscribers in the
next six months and apply for
further allocation of 2G spectrum. This is likely to intensify competition
further as new entrants drop
tariffs while vying for more subscribers and minutes. Hence, the tariff
war may not bottom out for six
more months.
But incumbents have been resilient to competition till now
Competition has increased since launch of operations by new entrants
in 2009. The intensifying
competition led to a sharp drop in tariffs. However, the revenue share
of GSM incumbents such as
BHARTI, Vodafone and IDEA has not deteriorated. While new entrants
are able to garner a higher share
of subscribers, their revenue share has still not seen an uptrend after
more than three quarters since
launch. Thus, incumbents have been resilient to competition till now.
Spectrum sharing may benefit new entrants
TRAI has recommended spectrum sharing only for 2G spectrum. The
sharing is restricted to service
providers with spectrum up to 4.4MHz. Based on current spectrum
allocation, only new entrants would
be able to share spectrum as incumbents possess more than 4.4MHz
spectrum in most circles. New
entrants are likely to gain additional revenues by sharing spectrum with
other service providers; thus,
reducing their losses.
In Delhi, a few licensees have not been allocated spectrum as yet.
These licensees may, thus, be able to
share spectrum with new entrants that possess spectrum and launch
operations. Hence, such licensees
may not have to wait for the government to allocate spectrum to
launch services.
India Equity Research Telecom Sector
Telecom 11
Worst priced in, potential upside as earnings recover after Mar11f
The erosion in market value of telecom stocks exceeds the present
value of the potential erosion in net profits. This
suggests that the worst case assessment of the impact of TRAI
proposals has been priced in. Market capitalization of the
three large telecom stocks fell by up to 22% within days of the TRAI
proposals, considerably more than the cuts to their
earnings forecasts. The impact of these proposals, as well as of the
higher gearing resulting from funding 3G, is likely to
be concentrated in their FY11f performance. We foresee a rebound in
net profits starting FY12f, leading to a three‐year
CAGR of up to 66%. The forecasts may need to be reassessed,
positively, if the TRAI proposals were to be amended.
Some of the proposals may not be implementable, e.g. there may be
insufficient spectrum in the 1,800MHz band to
replace the entire 900MHz band spectrum that is sought to be taken
back from operators. Should valuations revert to a
‘normal’ range, stock prices could rebound by up to 160% by end
Mar11f.
Stock prices have reacted faster than earnings forecasts
TRAI recommendations were released on 11 May10 and 3G auctions
ended on 19 May10. Since 11
May10, the stock price of BHARTI, RCOM and IDEA has fallen by 13%,
10% and 22%, respectively.
However, over the same period, the mean consensus estimates for
FY11f net income have been
downgraded by 1% for BHARTI, 11% for RCOM and 3% for IDEA.
RCOM’s higher downgrade in forecasts
may be partially explained by the change in forecasts after its 4QFY10
results were announced on 15
May10. Hence, stock prices have reacted faster than the downgrade of
forecasts.
Earnings rebound likely to begin after Mar11; ROCEs to stabilize
Capital intensity of the providers is likely to rise after the investments in
the 3G business, possible
investments in BWA and the probable implementation of the TRAI
recommendations. Exhibit 9
indicates the consequent fall in ROCE. However, our ROCE estimates
stabilize after FY12f with an
upward bias.
The brunt of the impact is likely to be borne in FY11f. We believe net
profit growth would resume in
FY12f. We estimate the three‐year CAGR in net profits, till FY14f, to be
13% for BHARTI and 22% for
RCOM. IDEA’s net profit CAGR during FY12f‐FY14f is likely to be 66%.
Exhibit 10: ROCE before and after considering the impact of 3G and
TRAI recommendations
(%) ‐‐‐‐‐‐‐‐‐‐‐‐ BHARTI* ‐‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐‐‐ RCOM ‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐ IDEA ‐‐‐‐‐‐‐‐‐‐‐‐‐
FY11f FY12f FY13f FY14f FY11f FY12f FY13f FY14f FY11f FY12f
FY13f FY14f
ROCE (excl 3G and TRAI reco.) 20 19 18 17 5 5 6 6 8 10 11 15
ROCE (incl 3G and TRAI reco.) 11 11 11 11 3 4 4 5 3 6 7 10
Source: Company, TRAI, Avendus Research Note:* BHARTI’s ROCE
excludes the financials for African operations
The inclusion of African operations is likely to reduce BHARTI’s
consolidated ROCE to 8% in FY11f. The
ROCE is likely to increase after FY11f due to revenue growth and margin
expansion in African
operations. We estimate the FY14f consolidated ROCE (including
African operations) for BHARTI at
11%.
Erosion in market capitalization exceeds erosion in profits
Profits of BHARTI, RCOM and IDEA during FY11f‐FY14f are likely to be
lower than current forecasts. We
have discounted the ‘change in profit forecasts’ for the period of FY11f
to FY14f at a WACC of 13%. The
discounted value for BHARTI is INR92bn, RCOM is INR30bn and IDEA is
INR18bn. However, market
capitalization of BHARTI, RCOM and IDEA has declined by INR142bn,
INR32bn and INR46bn,
respectively. Hence, we believe the worst‐case assessment of the
impact of 3G, BWA and TRAI
proposals has been priced for BHARTI, RCOM and IDEA.
India Equity Research Telecom Sector
Telecom 12
Exhibit 11: PV of the ‘change in profit’ forecasts from FY11f to FY14f
and decline in Mcap
‐‐‐‐‐‐‐‐‐‐‐‐‐‐ BHARTI* ‐‐‐‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐‐‐‐ RCOM ‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐ IDEA ‐‐‐‐‐‐‐‐‐‐‐‐‐‐
(INRbn) FY11f FY12f FY13f FY14f FY11f FY12f FY13f FY14f
FY11f FY12f FY13f FY14f
PAT (excl. 3G, BWA and TRAI reco.) 92 100 109 114 33 35 39 41 8 10 14
22
PAT (incl. 3G, BWA and TRAI reco.) 58 72 79 82 19 29 29 31 ‐4 7 9 19
Difference ‐34 ‐28 ‐30 ‐32 ‐14 ‐6 ‐10 ‐10 ‐12 ‐4 ‐5 ‐3
Discount factor @ WACC of 13% 0.9 0.8 0.7 0.6 0.9 0.8 0.7 0.6 0.9 0.8
0.7 0.6
Present value of the difference ‐92 ‐30 ‐18
Change in Mcap since 10 May10 ‐142 ‐32 ‐46
Source: Company, TRAI, DoT, Avendus Research Note:* BHARTI’s
financials exclude African operations
Low probability of complete implementation of proposals
TRAI’s recommendations are likely to impact most telecom operators
negatively. While key negatives
for GSM incumbents are one‐time fee for excess spectrum and
refarming of spectrum in the 900MHz
band; unfavorable and stricter spectrum allocation criteria and 51%
promoter’s equity lock‐in for five
years are key negatives for new entrants. Conservative M&A guidelines
are negative for the overall
sector.
Exhibit 12: Key positive and negative impact of TRAI’s recommendation
on each segment
Segment Positive Negative
Public sector telcos
‐ Reduction in license fees
‐ One‐time fees for excess spectrum
‐ Increase in recurring spectrum fees
‐ Refarming of 900MHz spectrum
‐ Conservative M&A guidelines
Private incumbents
‐ Reduction in license fees
‐ One‐time fees for excess spectrum
‐ Increase in recurring spectrum fees
‐ Refarming of 900MHz spectrum
‐ Conservative M&A guidelines
New entrants – GSM
‐ Spectrum sharing
‐ Stricter spectrum allocation norms
‐ Minimum license and spectrum fees
‐ Conservative M&A guidelines
Dual technology
license holder
‐ Spectrum sharing
‐ Reduction in license fees
‐ Clarity on spectrum allocation
‐ Unfavorable spectrum allocation criteria for TTSL
‐ Conservative M&A guidelines
Source: TRAI, Avendus Research
The TRAI recommendations have not been received well by telcos.
BHARTI, Vodafone and IDEA had
filed a petition against TRAI’s recommendation with the Telecom
Disputes Settlement & Appellate
Tribunal (TDSAT), which was later withdrawn. Additionally, the TRAI has
clarified that the proposal of
linking the price of excess 2G spectrum to the 3G winning price was an
interim recommendation. The
final recommendations, post consultation process, would be submitted
to the DoT by 15 Jul10. In two
recent cases, the TDSAT has decided in favor of telcos in the backhaul
spectrum case and given a stay
on the hike of spectrum charges. Hence, we believe, complete
implementation of TRAI’s
recommendation is unlikely.
Scaling back of proposals may lead to re‐rating
There is a likely chance that higher efficiency of 3G spectrum, compared
to 2G spectrum, may be
considered while pricing the excess 2G spectrum. This may reduce the
one‐time cash outgo for excess
spectrum by 50% to 66%, if 3G spectrum is considered to be 2x to 3x
more efficient than 2G spectrum.
This is likely to have a positive impact on net debt, interest costs and
amortization.
Refarming of spectrum in 900MHz band is less probable
As per current availability of spectrum in the 1,800MHz band, there
exists a shortfall compared to the
spectrum to be refarmed starting 2014. Recommendation on refarming
assumes release of spectrum in
the 1,800MHz band by government agencies. Any negative outlook on
the same would reduce the
likelihood of replacement of spectrum in the 900MHz band with the
1,800MHz band.
India Equity Research Telecom Sector
Telecom 13
Exhibit 13: Spectrum allocated and available for refarming of spectrum
in the 900MHz band
(MHz)
Spectrum available
for telcos
Spectrum already
allocated
Spectrum yet to be allocated
in 1,800MHz band
Amount of spectrum
to be refarmed
Supply‐demand
gap
Delhi 57 54 4 22 ‐19
Mumbai 75 73 2 22 ‐20
Kolkata 78 60 18 20 ‐2
Maharashtra 69 65 4 20 ‐16
Gujarat 60 60 0 20 ‐20
Andhra Pradesh 84 69 14 20 ‐6
Karnataka 79 65 14 20 ‐6
Tamil Nadu 87 67 20 20 0
Kerala 89 61 28 19 9
Punjab 63 59 4 22 ‐17
Haryana 64 59 4 12 ‐8
Uttar Pradesh (West) 61 61 0 19 ‐19
Uttar Pradesh (East) 62 62 0 19 ‐19
Rajasthan 64 64 0 19 ‐19
Madhya Pradesh 96 63 33 19 15
West Bengal 57 53 4 19 ‐15
Himachal Pradesh 58 58 0 19 ‐19
Bihar 71 67 4 19 ‐14
Orissa 77 59 18 19 ‐1
Assam 59 55 4 19 ‐14
North East 58 53 4 19 ‐15
Jammu & Kashmir 49 49 0 19 ‐19
Source: DoT, TRAI, Avendus Research
Re‐rating, EBITDA growth may lead to significant potential upside
We have analyzed the potential upside in BHARTI, RCOM and IDEA from
the current stock prices in the
following three scenarios for the 1‐year forward EV/EBITDA multiples:
􀁦 Scenario A: Lowest 1‐year forward EV/EBITDA multiple of the
highest quartile from Jan09 to May10
(sorted in descending order of the values).
􀁦 Scenario B: Highest 1‐year forward EV/EBITDA multiple of the
lowest quartile from Jan09 to May10
(sorted in descending order of the values).
􀁦 Scenario C: Minimum 1‐year forward EV/EBITDA multiple during
Sep08‐Mar09.
We have considered the 1‐year forward EV/EBITDA multiples for the
above periods on account of:
􀁦 Jan09‐May10: After the quarter ended Dec09, the super‐normal
growth rates for earnings ended.
Also, the market may have factored in competition and concerns on 3G
auctions.
􀁦 Sep08‐Mar09: During this period, telecom stocks were impacted due
to the global economic crisis.
The potential upside is calculated including the impact of investments
in the 3G business, possible
investments in BWA and the probable implementation of the TRAI
recommendations. The potential
price in Mar12f (not the Avendus target price) is calculated on FY13f
financials.
India Equity Research Telecom Sector
Telecom 14
Exhibit 14: Potential upside till Mar12f under three scenarios for target
EV/EBITDA multiple for RCOM and IDEA
(INRbn)
FY13f
EBITDA
Target EV/EBITDA
multiple (x)
Target EV
Net
Debt
Target market
cap
Number
of shares
Target price
(INR)
CMP
(INR)
Potential upside
(%)
A B C A B C A B C (bn) A B C A B C
RCOM 101 10.7 7.8 7.4 1,077 785 745 222 855 563 523 2 363 239 222
139 160 71 59
IDEA 65 8.7 7.0 5.1 568 457 333 109 412 301 177 4 125 91 54 49 155 86
9
Source: Company, Bloomberg, Avendus Research
Exhibit 15: Potential upside by end Mar12f in three scenarios for 1‐year
forward EV/EBITDA multiple for BHARTI
(INRbn)
FY13f
EBITDA
Target EV/EBITDA
multiple (x)
Target EV
Net
Debt
Target market
cap
No. of
shares
Target price
(INR)
CMP
(INR)
Potential upside
(%)
A B C A B C A B C (bn) A B C A B C
Non‐Africa 212 9.3 7.1 6.4 1,968 1,502 1,354
African ops 76 5.7 433 433 433
Cons. 288 8.3 6.7 6.2 2,401 1,935 1,787 578 1,823 1,357 1,209 4 448
334 297 257 74 30 16
Source: Company, Bloomberg, Avendus Research
Note: A: Lower end of highest quartile; B: Higher end of the lowest
quartile; C: Minimum during Sep08‐Mar09.
For BHARTI, we have analyzed the potential upside with the target 1‐
year forward EV/EBITDA multiple
for the non‐African business under the three above‐mentioned
scenarios. For the African business, the
target 1‐year forward EV/EBITDA multiple is constant, at a 10%
premium to its peer MTN.
India Equity Research Telecom Sector
Telecom 15
Annexure
In Exhibit 15 we have summarized the impact of 3G, BWA and TRAI’s
recommendations on the FY11f and FY12f financials (assuming
50% of capital employed in the 3G business to be funded through
equity).
Exhibit 16: Consolidated impact on the financials for BHARTI, RCOM and
IDEA
(INRbn) ‐‐‐‐‐‐‐‐‐‐‐ BHARTI *‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐ RCOM ‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐ IDEA ‐‐‐‐‐‐‐‐‐‐‐
FY11f FY12f FY11f FY12f FY11f FY12f
Existing forecasts
Net Debt ‐64 ‐137 224 217 57 43
Revenue 438 491 238 250 161 188
EBITDA 171 183 76 81 39 45
EBIT 112 121 36 39 16 19
PAT 92 100 33 35 8 10
Number of shares (bn) 4 4 2 2 3 3
EPS (INR) 24 26 16 17 3 3
Impact of 3G win
3G winning price 123 123 86 86 58 58
3G Capex 25 37 17 26 12 17
Revenue 4 38 4 35 3 31
EBITDA 1 13 1 12 1 11
PAT ‐19 ‐12 ‐13 ‐6 ‐9 ‐1
Potential Impact of BWA
Increase in net debt 61 61 43 43 29 29
Change in EBIT margins (bp) ‐70 ‐70 ‐90 ‐90 ‐90 ‐90
Change in PAT margins (bp) ‐164 ‐164 ‐221 ‐221 ‐219 ‐219
Impact of TRAI's reco.
Increase in net debt 46 46 0 0 15 15
Change in EBITDA margins (bp) ‐168 ‐129 ‐18 ‐1 ‐44 29
Change in EBIT margins (bp) ‐283 ‐244 ‐20 ‐3 ‐148 ‐75
Change in PAT margins (bp) ‐354 ‐315 ‐21 ‐4 ‐217 ‐144
Consolidated
Net Debt 191 63 327 282 142 102
Revenue 442 528 242 285 164 220
EBITDA 165 190 77 93 39 56
% change from current forecasts ‐4 4 1 15 1 25
EBIT 89 100 28 36 9 19
% change from current forecasts ‐21 ‐17 ‐21 ‐8 ‐43 ‐4
PAT 58 72 19 29 ‐4 7
% change from current forecasts ‐37 ‐28 ‐42 ‐18 ‐147 ‐34
Number of shares (bn) 4 4 2 2 3 4
EPS (INR) 15 18 9 12 ‐1 2
% change from the current forecasts ‐37 ‐33 ‐42 ‐28 ‐147 ‐45
Source: TRAI, DoT, Company, Avendus Research Note:* BHARTI’s
financials exclude African operations
India Equity Research Telecom Sector
Telecom 16
Analyst Certification
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