Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Indian
Telecommunications
Stable tariffs = 2x revenue
growth; 3G to add more
We reiterate our Attractive view on Indian telcos,
given our views on four key debates: 1) Reduction in
competitive intensity should lead 2G revenue growth to
double in F2012 vs. F2011; 2) 3G tariff launches are
costlier than 2G and already account for 2-3% of overall
revenues; 3) regulatory concerns should decrease in
2011; 4) telco operators are FCF-positive incrementally.
Our two key picks are Idea and Bharti.
Idea is our favorite idea – highest leverage to
domestic wireless business: It has gained the highest
revenue market share in the last three years and also
has the highest active subscriber base ratio.
Bharti – lower return, albeit lower risk: Bharti has
India’s highest wireless revenue market share, the
strongest balance sheet amongst Indian telcos, strong
earnings growth outlook of 25% p.a. over the next three
years, is FCF-positive, and the contribution from its Zain
acquisition is increasing.
Decreasing competitive intensity = high growth
ahead: New operators are reeling under the pressure of
EBITDA losses and hence we believe their propensity to
spend incrementally on tariff wars has waned. We
estimate healthy traffic growth of 5-6% per quarter to
lead to annual growth of 20-25% in minutes; even
assuming a 6% p.a. decline in industry ARPMs from
current levels, 2G revenue growth in F2012E should
almost double to 14% p.a. from 8% in F2011E.
Initial data points on 3G are promising: 3G data
tariffs are ~45%-90% costlier than 2G. 3G has neither
endured any tariff wars nor been given handset
subsidies. Channel checks suggest 3G traffic growth is
already 2-3% of overall revenues and volumes, in the
first quarter of launch. We believe India could have
90mn subscribers by 2015, generating US$2.3bn in
EBITDA.
Key Stock Ideas
Bharti: Geared Up for Growth
• FCF-positive from F1Q12: Bharti was
FCF-negative in F2011 (-45%) because of its
investments in Zain, 3G, and broadband license
fees – but we project that it should be 13%
FCF-positive in F2014. Its ratio of net debt to
EBITDA should move from 3x to 1.1x during the
same period.
• One of the fastest-growing large-cap telcos:
We expect Bharti to have ~300mn subs by
F2014 and look for it to register strong CAGRs
over F2011-14 of 12% in subs, 14% in revenue,
19% in EBITDA, and 25% in profit.
• We see three catalysts: 1) strong quarterly
results (we expect 6% sequential growth; 2)
traffic growth returning in Africa; and 3) reduced
rate of tariff decline in the domestic business
and hence faster revenue growth.
• If Bharti were to cross US$5bn in revenues and
reach 40% EBITDA margins in its African
operations (as per management targets), that
would present upside of Rs29/share to our
target price and of 7-8% to our EPS estimates.
• We estimate 3G upside of Rs51/share
assuming 30mn subscribers and incremental
ARPU of Rs200/share. That would raise our
EBITDA and earnings estimates on average by
~7% and ~17% by F2015, respectively.
Idea: Highest Leverage to Indian Wireless Business
• Of late, the intense competition in the Indian
telecom industry has been turning more benign
– but during the past three intense years, Idea
has increased its revenue market share to 4%.
Idea also has the highest active subscriber
base ratio, implying high-quality subscribers.
• Idea has also been maintaining a relatively
higher capex to sales ratio vs. peers. Idea has
the third largest GSM spectrum amongst
operators, including the superior 900 MHz of
spectrum, which gives it the lowest subscriber
per spectrum ratio of the top six operators and
the lowest subscriber per Base Terminal
Station (BTS). Hence, we believe that in the
future Idea will need less capex than its peers.
• Idea has higher exposure to the domestic
wireless business and highest sensitivity to
growth via 3G.
• We estimate 3G value of Rs37/share assuming
13mn subscribers and incremental ARPU of
Rs180/share. That would raise our EBITDA and
earnings estimates by an average ~12% and
~41%, respectively, by F2015.
Debate #1: Will India’s Wireless Segment Go through Another Lull
Because of Heightened Competition?
Market’s view: Yes. Most investors are underweight
Indian telcos. Our discussions with them reveal that
their key reason is their negative outlook on competition
in the industry. They believe that wireless revenues will
not grow significantly.
Our view: No. We believe revenue growth will be
double that of the last two years, thanks to reduced
competitive intensity. Uninor, a new operator, has
already suffered EBITDA losses of US$1bn and laid out
another US$1bn on capex. Hence Uninor’s ability – and
similarly, that of other new operators – to withstand
such losses seems to be diminishing. Since F2H11,
incumbents have registered revenue growth of 3-4%, vs.
stagnant to declining revenues in the last two years.
We Observe Diminishing Competitive Intensity
We thus project a 14% CAGR in wireless revenues over
F2011-13E: After the tariff wars during June to December
2009, we have not seen any major tariff cuts by operators.
Postpaid tariffs have fallen in anticipation of mobile number
portability and now the differential between prepaid and post
has narrowed to 10-15%.
Exhibit 5shows the current tariff plans. Most players now have
similar tariff packages, hence there is little differentiation for
consumers. The average 2G voice retention per minute is
approximately 36-37p. Data retention per minute is 5p now.
One key reason for the reduction in competitive intensity has
been that the biggest new operator in terms of subscriber
base – Uninor – is reeling under pressure. It has incurred over
US$1bn in EBITDA losses since inception and has devoted
another US$1bn to capex, as shown in Exhibit 4 Thus its
balance sheet has been stretched, and the company plans to
spend another US$1.5bn before it believes it may break even.
We think that based on its quarterly spending rate of
US$300-400 mn, the US$1.5bn would last Uninor only a year
more. Our discussions with industry sources suggest the
smaller players have already scaled back their coverage plans.
Hence we believe their propensity to spend incrementally on
tariff wars has waned. Exhibit 3 shows that the seven new
operators have a 5.5% subscriber market share, whereas they
only have a 2.4% revenue market share.
The contribution of data in the last eight quarters has been
increasing as a percentage of sales to 12%. Traffic growth
historically has been an impressive 27% p.a. F2009-11, and
we expect the growth to be a healthy 22% p.a. over the next
two years. ARPM fall has been a high 19% last two years and
we expect a slowdown to 6% p.a. next two years.
This would lead to healthy growth in revenue of 14% p.a.
F2011/13, up from muted revenue growth of 9% p.a.
F2009/11 (Exhibit 6).
Where we could be wrong. The new players could make one
last effort with a tariff war to gain market share, before they
give up their licenses to the government. In the short term this
could intensify competition.
Debate 2: Will 3G Be Incrementally More Negative for the Industry?
Market’s view: Yes. 3G could intensify tariff wars and
also possibly lead to the introduction of handset
subsidies in India.
Our view: No. We believe the incumbents that have
bought 3G have stretched balance sheets. This has led
to rationalization of 3G tariffs and no subsidies. The
payback period for 3G license fees paid would be around
10 years, implying low IRR. However, we believe that
incrementally, 3G should lead to further revenue growth
for the industry, with increasing ARPM. Incremental 3G
capex is lower than 2G capex.
3G Should Compound Overall Wireless Growth
We project a revenue CAGR of 17% in F2011-13: After the
license fees they paid for 3G, incumbents have stretched
balance sheets and rationality has prevailed in pricing. The
focus seems to be on getting 2-2.5x of incremental ARPU
~Rs250/month. The 3G data packages are priced up to 45%
costlier than 2G at sub-250 MB consumption; and as much as
90% more for higher consumption of 2GB (see Exhibit 7).
Importantly, 3G so far has neither endured any tariff wars or
been given any subsidies on handsets. Our discussion with
various industry sources reveal that almost 9% of active
subscribers have 3G-enabled handsets – 60 mn, as shown in
Exhibit 8. Initial feedback from vendors and operators suggests
that traffic growth from 3G seems to be already 2-3% of overall
revenues and volumes, in the first quarter of launch.
Exhibit 7
Indian Telecoms: 3G data tariffs are costlier than 2G
Monthly
Charges (Rs)
Usage Limit
(MB) Implied (Rs/MB)
3G 101 100 1.01
2G 350 500 0.70
Premium 44%
3G 750 2000 0.375
2G 398 2000 0.199
Premium 88%
Source: Company data, Morgan Stanley Research
Exhibit 8
Indian Telecoms: 3G Early Indications
Estimated Smart phones/ 3G enabled handsets 60
% of Overall Active Subs 9%
3G ARPU 225
3G active subs 9
Quarterly revenue (Rs mn) 6,075
% of Revenues of 3G operators 2.2%
Source: Company data, Morgan Stanley Research
3G has lower capex than 2G: We estimate that incremental
capex per subscriber to move to 3G should be 20% lower than
for 2G, because of operators’ existing passive infrastructure.
The key focus in 3G capex has been backhaul, as shown in
Exhibit 9. Passive spending is about 10%, active radio
electronics and backhaul account for 45% each.
Incumbents are devoting only 10-15% additional spending to
the tower operators to add a 3G site on their 2G network, hence
saving costs. Opex for 3G is being largely covered by their
opex spending for their existing 2G business – and so
theoretically, EBITDA margins could be as high as 60%.
Exhibit 9
Indian Telecoms: Incremental 3G capex to be less
than 2G capex
Passive
Active
Radio
Active
Backhaul Total
2G 60 30 10 100
3G 8 36 36 80
Source: Company data, Morgan Stanley Research
Revenue upside: We believe the country could have 90mn
subscribers by 2015, who would spend Rs200/month more in
ARPU (i.e., US$4.6bn), thereby increasing India’s weighted
average ARPU by Rs2-3/month. The industry could gain
US$2.3bn in EBITDA, as shown in Exhibit 10. This could
further lead to stabilization in ARPU for the industry in the next
three years vs. 15-20% p.a. decline in the previous three years.
Overall industry revenues could thus increase from 14% to
17% p.a. in F2011-13.
Idea has the highest sensitivity to higher ARPUs and
margins due to 3G as well as 2G… Every 10% change in
ARPM changes profits by 30%. In our base case and target
price calculations, we include only the book value of 3G license
paid. We estimate 3G value of Rs37/share assuming 13mn
subscribers and incremental ARPU of Rs180/share. That
would raise our EBITDA and earnings estimates by an average
~12% and ~41%, respectively, by F2015.
…followed by RCOM… We estimate 3G value of Rs62/share
assuming 12mn subscribers and incremental ARPU of
Rs180/share. That would raise our EBITDA and earnings
estimates by an average ~9% and ~27% by F2015,
respectively.
…and then Bharti: We estimate 3G value of Rs92/share
assuming 30mn subscribers and incremental ARPU of
Rs150/share. That would raise our EBITDA and earnings
estimates by an average ~7% and ~17% by F2015,
respectively.
Where we could be wrong. Our biggest concern about 3G
could be that operators offer subsidies for 3G handsets
subsidies – subsidies have never been given by Indian
operators so far. If this were to happen, our projection of
positive free cash flows for the industry could be delayed by a
year.
Debate #3: Will Telecom Regulatory Policy Be Negative for the
Stocks?
Market’s view: Yes. Overpayment in 3G auctions has
shown the government the probable spending power of
operators. Hence regulations will be negative for the
Indian telecom operators. There are likely to be severe
charges pertaining to excess spectrum and license
renewal.
Our view: No. We believe that the operators may face
regulatory payouts – but policy should reduce the overall
uncertainty in the industry. We project that the
companies under our coverage should turn FCF-positive
in F2012. As a result, we believe that in the near to
medium term their balance sheets can withstand
payouts pertaining to excess spectrum charges and
renewal of licenses as per TRAI’s recommendations on
February 9, 2011.
Regulatory Concerns Could Decrease
Two developments – both of which should help remove
uncertainties – are expected in C2011:
Spectrum guidelines – addressing four areas: We expect
these to come out by August 2011. Our beliefs are:
• One-time excess spectrum charges: These would need to
be paid by the industry in line with the Telecom Regulatory
Authority of India (TRAI) recommendations on February 9,
2011.
• License renewal fees: These are scheduled to commence
during 2014-21E. We think they could be half the
magnitude as suggested by TRAI on February 9, 2011.
• Annual license fee reduction: The move from 10% to a
uniform 6% may not be accepted by the government, as
suggested by TRAI in May 2010, because it may lower the
collections for the government by US$400-600mn p.a.
• Refarming: We do not believe this would be accepted in
view of the complexities involved in taking back 900 MHz
spectrum in various years, sourcing the 1800 MHz, and
swapping it subsequently.
The New Telecom Policy 2011: We expect this to come out
by the end of the year and provide longer-term direction on the
remaining issues, such as:
• Broadband: A policy relating to increasing broadband
penetration in our country from the dismal 1% currently.
• M&A: A policy relating to providing an exit/consolidation
route to an overly populated industry with 12-14 operators.
• Tower sharing: Regulation pertaining to creation and
sharing of towers.
Exhibits 12-13 show our assumptions in our target prices
relating to regulatory hurdles.
Where we could be wrong. As shown in Exhibit 13, in our bear
case we assume that each operator pays 100% of license fee
renewals. We assume just 50% in our base case.
Debate #4: Will the Telecom Industry Ever Turn FCF-Positive?
Market’s view: Not any time soon. Increased
competition and regulatory payments would keep
telecom incumbents FCF-negative.
Our view: Yes – this year, in fact. We believe that in
the current year (F2012), all telecom operators should
turn FCF-positive before regulatory one-offs. Assuming
the excess spectrum fee, Bharti and RCOM would be
FCF-positive in F2012.
Turning FCF-Positive before Regulatory One-offs
We project that the Indian operators should be FCF-positive
with the 3G auction over and capex under control. In our view,
Bharti has the most stable FCF amongst operators.
Bharti has projected overall F2012 capex of US$2.9-3.1bn with
domestic capex of around US$1.9bn and capex in Africa (Zain)
of US$1-1.2 bn (Exhibit 14). Our capex estimates are a bit
more aggressive at US$3.3bn, implying cash outflow of
US$4bn, including the US$700 million for the final payment
pertaining to the African acquisition. Bharti should be
FCF-positive at 13% in F2014. The net debt to EBITDA ratio
should move from 3x to 1.1x by F2014.
For F2012, we estimate that Idea has overall capex of
~US$900mn. The 3G debt in F2011 has driven net debt to
EBITDA up to 2.8x; however, in F2012 we expect Idea to be
FCF-positive, not including excess spectrum charges. That
could lower the net debt to EBITDA ratio to 1.4x by F2013
(Exhibit 15).
RCOM has domestic capex of US$537mn in F2012E and the
company has net debt amounting to US$7bn. Net debt to
EBITDA is thus highest at 4.9x currently, decreasing to 3.1x by
F2013E (Exhibit 16).
Where we could be wrong. Increase in regulatory risks as
discussed in Debate #3, as well as 3G handset subsides, could
delay positive FCF for the industry by 1-2 years.
Valuation Methodology and Risks
Idea Cellular
Our 12-month target price for Idea is Rs91/share, up 11% from
Rs82 per share. It is based on our DCF model and the value we
attribute to the company’s towers. Our sum-of-the-parts
valuation is shown in Exhibit 13.
Our core business value for Idea remains the midpoint of the
value derived from our DCF calculation on a one-year forward
basis, assuming a terminal growth rate of 3% and cost of
capital of 12%, as shown in Exhibit 14. Based on our revised
estimates, we arrive at our new core business enterprise value
of Rs90/share The company’s net debt equates to Rs31/share.
However, since in our base case we do not include any
revenue upside due to 3G, we add back the book value of the
3G license to the net debt for the company. This equates to
Rs14/share.
We value Idea’s towers in Indus using DCF and use an
EV/tower of 100k to value the company’s directly owned towers.
The combined value for Idea’s towers is US$2.2bn or
Rs30/share, 40% of its market cap; as shown in Exhibit 12 and
13. We add this tower value to our core business equity value
(Exhibit 13).
We also incorporate regulatory payouts for excess spectrum
beyond 6.2MHz and cost of renewal of total spectrum on expiry
of licenses. These amount to US$322mn or Rs4 per share and
US$862mn or Rs12 per share respectively.
Exhibit 17
Idea Cellular: Sum of the Parts Valuation
Core Business Enterprise Value 90
Net Debt 14
Core Business Equity Value 77
Tower Valuation 30
Regulatory Payouts (16)
Target Price 91
Source: Company data, Morgan Stanley Research
Exhibit 18
Idea Cellular: Cost of Capital Assumptions
Risk Free Return (Rf) 8.0%
Market Premium (Rm) 6.0%
Assumed Beta 0.98
Cost of Equity (Re) 13.9%
Equity (%) 60.0%
Cost of Debt (Rd) 12.0%
Tax rate 22.5%
After-tax cost of debt (Rd [1-t]) 9.3%
Debt (%) 40.0%
WACC 12.0%
Assumed WACC 12.0%
Source: Company data, Morgan Stanley Research
Downside risks to our price target
• Greater-than-expected fall in tariffs due to aggressive
pricing from new operators to gain subscribers.
• Regulatory uncertainty regarding spectrum and Idea’s
need to pay additional spectrum charges.
Bharti Airtel
For our bear-, base-, and bull-case scenarios, we use a
sum-of-the-parts methodology, which adds discounted cash
flow (DCF) value for Bharti’s core business, 3G book value and
value derived from its tower business and net accrual from
Africa acquisition.
Bharti’s core business value remains at the midpoint of the
value derived from our DCF calculation on a one-year forward
basis, assuming a terminal growth rate of 3% and cost of
capital of 12%, as shown in Exhibit 17. Based on one-quarter
forward rollover, we arrive at our new core business enterprise
value of Rs396/share.
Since in our base case we do not include any revenue upside
due to 3G, we add back the book value of the 3G license
(Rs41/share) to the net debt for the company. This equates to
Rs9/share.
We base our valuation of Bharti’s tower business on our DCF of
the company’s seven circles as well as its ownership in Indus to
arrive at a value of US$110k per usable tower.
We value Bharti’s tower business at Rs85/based on our DCF
model and add this to our core business equity value.
Our valuation methodology for African assets is DCF. Since our
analysis suggests Bharti has acquired these assets at a
premium by taking on higher debt, the net accrued value has a
negative Rs16/share impact (Exhibit 16).
We also incorporate regulatory payouts for excess spectrum
beyond 6.2MHz and cost of renewal of total spectrum on expiry
of licenses. These amount to US$790mn or Rs9.4 per share
and US$1.2bn or Rs14.3 per share, respectively.
We set our price target at our base case value of
Rs450/share.
Downside risks to our price target
• Higher-than-expected drop in tariffs due to aggressive
pricing by new operators to gain subscribers.
• Regulatory uncertainty regarding spectrum and Bharti’s
need to pay additional spectrum charges. In our bear case,
we estimate US$1bn for the company based on Trai’s
recommendations.
Exhibit 19
Bharti: Sum-of-the-Parts Valuation
(Rs/share)
Core Enterprise Value (EV) DCF 396
Less: Core Net Debt (9)
Core Equity Value DCF 405
Towerco Contribution to Bharti's base case 85
Net accrual of African acquisition to Bharti (16)
Regulatory Payouts (24)
Target Price for Bharti based on SOTP 450
Source: Company data, Morgan Stanley Research
Exhibit 20
Bharti: Assumptions for Cost of Capital
Risk Free Return (Rf) 8.0%
Market Premium (Rm) 6.0%
Assumed Beta 0 .90
Cost of Equity (Re) 13.4%
Equity (%) 72.0%
Cost of Debt (Rd) 11.0%
Tax rate 22.5%
After-tax cost of debt (Rd [1-t]) 8.5%
Debt (%) 28.0%
WACC 12.0%
Source: Company data, Morgan Stanley Research
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Indian
Telecommunications
Stable tariffs = 2x revenue
growth; 3G to add more
We reiterate our Attractive view on Indian telcos,
given our views on four key debates: 1) Reduction in
competitive intensity should lead 2G revenue growth to
double in F2012 vs. F2011; 2) 3G tariff launches are
costlier than 2G and already account for 2-3% of overall
revenues; 3) regulatory concerns should decrease in
2011; 4) telco operators are FCF-positive incrementally.
Our two key picks are Idea and Bharti.
Idea is our favorite idea – highest leverage to
domestic wireless business: It has gained the highest
revenue market share in the last three years and also
has the highest active subscriber base ratio.
Bharti – lower return, albeit lower risk: Bharti has
India’s highest wireless revenue market share, the
strongest balance sheet amongst Indian telcos, strong
earnings growth outlook of 25% p.a. over the next three
years, is FCF-positive, and the contribution from its Zain
acquisition is increasing.
Decreasing competitive intensity = high growth
ahead: New operators are reeling under the pressure of
EBITDA losses and hence we believe their propensity to
spend incrementally on tariff wars has waned. We
estimate healthy traffic growth of 5-6% per quarter to
lead to annual growth of 20-25% in minutes; even
assuming a 6% p.a. decline in industry ARPMs from
current levels, 2G revenue growth in F2012E should
almost double to 14% p.a. from 8% in F2011E.
Initial data points on 3G are promising: 3G data
tariffs are ~45%-90% costlier than 2G. 3G has neither
endured any tariff wars nor been given handset
subsidies. Channel checks suggest 3G traffic growth is
already 2-3% of overall revenues and volumes, in the
first quarter of launch. We believe India could have
90mn subscribers by 2015, generating US$2.3bn in
EBITDA.
Key Stock Ideas
Bharti: Geared Up for Growth
• FCF-positive from F1Q12: Bharti was
FCF-negative in F2011 (-45%) because of its
investments in Zain, 3G, and broadband license
fees – but we project that it should be 13%
FCF-positive in F2014. Its ratio of net debt to
EBITDA should move from 3x to 1.1x during the
same period.
• One of the fastest-growing large-cap telcos:
We expect Bharti to have ~300mn subs by
F2014 and look for it to register strong CAGRs
over F2011-14 of 12% in subs, 14% in revenue,
19% in EBITDA, and 25% in profit.
• We see three catalysts: 1) strong quarterly
results (we expect 6% sequential growth; 2)
traffic growth returning in Africa; and 3) reduced
rate of tariff decline in the domestic business
and hence faster revenue growth.
• If Bharti were to cross US$5bn in revenues and
reach 40% EBITDA margins in its African
operations (as per management targets), that
would present upside of Rs29/share to our
target price and of 7-8% to our EPS estimates.
• We estimate 3G upside of Rs51/share
assuming 30mn subscribers and incremental
ARPU of Rs200/share. That would raise our
EBITDA and earnings estimates on average by
~7% and ~17% by F2015, respectively.
Idea: Highest Leverage to Indian Wireless Business
• Of late, the intense competition in the Indian
telecom industry has been turning more benign
– but during the past three intense years, Idea
has increased its revenue market share to 4%.
Idea also has the highest active subscriber
base ratio, implying high-quality subscribers.
• Idea has also been maintaining a relatively
higher capex to sales ratio vs. peers. Idea has
the third largest GSM spectrum amongst
operators, including the superior 900 MHz of
spectrum, which gives it the lowest subscriber
per spectrum ratio of the top six operators and
the lowest subscriber per Base Terminal
Station (BTS). Hence, we believe that in the
future Idea will need less capex than its peers.
• Idea has higher exposure to the domestic
wireless business and highest sensitivity to
growth via 3G.
• We estimate 3G value of Rs37/share assuming
13mn subscribers and incremental ARPU of
Rs180/share. That would raise our EBITDA and
earnings estimates by an average ~12% and
~41%, respectively, by F2015.
Debate #1: Will India’s Wireless Segment Go through Another Lull
Because of Heightened Competition?
Market’s view: Yes. Most investors are underweight
Indian telcos. Our discussions with them reveal that
their key reason is their negative outlook on competition
in the industry. They believe that wireless revenues will
not grow significantly.
Our view: No. We believe revenue growth will be
double that of the last two years, thanks to reduced
competitive intensity. Uninor, a new operator, has
already suffered EBITDA losses of US$1bn and laid out
another US$1bn on capex. Hence Uninor’s ability – and
similarly, that of other new operators – to withstand
such losses seems to be diminishing. Since F2H11,
incumbents have registered revenue growth of 3-4%, vs.
stagnant to declining revenues in the last two years.
We Observe Diminishing Competitive Intensity
We thus project a 14% CAGR in wireless revenues over
F2011-13E: After the tariff wars during June to December
2009, we have not seen any major tariff cuts by operators.
Postpaid tariffs have fallen in anticipation of mobile number
portability and now the differential between prepaid and post
has narrowed to 10-15%.
Exhibit 5shows the current tariff plans. Most players now have
similar tariff packages, hence there is little differentiation for
consumers. The average 2G voice retention per minute is
approximately 36-37p. Data retention per minute is 5p now.
One key reason for the reduction in competitive intensity has
been that the biggest new operator in terms of subscriber
base – Uninor – is reeling under pressure. It has incurred over
US$1bn in EBITDA losses since inception and has devoted
another US$1bn to capex, as shown in Exhibit 4 Thus its
balance sheet has been stretched, and the company plans to
spend another US$1.5bn before it believes it may break even.
We think that based on its quarterly spending rate of
US$300-400 mn, the US$1.5bn would last Uninor only a year
more. Our discussions with industry sources suggest the
smaller players have already scaled back their coverage plans.
Hence we believe their propensity to spend incrementally on
tariff wars has waned. Exhibit 3 shows that the seven new
operators have a 5.5% subscriber market share, whereas they
only have a 2.4% revenue market share.
The contribution of data in the last eight quarters has been
increasing as a percentage of sales to 12%. Traffic growth
historically has been an impressive 27% p.a. F2009-11, and
we expect the growth to be a healthy 22% p.a. over the next
two years. ARPM fall has been a high 19% last two years and
we expect a slowdown to 6% p.a. next two years.
This would lead to healthy growth in revenue of 14% p.a.
F2011/13, up from muted revenue growth of 9% p.a.
F2009/11 (Exhibit 6).
Where we could be wrong. The new players could make one
last effort with a tariff war to gain market share, before they
give up their licenses to the government. In the short term this
could intensify competition.
Debate 2: Will 3G Be Incrementally More Negative for the Industry?
Market’s view: Yes. 3G could intensify tariff wars and
also possibly lead to the introduction of handset
subsidies in India.
Our view: No. We believe the incumbents that have
bought 3G have stretched balance sheets. This has led
to rationalization of 3G tariffs and no subsidies. The
payback period for 3G license fees paid would be around
10 years, implying low IRR. However, we believe that
incrementally, 3G should lead to further revenue growth
for the industry, with increasing ARPM. Incremental 3G
capex is lower than 2G capex.
3G Should Compound Overall Wireless Growth
We project a revenue CAGR of 17% in F2011-13: After the
license fees they paid for 3G, incumbents have stretched
balance sheets and rationality has prevailed in pricing. The
focus seems to be on getting 2-2.5x of incremental ARPU
~Rs250/month. The 3G data packages are priced up to 45%
costlier than 2G at sub-250 MB consumption; and as much as
90% more for higher consumption of 2GB (see Exhibit 7).
Importantly, 3G so far has neither endured any tariff wars or
been given any subsidies on handsets. Our discussion with
various industry sources reveal that almost 9% of active
subscribers have 3G-enabled handsets – 60 mn, as shown in
Exhibit 8. Initial feedback from vendors and operators suggests
that traffic growth from 3G seems to be already 2-3% of overall
revenues and volumes, in the first quarter of launch.
Exhibit 7
Indian Telecoms: 3G data tariffs are costlier than 2G
Monthly
Charges (Rs)
Usage Limit
(MB) Implied (Rs/MB)
3G 101 100 1.01
2G 350 500 0.70
Premium 44%
3G 750 2000 0.375
2G 398 2000 0.199
Premium 88%
Source: Company data, Morgan Stanley Research
Exhibit 8
Indian Telecoms: 3G Early Indications
Estimated Smart phones/ 3G enabled handsets 60
% of Overall Active Subs 9%
3G ARPU 225
3G active subs 9
Quarterly revenue (Rs mn) 6,075
% of Revenues of 3G operators 2.2%
Source: Company data, Morgan Stanley Research
3G has lower capex than 2G: We estimate that incremental
capex per subscriber to move to 3G should be 20% lower than
for 2G, because of operators’ existing passive infrastructure.
The key focus in 3G capex has been backhaul, as shown in
Exhibit 9. Passive spending is about 10%, active radio
electronics and backhaul account for 45% each.
Incumbents are devoting only 10-15% additional spending to
the tower operators to add a 3G site on their 2G network, hence
saving costs. Opex for 3G is being largely covered by their
opex spending for their existing 2G business – and so
theoretically, EBITDA margins could be as high as 60%.
Exhibit 9
Indian Telecoms: Incremental 3G capex to be less
than 2G capex
Passive
Active
Radio
Active
Backhaul Total
2G 60 30 10 100
3G 8 36 36 80
Source: Company data, Morgan Stanley Research
Revenue upside: We believe the country could have 90mn
subscribers by 2015, who would spend Rs200/month more in
ARPU (i.e., US$4.6bn), thereby increasing India’s weighted
average ARPU by Rs2-3/month. The industry could gain
US$2.3bn in EBITDA, as shown in Exhibit 10. This could
further lead to stabilization in ARPU for the industry in the next
three years vs. 15-20% p.a. decline in the previous three years.
Overall industry revenues could thus increase from 14% to
17% p.a. in F2011-13.
Idea has the highest sensitivity to higher ARPUs and
margins due to 3G as well as 2G… Every 10% change in
ARPM changes profits by 30%. In our base case and target
price calculations, we include only the book value of 3G license
paid. We estimate 3G value of Rs37/share assuming 13mn
subscribers and incremental ARPU of Rs180/share. That
would raise our EBITDA and earnings estimates by an average
~12% and ~41%, respectively, by F2015.
…followed by RCOM… We estimate 3G value of Rs62/share
assuming 12mn subscribers and incremental ARPU of
Rs180/share. That would raise our EBITDA and earnings
estimates by an average ~9% and ~27% by F2015,
respectively.
…and then Bharti: We estimate 3G value of Rs92/share
assuming 30mn subscribers and incremental ARPU of
Rs150/share. That would raise our EBITDA and earnings
estimates by an average ~7% and ~17% by F2015,
respectively.
Where we could be wrong. Our biggest concern about 3G
could be that operators offer subsidies for 3G handsets
subsidies – subsidies have never been given by Indian
operators so far. If this were to happen, our projection of
positive free cash flows for the industry could be delayed by a
year.
Debate #3: Will Telecom Regulatory Policy Be Negative for the
Stocks?
Market’s view: Yes. Overpayment in 3G auctions has
shown the government the probable spending power of
operators. Hence regulations will be negative for the
Indian telecom operators. There are likely to be severe
charges pertaining to excess spectrum and license
renewal.
Our view: No. We believe that the operators may face
regulatory payouts – but policy should reduce the overall
uncertainty in the industry. We project that the
companies under our coverage should turn FCF-positive
in F2012. As a result, we believe that in the near to
medium term their balance sheets can withstand
payouts pertaining to excess spectrum charges and
renewal of licenses as per TRAI’s recommendations on
February 9, 2011.
Regulatory Concerns Could Decrease
Two developments – both of which should help remove
uncertainties – are expected in C2011:
Spectrum guidelines – addressing four areas: We expect
these to come out by August 2011. Our beliefs are:
• One-time excess spectrum charges: These would need to
be paid by the industry in line with the Telecom Regulatory
Authority of India (TRAI) recommendations on February 9,
2011.
• License renewal fees: These are scheduled to commence
during 2014-21E. We think they could be half the
magnitude as suggested by TRAI on February 9, 2011.
• Annual license fee reduction: The move from 10% to a
uniform 6% may not be accepted by the government, as
suggested by TRAI in May 2010, because it may lower the
collections for the government by US$400-600mn p.a.
• Refarming: We do not believe this would be accepted in
view of the complexities involved in taking back 900 MHz
spectrum in various years, sourcing the 1800 MHz, and
swapping it subsequently.
The New Telecom Policy 2011: We expect this to come out
by the end of the year and provide longer-term direction on the
remaining issues, such as:
• Broadband: A policy relating to increasing broadband
penetration in our country from the dismal 1% currently.
• M&A: A policy relating to providing an exit/consolidation
route to an overly populated industry with 12-14 operators.
• Tower sharing: Regulation pertaining to creation and
sharing of towers.
Exhibits 12-13 show our assumptions in our target prices
relating to regulatory hurdles.
Where we could be wrong. As shown in Exhibit 13, in our bear
case we assume that each operator pays 100% of license fee
renewals. We assume just 50% in our base case.
Debate #4: Will the Telecom Industry Ever Turn FCF-Positive?
Market’s view: Not any time soon. Increased
competition and regulatory payments would keep
telecom incumbents FCF-negative.
Our view: Yes – this year, in fact. We believe that in
the current year (F2012), all telecom operators should
turn FCF-positive before regulatory one-offs. Assuming
the excess spectrum fee, Bharti and RCOM would be
FCF-positive in F2012.
Turning FCF-Positive before Regulatory One-offs
We project that the Indian operators should be FCF-positive
with the 3G auction over and capex under control. In our view,
Bharti has the most stable FCF amongst operators.
Bharti has projected overall F2012 capex of US$2.9-3.1bn with
domestic capex of around US$1.9bn and capex in Africa (Zain)
of US$1-1.2 bn (Exhibit 14). Our capex estimates are a bit
more aggressive at US$3.3bn, implying cash outflow of
US$4bn, including the US$700 million for the final payment
pertaining to the African acquisition. Bharti should be
FCF-positive at 13% in F2014. The net debt to EBITDA ratio
should move from 3x to 1.1x by F2014.
For F2012, we estimate that Idea has overall capex of
~US$900mn. The 3G debt in F2011 has driven net debt to
EBITDA up to 2.8x; however, in F2012 we expect Idea to be
FCF-positive, not including excess spectrum charges. That
could lower the net debt to EBITDA ratio to 1.4x by F2013
(Exhibit 15).
RCOM has domestic capex of US$537mn in F2012E and the
company has net debt amounting to US$7bn. Net debt to
EBITDA is thus highest at 4.9x currently, decreasing to 3.1x by
F2013E (Exhibit 16).
Where we could be wrong. Increase in regulatory risks as
discussed in Debate #3, as well as 3G handset subsides, could
delay positive FCF for the industry by 1-2 years.
Valuation Methodology and Risks
Idea Cellular
Our 12-month target price for Idea is Rs91/share, up 11% from
Rs82 per share. It is based on our DCF model and the value we
attribute to the company’s towers. Our sum-of-the-parts
valuation is shown in Exhibit 13.
Our core business value for Idea remains the midpoint of the
value derived from our DCF calculation on a one-year forward
basis, assuming a terminal growth rate of 3% and cost of
capital of 12%, as shown in Exhibit 14. Based on our revised
estimates, we arrive at our new core business enterprise value
of Rs90/share The company’s net debt equates to Rs31/share.
However, since in our base case we do not include any
revenue upside due to 3G, we add back the book value of the
3G license to the net debt for the company. This equates to
Rs14/share.
We value Idea’s towers in Indus using DCF and use an
EV/tower of 100k to value the company’s directly owned towers.
The combined value for Idea’s towers is US$2.2bn or
Rs30/share, 40% of its market cap; as shown in Exhibit 12 and
13. We add this tower value to our core business equity value
(Exhibit 13).
We also incorporate regulatory payouts for excess spectrum
beyond 6.2MHz and cost of renewal of total spectrum on expiry
of licenses. These amount to US$322mn or Rs4 per share and
US$862mn or Rs12 per share respectively.
Exhibit 17
Idea Cellular: Sum of the Parts Valuation
Core Business Enterprise Value 90
Net Debt 14
Core Business Equity Value 77
Tower Valuation 30
Regulatory Payouts (16)
Target Price 91
Source: Company data, Morgan Stanley Research
Exhibit 18
Idea Cellular: Cost of Capital Assumptions
Risk Free Return (Rf) 8.0%
Market Premium (Rm) 6.0%
Assumed Beta 0.98
Cost of Equity (Re) 13.9%
Equity (%) 60.0%
Cost of Debt (Rd) 12.0%
Tax rate 22.5%
After-tax cost of debt (Rd [1-t]) 9.3%
Debt (%) 40.0%
WACC 12.0%
Assumed WACC 12.0%
Source: Company data, Morgan Stanley Research
Downside risks to our price target
• Greater-than-expected fall in tariffs due to aggressive
pricing from new operators to gain subscribers.
• Regulatory uncertainty regarding spectrum and Idea’s
need to pay additional spectrum charges.
Bharti Airtel
For our bear-, base-, and bull-case scenarios, we use a
sum-of-the-parts methodology, which adds discounted cash
flow (DCF) value for Bharti’s core business, 3G book value and
value derived from its tower business and net accrual from
Africa acquisition.
Bharti’s core business value remains at the midpoint of the
value derived from our DCF calculation on a one-year forward
basis, assuming a terminal growth rate of 3% and cost of
capital of 12%, as shown in Exhibit 17. Based on one-quarter
forward rollover, we arrive at our new core business enterprise
value of Rs396/share.
Since in our base case we do not include any revenue upside
due to 3G, we add back the book value of the 3G license
(Rs41/share) to the net debt for the company. This equates to
Rs9/share.
We base our valuation of Bharti’s tower business on our DCF of
the company’s seven circles as well as its ownership in Indus to
arrive at a value of US$110k per usable tower.
We value Bharti’s tower business at Rs85/based on our DCF
model and add this to our core business equity value.
Our valuation methodology for African assets is DCF. Since our
analysis suggests Bharti has acquired these assets at a
premium by taking on higher debt, the net accrued value has a
negative Rs16/share impact (Exhibit 16).
We also incorporate regulatory payouts for excess spectrum
beyond 6.2MHz and cost of renewal of total spectrum on expiry
of licenses. These amount to US$790mn or Rs9.4 per share
and US$1.2bn or Rs14.3 per share, respectively.
We set our price target at our base case value of
Rs450/share.
Downside risks to our price target
• Higher-than-expected drop in tariffs due to aggressive
pricing by new operators to gain subscribers.
• Regulatory uncertainty regarding spectrum and Bharti’s
need to pay additional spectrum charges. In our bear case,
we estimate US$1bn for the company based on Trai’s
recommendations.
Exhibit 19
Bharti: Sum-of-the-Parts Valuation
(Rs/share)
Core Enterprise Value (EV) DCF 396
Less: Core Net Debt (9)
Core Equity Value DCF 405
Towerco Contribution to Bharti's base case 85
Net accrual of African acquisition to Bharti (16)
Regulatory Payouts (24)
Target Price for Bharti based on SOTP 450
Source: Company data, Morgan Stanley Research
Exhibit 20
Bharti: Assumptions for Cost of Capital
Risk Free Return (Rf) 8.0%
Market Premium (Rm) 6.0%
Assumed Beta 0 .90
Cost of Equity (Re) 13.4%
Equity (%) 72.0%
Cost of Debt (Rd) 11.0%
Tax rate 22.5%
After-tax cost of debt (Rd [1-t]) 8.5%
Debt (%) 28.0%
WACC 12.0%
Source: Company data, Morgan Stanley Research
No comments:
Post a Comment