Telecom - Earnings traction strong but beat unlikely; regulatory visibility increases ::Motilal Oswal

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Telecom
Earnings traction strong but beat unlikely; regulatory visibility increases
Initial signs of weakening industry discipline; downgrading EBITDA by 2-5%; maintain Buy
While our recent industry interactions suggest strong 3Q business momentum, we downgrade EBITDA estimates
for Bharti/Idea by 2-5% and target prices by 7-10% led by 1) lower visibility on near-term margin expansion
despite the companies entering seasonally strong period, 2) poor 3G uptake which will likely lead to higher
marketing spends and data tariff cuts, and 3) likely higher competitive intensity within the top-3 operators as
manifested in divergent subscriber addition and market share trends. However post recent ~15% stock price
correction and expected resolution of near-term regulatory issues, we believe valuations for Bharti/Idea at
~6x FY13E EV/EBITDA are attractive. Maintain Buy on Bharti/Idea and Neutral on RCom.
 Our recent interactions with Bharti, Idea and other industry participants reconfirm strong traffic growth rebound in 3Q,
along with continued RPM increase, led by tariff hikes getting effective for subscribers coming up for renewals. Both
traffic growth and RPM trends appear broadly in-line; we do not see much room for positive surprise in the near-term.
 Our interactions also indicate that industry discipline might be getting weaker at the margin, with net subscriber
additions getting skewed in favor of a few operators and disparate revenue market share trends amongst the top-3
operators, with Bharti continuing to lose revenue market share while Vodafone and Idea have maintained their share.
 Idea has been posting the highest net subscriber additions among the incumbents post the tariff hikes in July, which
might be an indicator of relatively higher aggression v/s other players. Some part of this outperformance might also be
due to the fact that Idea has raised tariffs only in its leadership circles while operating at a discount in other circles.
 Margin commentary remains mixed. While operating leverage should kick in, the impact is being diluted by 3Grelated
costs as well as pressure on SG&A in case of some operators. During 2HFY12, we expect 80bp EBITDA
margin improvement for Idea (4QFY12 v/s 2QFY12) and 180bp improvement for Bharti. Higher margin improvement
assumption for Bharti is driven by tighter cost control post recent restructuring and lower SG&A.
 3G uptake remains weak, largely due to lower device penetration (estimated at early double-digits for Bharti and mid
single digits for other players) and high data tariffs (~INR0.5/MB on promotional basis for lower denominations of
monthly packs). While 3G is unlikely to be a significant revenue driver in 2HFY12, we expect significant cut in 3G
tariffs over the next few months and continued increase in 3G handset penetration to drive 3G revenue from FY13.
 Regulatory visibility has increased in the near term, with media reports indicating crystallization of final policy decision
on excess spectrum and M&A rules. We highlight that the liability/share for excess spectrum (INR4/share for Idea
and INR10/share for Bharti) is much lower than the potential liability for spectrum renewal; our target prices incorporate
50% of this. Uniform pan-India licence fee of 8% and similar licence fee on tower rentals are likely to have largely offsetting
impact on EBITDA for Bharti/Idea. Resolution of other issues like spectrum renewal and re-farming could also
happen with a lag, since first licence renewals would happen only in late 2014. Policy for providing exit to distressed
new entrants is also unlikely to be addressed, as TRAI is starting a fresh consultation process on the same.
 During the current quarter the INR has depreciated against the USD by ~9%. We have modelled 3QFY12 forex loss
of INR2.5b for Bharti and INR 0.2b for Idea. Assuming net forex exposure of USD10b we estimate net worth impact of
INR47b (INR12/sh) on Bharti.
 We are downgrading our FY12/13 EBITDA estimates for Bharti by 2/4% and Idea by 3/5%, largely on lower margin
assumptions. We are reducing our target price for Bharti from INR515 to INR465 and for Idea from INR135 to INR125.
 Post the recent ~15% correction in Bharti/Idea, we believe valuations at ~6x FY13E EV/EBITDA are attractive.
Maintain Buy on Bharti/Idea and Neutral on RCom.