Indian Telecoms More spectrum likely, change in reserve price unlikely  HSBC Research

Indian Telecoms
More spectrum likely, change in reserve price unlikely
 Spectrum reserve price unlikely to be revised downwards
 Don’t expect meaningful participation from incumbent telcos,
RIL participation debatable
 Retain OW on Bharti and TP of INR406

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More spectrum but no change to reserve price. We believe there may not be significant
changes to the auction reserve price. However, we expect the regulator to make more spectrum
available for auction. TRAI clarifications have already suggested more spectrum being made
available. In our view, an average c10Mhz of 2G spectrum could be made available.
Likely bidders. We expect Idea (seven impacted circles only) and Uninor (selective
participation) to participate in spectrum auctions and don’t expect meaningful participation
from Bharti and Vodafone, as bidding intensity could adversely impact license renewal
payouts. Separately, Bharti may add more BWA spectrum, in our view, given that 700MHz
auctions look delayed and Reliance Industries’( RIL IN, N, TP INR800) BWA launch is
getting more visible.
RIL factor. We believe that data remains core to its strategy and it doesn’t seem to be in a
hurry to provide voice and likely to focus on VOIP (via existing spectrum), in our view. That
said, it may need spectrum for a fall back (as an interim voice solution). While upcoming
auctions could be an option, there are other alternatives available as well such as M&A and as
such its participation in the upcoming auctions remains a matter of debate. We believe RIL
may benefit most from procuring 900/700MHz and re-farming of 900MHz spectrum will be
positive for RIL. In the interim, RIL is likely to offer data cards, similar to what Bharti is
doing. Key for RIL will be ability to arrive at mechanisms to provide dense coverage in a cost
effective manner given the in-building penetration issues with 2,300MHz spectrum.
Impact on tariffs. As there is no immediate increase in costs for incumbents like Bharti,
Vodafone, Tata, and RCOM; we see fewer possibilities for immediate headline rate hikes.
However, minute discounting is likely to ease as costs for both Uninor and Idea input costs are
likely to rise and as both of them have been most aggressive on special tariff vouchers
(reduction in discounts could improve voice realizations by c5% easily).
Stock implications. Bharti is our preferred pick in the sector with target price of INR406.
The recent bump up in India capex suggests that Bharti is closing network gaps/increasing
population coverage and allows it to play the minute game. We believe this not only
allows Bharti to gain minute market share but also increases in revenue market share. We
value Bharti using a blend of SOTP-based DCF analysis and PE. The key downside risk
would be spectrum re-farming as it will be significantly disruptive for the telco.


Bharti may add more BWA spectrum
Qualcomm has spectrum holding in four circles, which account for 22% of total mobile revenues (these circles
account for 18% of total Bharti revenues) and have no overlap with Bharti’s BWA presence. In our 23 April
note, Recovery driven by Voice, we highlighted that Bharti's purchase of the BWA spectrum of Qualcomm
(reported by Reuters, Bharti in talks for stake in Qualcomm India unit-May 16, 2012) would be linked to RIL’s
rollout and timing of the 700MHz auctions. With the 700MHz auctions delayed (if we go by the recent TRAI
recommendations) and RIL’s 4G launch likely by the end of this year, it makes sense for Bharti to procure
additional BWA spectrum in the metros of Mumbai and Delhi. We note that both Mumbai and Delhi are at
150% mobile penetration suggesting incremental growth driver in these markets is data only.
Separately as and when, government incentivises data growth, BWA players may benefit and Bharti may gain.
To sum it up, we are of the view that purchase of Qualcomm spectrum would allow Bharti to mitigate risks
from any possible disruption by RIL’s 4G launch in addition to add the data card revenue stream and address
the residential broadband space where telemedia business cannot reach. We believe Bharti with its 900/1,800
spectrum and mobile coverage in metros may be better off than RIL, in terms of providing voice fall back and
providing residential broadband. In terms of payout, we believe except for Bharti there may not be many
buyers of this spectrum from Qualcomm, and with Bharti having a presence in four markets with LTE already,
the opportunity is more viable for Bharti than others. In our view, payout to obtain this spectrum may not be
more than 1.1x-1.3x of the price paid by Qulacomm to obtain this spectrum. We believe the key rationale for
Qualcomm to purchase this spectrum was to encourage adoption to LTE by all service providers, which
procured BWA spectrum and, in our view, this is in place.


Bharti: valuation and risks
We have an Overweight rating on Bharti with a target price of INR406. We value Bharti using a blend of
SOTP-based DCF analysis and PE. Our valuation has two components: India and the Africa operations.
We value the tower division along with the India business, which we value on a mix of equally weighted
PE and DCF. For our DCF analysis, we assume a WACC of 12% and a cost of equity of 13% (cost of
debt 10.5%) to arrive at a value of INR602 per share. For the purpose of our PE methodology, we use a
PE of 16x and apply this to our FY13e EPS to arrive at a fair value INR294 per share. Our target price
includes a negative adjustment for the TRAI recommendations of INR48; however, we see a small chance
of these recommendations being accepted in the current format. We value the Africa business through
DCF methodology assuming WACC of c13% to arrive at a value of -INR16 per share. Under our research
model, for stocks without a volatility indicator, the Neutral band is 5ppts above and below the hurdle rate
for Indian stocks of 11%. At the time we set our target price, it implied a potential return that was above
the Neutral band; therefore, we rate the stock Overweight Potential return equals the percentage
difference between the current share price and the target price, including the forecast dividend yield when
indicated. Key downside risks include re-farming of spectrum in 900 MHz band and revision of
termination charges. Key catalysts include faster-than-estimated margin improvement in Africa and an
accelerated enrolment of subscribers for 3G services.