Action/ Valuation: Downgrade to Reduce
Recent 1Q results have raised a lot more questions on Bharti’s domestic
wireless strategy, African potential, capital needs, regulatory impacts, etc,
with little clarity in sight. Bharti’s earnings are also becoming inherently
difficult to forecast, and in the past two years, although the market has
given it the benefit of the doubt consistently, analysts have subsequently
downgraded it (negative 60% revisions since Jan-11, based on Bloomberg
consensus). FY13 EPS is likely to be low (INR8-12 range), but we believe
the issue is more on the growth profile (consensus still expects 30% EPS
CAGR over the next 2-3 years vs a profit decline every year for the past
three years). Given the extent of negativity, it could be argued that
downside may be limited from here, but this is hardly being reflected in its
high valuation of 20x FY14 P/E. Downgrade to Reduce with a INR210 TP.
Catalysts and concerns
1) Potential listing of its towers could be a positive catalyst, but is in our
view more reflective of its capital needs rather than optimising value given
weak market conditions along with muted underlying performance. 2) Post
1Q results, the market has become more unsettled on its operating
outlook and how effective its strategy of protecting revenue share will be –
domestic voice pressures could continue even if there are 3-4 viable
players. 3) It was widely expected that Africa will show consistent margin
improvement, but in 1Q it fell 200bps to 26% (28% in 4Q), and we believe
these trends will remain choppy. 4) On regulations, the concern now is
more on the ‘process’ rather than just the ‘prices’ which in our view will
likely be high anyway. A deferred payment structure for spectrum could
see more competition.
Various unknowns
• Bharti’s recent 1Q results have left most people confused about: 1) the impact of its
current revenue-share focused strategy, which is incurring high costs; 2) the African
turnaround potential or lack thereof; and 3) potential capitalization given its high
gearing levels (USD13bn in net debt). After a further assessment of the recent results
along with a review of catalysts, we see more risks ahead and downgrade Bharti to
Reduce with a target price of INR210. Its current FY13-14 P/E of 20-24x is expensive,
in our opinion, and we also do not rule out the possibility of an equity raising, especially
if refinancing (USD3bn in short-term loans) becomes difficult or expensive.
• We have been bearish on Indian telcos for a while, but we kept Bharti at Neutral
previously as we thought the EPS downside risks were moderating. But recent results
again highlights that this downward revision cycle is far from over. Current consensus
EPS for FY13-15 is INR14, INR20 and INR24 (as per Bloomberg), which implies a 30%
CAGR. The CAGR for the previous three-years is minus 20%.
– Analysts’ track record in forecasting Bharti’s earnings over the past two years has
been very ordinary to say the least. Domestic operations have remained volatile and
the tendency has always been to generalise pan-India strategy as one, although there
has been different approaches in different circles. The net impact at the group level is
that average pricing pressure has continued, alongside margin pressure and there is
still little evidence of share gain.
– Even for Africa, since the acquisition in 2011, the market has given Bharti the benefit
of the doubt on a consistent improvement in margins and earnings where there has
been very little visibility on the market. A lot of the trends/ expectations such as
elasticity has not played out – average prices still remain high at US5c while usage is
relatively lower (compared to India) at 120 MoUs. There have also been some oneoffs
every quarter – and given the complexity of these markets, these one-offs will
likely continue, in our view.
What has happened, and what do we
expect now?
Domestic wireless trends
• Over the four quarters in FY12, Bharti averaged 3% sequential domestic wireless
revenue growth, translating to about 11% y-y growth. Bharti added INR38-39bn in
incremental wireless revenues in FY11-12, and for FY13-14F, we model in a rise of
INR39-42bn in wireless revenues which is in-line with past trends. There are still (and
will likely be) 4-5 viable players and hence, we believe it is difficult to see many
surprises on prices or volume. We expect data take-up to pick up, and expect this to
rise 2-3 pp ever year to contribute 21% of revenues by FY15F.
• Likewise, sequential EBITDA growth through FY12 averaged 3% q-q, translating into
an 8% y-y growth. In FY12, Bharti added INR10bn in incremental wireless EBITDA.
However, in 1Q13, EBITDA declined sharply by 9% q-q (lower by INR3bn) and 4% y-y.
Despite this, we are expecting flat EBITDA in FY13F and incremental EBITDA of
INR13bn in FY14F.
Africa
• In Africa, we estimate Bharti added around USD500mn in incremental revenues in
2012, but only USD230mn in incremental EBITDA; we believe this should see margins
improve from 24% to 28% through FY12.
• Despite no revenue/EBITDA improvement in 1Q13 and margins going backward, our
FY13F estimates mimic a similar improvement in revenue and EBITDA as seen in
2012.
Other businesses
• Trends in other businesses have been mixed in the past couple of years and have not
been major drivers of growth or earnings revision for Bharti.
– In enterprise, margins have dropped from mid 20’s to mid-teens now.
– In Telemedia, growth has been in the low single-digit range.
– Bharti began to report DTH as a separate segment recently, and this business is just
turning EBITDA profitable. However, content costs remains a risk as seen in 1Q13
where EBITDA margins dropped to negative 1% (vs an average of 4% in the previous
three quarters).
Consensus EPS revisions – downward cycle far from over
• Despite close to 40-60% negative revisions to Bharti’s EPS outlook over the past 1-2
years, we still think consensus EPS remains high.
• Current consensus EPS for FY13-15 is INR14, INR20 and INR24, which implies a 30%
CAGR.
• The CAGR for the previous 3-years is minus 20%.
• We have given Bharti the benefit of doubt in the past – be it for the ability to sustain
domestic price increases or Africa turnaround. However, this hasn’t quite panned out as
expected and it is hard to see the stock re-rating when there are still downside risks to
earnings.
Balance sheet concerns
• Of its USD13bn net debt, Bharti has refinanced USD2bn this year, and has another
USD3bn in short-term loans (or around USD1.5bn for acquisition re-financing). Further
refinancing/repayments could coincide with potential spectrum renewal payments.
• Gearing levels remain high at 3x net debt to EBITDA – especially as its operating
trends have remained lacklustre, and there could be potential cash outflows for
regulatory payments (eg, upcoming auctions) in India. Total debt at the end of the
quarter was INR740bn or net debt of INR717bn (USD13.5bn).
• We think that further refinancing or capitalisation is likely in the next 6-12 months. This
could also coincide with license renewals. Management also discussed the possibility
of listing its tower portfolio; however, this has been discussed in the past too, and could
take time to conclude. Africa is unlikely to be significantly FCF-positive (post interest) in
the near-term, we believe.
• In the June quarter, Bharti appears to have refinanced its short-term debt with long
term ones, in our view. As per the cash flow statement, it paid off INR97bn but also
raised INR95bn. On the conference call, management noted that around USD2bn of
debt was refinanced and another USD1.3bn would be up for repayment in a year,
which it believes is manageable.
Regulations – what next?
On the regulatory side, we believe the focus will now shift to the auction processes and
outcome, given that lower pricing appears to be a foregone conclusion. Recent decision
by the cabinet to lower reserve prices by around 20% (at INR140bn) doesn’t necessarily
improve the economics and it is hard to know what final prices could be. Most
importantly, a staggered payment structure has also been decided upon by the group of
ministers which would allow more players to participate and keep competition tight.
The Department of Telecommunications is likely to release a draft information
memorandum, and auctions are now expected to be delayed to end-November vs the
court’s decided deadline of end-August.
Earnings revisions and valuation
• We revise our earnings estimates lower by 22-24% for FY13F and FY14F to account
for slower top-line growth, weaker margins and also higher D&A/interest costs.
• Following which, our DCF-based (valuation methodology unchanged) target price
moves to INR280. To this, we apply a discount of 23% to factor in operational, currency
and regulatory risks. This yields a target price of INR210
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