How to improve ROIC?
Resist the temptation
Action: Maintain Reduce... too many unknowns still How to improve Bharti‟s low 6% ROIC was a key topic in our recent meeting with Mr Akhil Gupta, MD. Within this, low operating margin is one concern, but asset turn of 0.7x is one of the lowest amongst regional telcos. The company attributes this to 3G/4G/Africa payments, which has increased the asset base, but is not generating much incremental earnings yet. With potential spectrum renewals ahead, and limited incremental earnings scope, we think ROIC could remain weak. On India, management expects rational competition, and voice prices may rise and stick over the next few quarters. Focus is also on managing acquisition costs to control margins. On Africa, the company believes cashflows will improve gradually but may not cover the principal repayments on debt over the next 2-3 years. On towers, the company attributes the rationale and timing of the listing (Bharti Infratel) to „shareholders agreements‟. We remain unclear/ unconvinced on the capital structure (low gearing). There were no specific comments on regulations. We don’t dismiss Bharti’s inherent potential, but given what we view as its expensive valuation and various unknowns, it is hard to conclude that the earnings downgrade cycle is over. Hence, we reiterate our Reduce rating. Has Bharti under-spent on capex? Management stated that current ~USD3bn capex could be the peak. We are skeptical: 1) as seen in the recent June quarter results, seven Asian telcos have increased their capex guidance (mainly data/4G related); and 2) annual capex by the Indian operators appears low vs regional peers, especially given its scale and spectrum differentials .
Catalysts: core operating trends, regulations, balance sheet
Management meeting… ROIC challenges and potential?
• In our recent meeting with Mr Akhil Gupta, Deputy Group CEO and MD of Bharti, our key question was on how to improve Bharti’s low ROIC of 6%, versus the regional telco average of 19%. As can be seen in Fig 3-4, low operating margin is one issue, but asset turn of 0.6-0.7x is one of the lowest amongst regional telcos.
– Management attributes this to 3G/4G and Africa payments, which has increased the asset base, but is not generating much incremental earnings yet, and this is expected to change. Data is expected to be a key driver, which is currently ~USD400mn in revenues (4% of total, ex SMS), and could rise to USD1bn pa in the next 1-2 years, as per management.
– We don‟t dismiss this pent-up data demand potential could be a driver of some return improvement, but with spectrum related payments ahead largely for license renewals, we think overall ROIC could remain under pressure given the lack of incremental earnings benefit in the next 1-2 years.
– We, and management, are optimistic on the TD-LTE potential for India and the region; however there are still many hurdles to overcome, including network rollout, spectrum limitations, ubiquitous coverage, handset ecosystem etc.
• Domestically, management stated that given India is still predominately a pre-paid voice market, operating strategies will need to change frequently for all operators. However, for Bharti specifically, losing revenue share cannot be tolerated for long, and it will protect it if and when necessary.
– Virtually every operator would like to see voice yields rise, but it may take longer than the next 2-3 quarters to stick, according to management. In our current forecasts, we are assuming broadly stable blended RPMs at 43p for the next 2-3 years.
– One area where all operators are looking to make improvements has been in subscriber acquisitions. SIM to customer conversion is currently low at 8-10%, and most of the top operators are looking to manage commissions in order to rationalise this cost.
• A key issue in Africa is affordability – voice pricing at US6-7c remains high and as had been echoed a few times in recent management calls, the evidence on elasticity is mixed. Bharti is also targeting data segment more closely and looking to make it more affordable and/ or bundle it with voice.
– On our question on African cashflow outlook, management believes that interest on its debt can be funded from local operations this year, and that over the next 2-3 years it should be able to fund the principal payments, too.
– There has been no explicit guidance on Africa cashflows, but given the initial payment schedule of the eight-year acquisition loan and balloon principal payment structure from year 3 to year 8, we believe that management would have expected much strong cashflow profile than what is being realised.
• Capex outlook – management believes that India is past its peak capex period. But on our assertion that regional telcos are experiencing higher capex as data continues to grow, management did not dismiss this possibility of higher capex for India, as well, if and when 4G becomes more readily available. Even on Africa, we were surprised with the USD900mn in capex guidance this year, which appears low given the lack of breadth and depth of its networks if Bharti is to still capture significant growth potential in the market. See the next section of this report for more discussion on this.
• On towers, the company attributed the timing of the listing/rationale of Bharti Infratel to shareholder agreements; however, we remain unclear/unconvinced on the capital structure. Listing is expected by November-December this year.
• No specific views were given on regulations, and management said the company will observe/participate in auctions if necessary.
• Overall, we don’t dismiss Bharti’s inherent potential given its scale and relative financial strength; but don’t think valuation is cheap at 17-24x P/E given various headwinds. Hence, we reiterate our Reduce rating.
What could make us turn bullish?
• There are four unknowns we think: 1) domestic earnings outlook; 2) Africa cashflows; 3) regulations; and 4) deleveraging potential.
• Of these, the big variable to consolidated earnings is the domestic business (Africa is widely expected to be more gradual improvement now), and if and when we see evidence of pricing or cost stability, it could then be argued that Bharti could be at the end of the downgrade cycle (which hasn‟t been the case for over two years now).
• After three years of earnings decline, Bharti‟s earnings should rise at some point. Consensus is currently expecting growth in the range of 20-50% next year, which again highlights the complexity in forecasting. We are forecasting EPS of INR11 in FY13 and INR13 in FY14.
Capex – has Bharti spent enough?
• On Bharti‟s capex profile, management stated that the current USD3bn could be the peak. We are skeptical: 1) as seen in the recent June quarter results, seven Asian telcos have increased their capex guidance, and some of these are the more progressive 4G players – see Fig 7; and 2) annual capex spend by the Indian operators is lower than for their Chinese or Indonesian counterparts, especially given the scale and spectrum differentials – see Fig 5-6 below.
• Over the past six years, total cumulative spend across regional telcos is:
– USD40bn for the three Indian listed operators;
– USD220bn for Chinese;
– USD34bn for Koreans;
– USD30bn for Telstra alone in Australia;
– USD20bn for Indonesians;
– USD10bn for Malaysians;
– USD8bn for Taiwanese;
– USD7bn for the Philippines;
– USD5bn for Singapore; and
– USD5bn for Thailand.
• Based on current forecasts, the three listed Indian telcos – Bharti, IDEA and RCOM – are expected to spend USD4.6bn in FY12. This compares to USD44bn for the three Chinese telcos and USD3.5bn for the three Indonesian telcos.
Other key takeaways
Domestic business – price hike possibility
• In the domestic business, management sympathised that the quarterly forecasts are very difficult to predict given there are so many moving parts, but stated most operators are looking for tariff increases – as evident once again by RCOM‟s announcement of 25% price hikes last week, but it has been difficult to make them stick and the ongoing promotional activity has reduced the realised rates at the consolidated level.
– Bharti too led on this initiative last year, but this wasn‟t widely replicated by other operators. Bharti therefore had to re-jig its offerings/prices once again and also increase its sales & marketing spend as it won‟t tolerate losing revenue share for too long.
• Management noted that in general, telcos have focused too much on customers and not enough on revenues, but this is now changing. Top 3-4 telcos have also decided to control commissions on subscriber acquisition as the conversion from SIM to customer is only around 8-10%. This should help in improving wireless margins (which fell by 370bps q-q in 1Q13), but it also reiterated that although prices need to rise or stabilise, competition/ performance is expected to remain volatile in the near-term.
• Bharti also clarified that the increase in network costs (7% q-q and 18% y-y) in the June quarter wasn‟t just due to additional 3G BTS additions. It was also for additional 2G capacity.
• On data, despite a slow take-up of 3G services this far, management remains optimistic about the data opportunity and believe the need for internet connectivity will be felt more strongly in the next 2-3 years.
– On TD-LTE potential, management is positive, but doesn‟t believe we will see strong adoption in the near-term (2013) as coverage is still limited for a truly nomadic offering. Bharti has launched a fixed wireless solution on this spectrum.
– It currently has 4G/BWA spectrum in 8 circles and would look to expand this coverage. TD-LTE will also be a positive for the towers we believe.
• In terms of network readiness for data, management notes that one of the bottlenecks in other markets has been backhaul (fibre), whereas in India, it may not be a significant issue as current microwave links in the country should be sufficient to support data in the next couple of years.
• On m-banking, Bharti notes that it is still very early days on this opportunity and believe this could aid in churn reduction in the medium-term.
Regulations…work in progress
• On regulations – management stated that “progress is being made on many fronts” which should improve clarity, and again Bharti sounded “relatively” relaxed, in our opinion. They made no specific comments on the upcoming auctions and they will assess bid/ spectrum etc if and when necessary. On spectrum refarming, the issue again is whether there is sufficient spectrum available in the 1800Mhz band.
Africa – gradual improvement in cashflows
• On Africa, management said the focus is on improving affordability (US6-7c pricing remains way too high). At the same time, steep price reductions could be detrimental to its existing revenues and profitability. Therefore, the aim is to lower pricing (per minute) in line with costs (per minute) to be able to drive elasticity/usage up.
– Bharti is also targeting data in this market. It believes that by next year, cashflows should improve from Africa to cover the interest costs (on debt), which is around USD300mn, and in another 2-3 years principal could be potentially funded, too.
Towers – not clear on capital structure?
• On towers – we are not entirely clear on the rationale or the timing for the listing (expected by November/ December this year). Bharti cited “shareholder agreements” as a key reason.
• Bharti isn‟t selling down its shares – there is some fresh equity being issued and some sell-down from private equity holders. Bharti‟s shareholding in the company post listing will be close to 80%, as per the prospectus.
• We also note that Infratel could be one of the lowest geared towerco compared with regional/ global players at 3-5x net debt to EBITDA. Potentially, Infratel could be geared up and pay dividends to Bharti over time, we believe.
• Management does not believe a subsequent (potential) listing of Indus over the next 2-3 years should reduce the attractiveness of Infratel. Infratel through its ownership in Indus will have a pan-India presence.
• As per press articles, Bharti is looking to raise USD1bn in this IPO from listing 10% of shares implying a market cap of USD10bn. This implies EV per tower of USD134k and EV/EBITDA of 13x (based on annualised FY13F EBITDA). We note Indonesian towers trade at 14-23x EV/EBITDA multiples (FY Dec-12). (Source: “Bharti Infratel files for nearly $1 bln IPO”, Reuters, 14 September 2012.)
Key highlights from the prospectus
– The issue consists of the fresh issue (146mn) and an offer for sale (43mn). Together, this represents 10% of total outstanding shares of the company.
– Offer for sale shares consist of – (i) 30mn shares by Compassvale; (ii) 6mn shares by GS Strategic; (iii) 3.6mn shares by Anadale; and (iv) 3mn shares by Nomura.
– The proceeds from fresh issue of equity will be used for: 1) rollout of 4.8k towers; 2) upgrade existing towers and infrastructure; and 3) for rolling out green initiatives at various tower sites which amount to INR29bn over FY14-16F.
– Total tower portfolio is 79k towers (33k from Infratel and 42% holding of Indus‟ 109k towers).
– In FY12, Infratel reported revenues of INR96bn (excluding other income) , EBITDA of INR37bn with margins of 39% and net income of INR7.5bn, or 8% net margins.
– In FY12, Indus reported revenues of INR121bn (excluding other income), EBITDA of INR26bn with margins of 22% and net income of INR6.9bn, or 6% net margins.
– Total gross debt is around USD600mn.
– In FY12, Bharti Airtel contributed 62% of Infratel‟s revenues.
– Average sharing for Bharti Infratel is 1.82 co-locations per tower, while Indus is 1.96.
– With recent 2G license cancellations around 4.4k co-locations could be at risk for Infratel and another 13.8k for Indus.
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