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Telecom
India
The weak shall not inherit the earth; upgrade Bharti/Idea. We turn constructive on
the GSM incumbents Bharti and Idea, upgrading both to ADD (from REDUCE earlier).
Challengers’ defensive stance to the recently announced tariff hikes by the incumbents,
perhaps driven by their stretched balance sheets, is likely to play into the hands of the
leaders with stronger balance sheets and networks. Sector’s domestic consumption
positioning in an uncertain global macro environment helps further. On a relative basis,
Idea as a leveraged pure Indian wireless play scores over Bharti.
System over-capacity exists, but needs capital infusion to be disruptive
Recent tariff hikes in the industry, started by Bharti and subsequently selectively followed by other
operators, do not mean the industry is out of the over-capacity phase. However, lack of balance
sheet muscle post massive 3G payouts and non-availability of incremental 2G spectrum has made
push for volume market share a difficult proposition for GSM challengers like RCOM, TTSL, and
Aircel. In the absence of potential equity infusion, the lure of short-term financial relief has driven
the challengers’ defensive (in our view) stance – they have all started participating in tariff hikes
along with the leaders. Even as we believe this is a sub-optimal long-term strategy for challengers
(versus a push for volume market share, we detail our thoughts on this later), lack of resources
(funding and quality spectrum) appears to have forced their hand. Advantage incumbents, clearly.
Calibrated tariff hikes can continue
We believe the incumbents, backed by superior networks and stronger customer loyalty
compared to the challengers, can continue to tweak tariff upwards, in a calibrated
manner. Volume market share loss risk is low given the defensive stance adopted by the
challengers. Risk to volumes (negative elasticity) exists but will be minimal as long as tariff revisions
are well-calibrated and paced out – in any case, price-led revenue growth is EBITDA and FCF
accretive even if it turns out to be marginally negative for volumes and is only marginally revenue
accretive. We have accordingly increased our RPM estimates for Bharti and Idea further marginally
after having revised them upwards post 1QFY12 earnings.
Upgrade Bharti and Idea to ADD (from REDUCE)
We upgrade Bharti to ADD (from REDUCE) and revise our end-FY2013E DCF-based TP on the
stock to Rs460/share (from Rs390). We also rate Idea an ADD (from REDUCE) with a revised TP of
Rs115/share (from Rs95). Changes to our estimates and target prices are driven solely by upward
revision in India wireless estimates – hence, higher revisions for Idea, which is a pure India wireless
play. Our relative preference between the two stocks would be Idea, given (1) higher operating
leverage compared to Bharti, which runs the most optimal network in the country, (2) pure India
wireless positioning – Bharti has other parts with slower forecast growth (fixed-line, enterprise)
and/or higher risks (Africa), and (3) lower foreign currency exposure compared to Bharti.
Risks to our call – regulatory (high probability but known), competitive (low in the near-term)
Adverse regulatory developments, especially on the spectrum pricing front, remain a risk –
however, the event is known with timing and quantum the uncertain variables. Street, hence, may
not react negatively to such a development. We do note that impact of a negative regulatory
development is higher on Idea as compared to Bharti. Return of tariff competition is a risk that
would always loom given system over-capacity. However, this risk is unlikely to play out unless
there is massive equity infusion into one of the challengers.
Key reason for our upgrade – change in view on near-term competitive intensity
in the sector
Our change in view on competitive intensity in the Indian wireless sector is driven by the
defensive response adopted by the challengers to the incumbents’ price hike move. Reeling
under severe balance sheet stress and under pressure to meet near-term operational and
financial targets set by lenders and strategic investors, challengers have taken a short-term
approach to tariffs. This could remain the situation over the near to medium term implying
low risk of price competition.
However, industry over-capacity situation remains (there are more networks out there than
viable businesses) and tariff hikes are unlikely to bring the industry to a sustained long-term
equilibrium unless some of the excess capacity gets consolidated or moves out of the system.
This could lead to some tension in the system and potential price competition down the line;
however, the near to medium term risk on this front is low. Even in the longer run, it would
be difficult for the challengers to wrest back the consumer mind share lost on account of
their recent move to hike tariffs despite networks vastly inferior to incumbents on coverage.
Valuations – on the richer side but defensive domestic consumption stories likely
to get a premium in current market environment
We continue to find the valuations of Bharti and Idea, at 6.7X and 6.5X FY2013E EV/EBITDA,
respectively, to be on the richer side as compared to global and EM telco valuations.
Nevertheless, these stocks, as defensive domestic consumption plays, and now with pricing
power, can sustain rich valuations, in our view.
Some thoughts on long-term industry structure and the challengers’ challenge
We present our thoughts on why we believe tariff hikes are not a long-term solution for the
challengers. Volume market share gain remains a more viable (and probably the only) longterm
organic survival strategy for the challengers in the market. Two key issues with the
challengers adopting the tariff hike strategy –
Volume market share gains stop – in fact, pricing services at par with the incumbents
exposes challengers to a potential decline in volume market share given that they do not
(in most circles) have a quality network to back. Overall price * volumes = revenues
equation has a risk of turning revenue neutral or only marginally revenue accretive at best,
for the challengers.
Modest price hikes do not take challengers anywhere close to FCF or even EBITDA breakeven
levels.
The point we are making is that participating in price hikes started by the incumbents
exposes challengers to
Serious risks of consumer mind-share loss (network strength lowers this risk for the
incumbents raising tariffs), not the best long-term strategy, in our view
Risk of getting into sustained network quality differential versus incumbents by making
more cash flows available to the incumbents – part of these cash flows are likely to be
deployed into the leaders’ networks.
There is little beyond some short-term P&L relief that these price hikes offer to the
challengers. And even this P&L relief, as we mentioned earlier, may not be good enough – it
does not make the challengers cash or EBITDA positive implying they remain dependent on
funding (hopefully slightly lower than earlier) to sustain operations.
To illustrate the point above, we present EBITDA breakeven and cash break-even (defined as
opex + maintenance capex + interest payment) RPM for different categories of operators at
different volume market share levels. We define operator categories (based on
spectrum assets, current scale of operations, and cost structures) as
1, for best-in-class operators - we place Bharti and Vodafone in this category
1.5, for Idea – slightly inferior to Bharti and Vodafone on each of the three parameters
3 – for BSNL, RCOM, and TTSL. BSNL gets placed here despite superior spectrum assets
on account of its bloated cost structure
4 – for Aircel
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Telecom
India
The weak shall not inherit the earth; upgrade Bharti/Idea. We turn constructive on
the GSM incumbents Bharti and Idea, upgrading both to ADD (from REDUCE earlier).
Challengers’ defensive stance to the recently announced tariff hikes by the incumbents,
perhaps driven by their stretched balance sheets, is likely to play into the hands of the
leaders with stronger balance sheets and networks. Sector’s domestic consumption
positioning in an uncertain global macro environment helps further. On a relative basis,
Idea as a leveraged pure Indian wireless play scores over Bharti.
System over-capacity exists, but needs capital infusion to be disruptive
Recent tariff hikes in the industry, started by Bharti and subsequently selectively followed by other
operators, do not mean the industry is out of the over-capacity phase. However, lack of balance
sheet muscle post massive 3G payouts and non-availability of incremental 2G spectrum has made
push for volume market share a difficult proposition for GSM challengers like RCOM, TTSL, and
Aircel. In the absence of potential equity infusion, the lure of short-term financial relief has driven
the challengers’ defensive (in our view) stance – they have all started participating in tariff hikes
along with the leaders. Even as we believe this is a sub-optimal long-term strategy for challengers
(versus a push for volume market share, we detail our thoughts on this later), lack of resources
(funding and quality spectrum) appears to have forced their hand. Advantage incumbents, clearly.
Calibrated tariff hikes can continue
We believe the incumbents, backed by superior networks and stronger customer loyalty
compared to the challengers, can continue to tweak tariff upwards, in a calibrated
manner. Volume market share loss risk is low given the defensive stance adopted by the
challengers. Risk to volumes (negative elasticity) exists but will be minimal as long as tariff revisions
are well-calibrated and paced out – in any case, price-led revenue growth is EBITDA and FCF
accretive even if it turns out to be marginally negative for volumes and is only marginally revenue
accretive. We have accordingly increased our RPM estimates for Bharti and Idea further marginally
after having revised them upwards post 1QFY12 earnings.
Upgrade Bharti and Idea to ADD (from REDUCE)
We upgrade Bharti to ADD (from REDUCE) and revise our end-FY2013E DCF-based TP on the
stock to Rs460/share (from Rs390). We also rate Idea an ADD (from REDUCE) with a revised TP of
Rs115/share (from Rs95). Changes to our estimates and target prices are driven solely by upward
revision in India wireless estimates – hence, higher revisions for Idea, which is a pure India wireless
play. Our relative preference between the two stocks would be Idea, given (1) higher operating
leverage compared to Bharti, which runs the most optimal network in the country, (2) pure India
wireless positioning – Bharti has other parts with slower forecast growth (fixed-line, enterprise)
and/or higher risks (Africa), and (3) lower foreign currency exposure compared to Bharti.
Risks to our call – regulatory (high probability but known), competitive (low in the near-term)
Adverse regulatory developments, especially on the spectrum pricing front, remain a risk –
however, the event is known with timing and quantum the uncertain variables. Street, hence, may
not react negatively to such a development. We do note that impact of a negative regulatory
development is higher on Idea as compared to Bharti. Return of tariff competition is a risk that
would always loom given system over-capacity. However, this risk is unlikely to play out unless
there is massive equity infusion into one of the challengers.
Key reason for our upgrade – change in view on near-term competitive intensity
in the sector
Our change in view on competitive intensity in the Indian wireless sector is driven by the
defensive response adopted by the challengers to the incumbents’ price hike move. Reeling
under severe balance sheet stress and under pressure to meet near-term operational and
financial targets set by lenders and strategic investors, challengers have taken a short-term
approach to tariffs. This could remain the situation over the near to medium term implying
low risk of price competition.
However, industry over-capacity situation remains (there are more networks out there than
viable businesses) and tariff hikes are unlikely to bring the industry to a sustained long-term
equilibrium unless some of the excess capacity gets consolidated or moves out of the system.
This could lead to some tension in the system and potential price competition down the line;
however, the near to medium term risk on this front is low. Even in the longer run, it would
be difficult for the challengers to wrest back the consumer mind share lost on account of
their recent move to hike tariffs despite networks vastly inferior to incumbents on coverage.
Valuations – on the richer side but defensive domestic consumption stories likely
to get a premium in current market environment
We continue to find the valuations of Bharti and Idea, at 6.7X and 6.5X FY2013E EV/EBITDA,
respectively, to be on the richer side as compared to global and EM telco valuations.
Nevertheless, these stocks, as defensive domestic consumption plays, and now with pricing
power, can sustain rich valuations, in our view.
Some thoughts on long-term industry structure and the challengers’ challenge
We present our thoughts on why we believe tariff hikes are not a long-term solution for the
challengers. Volume market share gain remains a more viable (and probably the only) longterm
organic survival strategy for the challengers in the market. Two key issues with the
challengers adopting the tariff hike strategy –
Volume market share gains stop – in fact, pricing services at par with the incumbents
exposes challengers to a potential decline in volume market share given that they do not
(in most circles) have a quality network to back. Overall price * volumes = revenues
equation has a risk of turning revenue neutral or only marginally revenue accretive at best,
for the challengers.
Modest price hikes do not take challengers anywhere close to FCF or even EBITDA breakeven
levels.
The point we are making is that participating in price hikes started by the incumbents
exposes challengers to
Serious risks of consumer mind-share loss (network strength lowers this risk for the
incumbents raising tariffs), not the best long-term strategy, in our view
Risk of getting into sustained network quality differential versus incumbents by making
more cash flows available to the incumbents – part of these cash flows are likely to be
deployed into the leaders’ networks.
There is little beyond some short-term P&L relief that these price hikes offer to the
challengers. And even this P&L relief, as we mentioned earlier, may not be good enough – it
does not make the challengers cash or EBITDA positive implying they remain dependent on
funding (hopefully slightly lower than earlier) to sustain operations.
To illustrate the point above, we present EBITDA breakeven and cash break-even (defined as
opex + maintenance capex + interest payment) RPM for different categories of operators at
different volume market share levels. We define operator categories (based on
spectrum assets, current scale of operations, and cost structures) as
1, for best-in-class operators - we place Bharti and Vodafone in this category
1.5, for Idea – slightly inferior to Bharti and Vodafone on each of the three parameters
3 – for BSNL, RCOM, and TTSL. BSNL gets placed here despite superior spectrum assets
on account of its bloated cost structure
4 – for Aircel
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