(Valuation Process) Does Bharti-MTN deal signal a recovery?

From The Hindu Business line on 28 May 2009

(The Indian market does not offer very much in terms of future growth. Fundamentally, the telecom story seems to have played out to a large extent)

Interview with VIVEK GUPTA, PARTNER, M&A PRACTICE, BMR ADVISORS

D. Murali

The first developing-nation foray into the ‘Big 5’ of the telecom world encompassing two fast-growing emerging wireless markets, India and Africa; consolidated post-deal financials, north of 200 million subscribers and revenues of $20 billion; one of India’s biggest cross-border deals, even relative to Tata-Corus or Hutch-Vodafone… These are some of the opening observations about the Bharti-MTN deal that Mr Vivek Gupta, Partner, M &A practice, BMR Advisors, New Delhi, shares with Business Line, during a quick email interaction shortly after the mega merger was in the news. “And the deal is slated to happen this time at fair sensible valuations – in a sense; it is good that the deal was not consummated last year,” adds Mr Gupta. Since May 2008, ignoring the last two days, Bharti’s capitalisation has declined over 5 per cent, while MTN fell over 32 per cent, he notes. “Given the deal terms that have emerged, it seems that the financial side is more or less stitched up, and thus, we believe the deal will likely go through this time.”

Excerpts from the interview:

What are the quantitative parameters of the valuation process, apart from the telecom companies’ subscriber base?

The deal envisages Bharti giving up 36 per cent equity — 25 per cent to MTN and 11 per cent to its shareholders — and $4.1 billion, in return for a controlling 49 per cent stake in MTN. MTN will become Bharti’s “subsidiary by governance structure.” I guess that Bharti may not have immediately pushed for a 50 per cent plus stake, due to regulatory issues around licences, but it does seem apparent that Bharti will be the controlling party.

A number of factors would have gone into the valuation discussions:

Bharti’s revenues of $7.5 billion vs MTN’s $12 billion.

EBIDTA (earnings before interest, taxes, depreciation and amortisation) margins around 40 per cent for both entities but finally, similar net profit numbers.

Bharti’s ARPU (average revenue per user) at around $6.5, with MTN at around $13.

Growth projections for both markets – Africa having relatively higher potential than India.

Relative market capitalisations of both listed entities, with Bharti carrying more generous market multiples.

Finally, the end result of all of these factors is a 30 per cent premium to MTN’s current market capitalisation — an EV/ EBIDTA in the region of sub 6 — a valuation that seems defensible, considering the large 49 per cent block of equity with a “governance structure” in Bharti’s favour.

India and Africa, are there similarities and differences of significance, from a telecom perspective?

Both are developing country markets and thus, have inherent similarities — number of subscribers, contribution of mobile subscribers to the overall telecommunication industry, etc. At the same time, they seem to be at different stages of their growth cycles. The African telecommunication market is estimated to grow at roughly 40 per cent. It is estimated that India will grow for the next couple of years and then will start stagnating, while Africa will potentially continue to show higher growth for four to five years.

On the ARPU front, Africa ranks better than India, at roughly $12 per subscriber as compared to $6 per subscriber in India. Also, as compared to India, in Africa, per-minute prices are higher, demand for SMS over voice is limited because of low literacy levels, and bottlenecks exist in sharing platforms between local operations on account of small populations in some countries, political issues, language barriers and lack of affordable cross-border connectivity.

By 2012-13, convergence is expected. The known factors should take over — increasing competition, price reductions and another wave of low-income customers should drive the ARPU levels down in Africa too. And Indian operators understand this game well — the game of working on high volumes, low margins, the game of building economies of scale, higher affordability and tight management of extensive outsourcing contracts.

Post meltdown, the deal space was barren for quite some time. Does the Bharti-MTN deal signal a recovery trajectory, leading to many more mega deals in other sectors, too?

One way to think about this deal is to really peg it as being independent of market conditions. The fundamental drivers have been there for a while. The lower markets and efflux of time may have helped the deal talks this time from the point of view of more flexibility on both sides to make the deal happen. And thus, we are hopefully in a situation where deal talks have progressed. For this reason, we do not necessarily believe that the announcement of this specific Bharti-MTN deal indicates a strong recovery trajectory in the deal space per se.

As an emerging market merger, does the Bharti-MTN deal have characteristics that may not be found in the developed markets?

The telecom industry has seen lot of transactions globally in the past. They have had different drivers. For example, in December 2006, AT&T acquired BellSouth. It was then estimated that the NPV of the expected synergies would be as high as $18 billion. In two other transactions which took place in 2005, SBC buying AT&T and Verizon buying MCI, the target was to save 20-50 per cent of their total operating costs by reducing the number of networks, thereby eliminating redundant switches, devices, people and buildings. Bharti-MTN is not entirely similar. The fundamental driver seems to be geographical expansion and along the way come benefits of scale and bargaining power.

The two companies could look to each other to add value to their operations and by sharing each other’s best practices. MTN should be able to use Bharti’s technology and techniques for rolling out networks inexpensively and quickly. Bharti will be able to diversify beyond India’s borders, where expanding its base means having to reach out to poorer consumers.

Put differently, from Bharti’s point of view, the Indian market does not offer very much in terms of future growth – 3G and some value-added services may carry some kickers but fundamentally, the telecom story has played out to a large extent. This foray probably is thus an attempt to carry the “telecom story” for the company further by expanding into another potentially high-growth market.

Any other points of interest?

This is the first really large deal that takes advantage of the recent change the Government has announced in what it considers foreign and domestic holding. Now, foreign shareholding in a majority Indian-owned and controlled company is not considered foreign for downstream investments and that offers much greater flexibility in opening up headroom for MTN and its shareholders to acquire stakes in Bharti.

Also, it’s interesting to see that the deal is structured in a way not to have to look at an open offer in India. That would have been a significant cost leakage, given that MTN was picking up more than the 15 per cent trigger limit. The Bharti release seems to indicate that the deal will happen through a Scheme of Arrangement, which means it will be taken to the High Court under Sections 391 to 394 of the Companies Act, 1956 and will thus, enjoy exemption from the Takeover Code. To a large extent, the deal’s success will be predicated on its being piloted successfully through the myriad regulatory and structuring issues governing a deal of this nature.

Bio:

Mr Vivek Gupta, who has worked in the M&A group of the tax practice at Ernst & Young for three years and Arthur Andersen for three and a half years, prior to joining BMR, has experience in mergers, acquisitions and business reorganisations, domestic as well as multi-jurisdictional, having participated in many cross-border and domestic transactions across diverse industries. He has advised a number of domestic and multinational companies on complex transactions which involve acquisitions, mergers, divestments and other business reorganisations and brings a blend of strategic, financial, tax, regulatory and commercial skills to such engagements. Mr Gupta, a Commerce graduate from the Delhi University and a Chartered Accountant, finds mention in the International Tax Review 2004, as a leading advisor on M&A transactions in India.

Merger move reflects telcos’ need to look beyond India

Adith Charlie on The Hindu Business Line on 26 May 2009

Mumbai, May 25 Indian telecom operators are venturing into emerging geographies such as Africa to arrest falling subscriber revenues and counter long-term fears of a slowdown in the home market.

This explains why Bharti Airtel is trying to woo over MTN all over again, exactly a year after the two fell short of a potential business arrangement, analysts and industry observers say.

Dip in ARPU
In India, telcos have been largely unable to arrest the dip in the average revenue per user (ARPU) which currently hovers around $4. Given the spate of new operators that have flooded the market, both average revenue per user and revenue per minute are expected to further decline. Nomura Securities analysts, Mr Sachin Gupta and Mr B. Roshan, expect the ARPU dip to continue on an average 6-8 per cent over the next three years for Bharti Airtel and Reliance Communications.

On the other hand, the ARPU in African countries (as a whole) and other emerging geographies is around $9-11, according to Mr Raman K., Practice Head (Telecom Media & Technology) at Tata Strategic Management Group.

“In regions such as Cyprus (Eurasia), the ARPU is close to $30 while in countries like Zambia, it is around $10,” he said. The overall tele-density in Africa could be around 30 per cent while it is around 36 per cent in India. Key markets such as Mali and Tanzania have a tele-density of less than 30 per cent, said Mr Raman.

Mr Madhusudan Gupta, senior research analyst with Gartner, believes that the telecom industry in India has passed the stage of hyper-growth and hence focusing on under-penetrated, yet profitable markets of Africa makes sense.

“The Indian telecom story is still very much intact. However, 4-5 years down the line, one expects the industry to still grow but at a slower pace,” said Mr Kunal Bajaj, Managing Director of advisory firm BDA Connect.

Greatest advantage
Achieving critical scale would be the greatest advantage for both Bharti Airtel and MTN if the deal were to go through.

“We are talking about creating a telecom entity which would be the sixth largest in the world. Moreover, it would have a footprint across 24 countries and hence be able to compete with the big boys of telecom world globally,” said Mr Mohd Saif, Deputy Director, Consulting, ICT Practice, Frost & Sullivan.

Telecom Sector Watch

Excerpt from article published on BS Reporter / Mumbai April 11, 2009, 0:56 IST

Bharti Airtel is expected to outperform Reliance Communications (RCom) due to a stronger revenue and a better growth in profit. A KRC analyst expects Bharti’s revenue to grow by over 50 per cent, while analysts at Edelweiss and MOSL expect it to grow by 28-29 per cent.

The Sunil Mittal-led firm is expected to benefit from lower forex losses due to a sharp depreciation in the yen’s value during the quarter as half of Bharti’s loans are denominated in the Japanese currency.

RCom, despite having witnessed a strong q-o-q subscriber growth of 10-14 per cent, is expected to post a revenue growth of around 14-17 per cent only. Also, the company is expected to see a drop of 4-6 per cent in revenue per minute (RPM) despite a strong growth in traffic. This weakness in RPM along with launch expenses and other associated costs is also likely to push down y-o-y margin by 390 bps. This may result either in a single-digit growth or even a decline in y-o-y net profit.

MOSL expects Bharti’s revenue to grow 28.1 per cent y-o-y and 4 per cent q-o-q due to a 10 per cent increase in q-o-q mobile services. Mobility revenues are expected to grow 3.3 per cent q-o-q, implying an ARPU (average revenue per user) of Rs 305. The margin is expected to decline by 80 bps y-o-y and 20 bps q-o-q to 40.7 per cent. But Edelweiss estimates Bharti’s mobility ARPU to decline by 2.6 per cent q-o-q on lower usage.

MOSL expects RCom’s revenue to grow 13 per cent y-o-y and 2.6 per cent q-o-q due to strong subscriber momentum. The ARPUs are expected to go down by 5-10 per cent on lower quality of incremental subscribers and free promotional minutes in GSM. The margin is expected to decline by 420 bps y-o-y due to an aggressive network expansion. The net profit is expected to fall by 10 per cent y-o-y and 5 per cent q-o-q.Edelweiss estimates mobility ARPU of RCom to decline by 9.5 per cent q-o-q owing to aggressive promotional schemes offered at the launch of its GSM services. Uncertainty in derivative income is a risk and, hence, Edelweiss expects a 9 per cent decline in RCom’s net profit.

The best is over (On how the future might be for Airtel)

Shobhana Subramanian / Mumbai May 11, 2009, 0:46 IST on Business Standard

It’s one of the best moves Bharti Airtel ever made. When peer Reliance Communications (RCom) rolled out its GSM network in January this year, it was dishing out free minutes to anyone who bought a connection. One might have expected Bharti to retaliate. But it refused to join the price war and didn’t even tweak its tariffs, let alone offer free minutes.

In fact, Bharti hasn’t touched its key rates for quite a while now, almost 18 months. That’s despite the fact that both Vodafone and Idea Cellular have been rolling out networks in new circles. Subscribers seem to be willing to pay up—the telco commands a revenue market share of an enviable 32 per cent. And the high base doesn’t seem to be coming in the way of growth.
In 2008-09, the Rs 36,962 crore firm added nearly 32 million subscribers, close to a fifth of the net additions during that period, so that its subscriber base is now nudging 94 million.

MOUs trend down

Indeed not tinkering with call tariffs seems to be paying off: in the March 2009 quarter, Bharti’s average revenue per user (arpu) fell by a less than expected 6 per cent sequentially.

Also, while the minutes of usage (mou) per subscriber dropped by 20 minutes (or 4 per cent) sequentially to Rs 485, eleven minutes were lost because of the fewer number of days in the quarter. Of the rest, some minutes were yielded to the competition and some lost because more connections are being sold in rural markets.

However, it’s evident that elasticity trends aren’t showing an uptick—people don’t seem to be talking more just because it costs less to do so. In fact, the drop in mou for RCom during the quarter was a sharper 9 per cent.

Also, since Bharti will continue to expand in the rural areas—currently over 50 per cent of new subscribers are from the hinterland— the growth in traffic can’t but slow down. It’s happening already: Bharti’s total wireless minutes grew by just 5.7 per cent sequentially in the March 2009 quarter lagging the 9.7 per cent growth in subscribers—the trend was similar in the December 2008 quarter.

Calling rural India

The rural spread could hurt arpus too. But that’s the only way forward for the telco, which now reaches 81 per cent of the population compared with 71 per cent at the end of 2007-08.
Given that roughly 70 per cent of India’s population is rural and urban-teledensity has already hit a high 75 per cent—90 per cent plus in the metros—it’s rural subscribers who will come into the fold and drive the industry for the next few years. Industry watchers say there’s an opportunity here for Bharti which it is well-positioned to exploit; that’s because it has 900MHz of spectrum in 13 service areas.

But a rural franchise can also mean lower arpus. So far though, the revenue per minute (rpm) has held up pretty well, coming off by just 2 per cent sequentially in the March 2009 quarter, a factor that helped the support margins for the wireless business at 31.5 per cent. As analysts point out, the ebitda (earnings before interest depreciation and tax) per minute at 20 paise has stayed more or less flat now for four quarters.

However, although the management has indicated that most of the capital expenditure is behind it and that some channel costs are lower in rural areas, that may not be enough to cushion a fall in the margins which could result from lower growth in revenues.

Top line to taper off

Indeed, the days of an annual 35-40 per cent growth in revenues are over. The sequential revenue growth in the March 2009 quarter was a rather disappointing 2 per cent betraying the severity of the competition.

Typically, revenues have grown at around 5-6 per cent and on occasions, even faster. So it’s not surprising that even for the current year, analysts are pencilling in a sales growth of just 16-17 per cent: compare that with the 37 per cent rise in revenues in 2008-09 to Rs 36,962 crore.
The growth for 2010-11 is a far more subdued sub-15 per cent. Even if the RCom threat has subsided after it withdrew the free minutes scheme, the competition from both incumbents and new entrants—who are also expanding their network—will continue to hurt.

Vodafone, for instance, is already netting 2 million subscribers a month and by the end of the year will have a pan-India footprint. The multinational has been gaining market share in many of the new circles where it has launched.

Idea Cellular too has become a stronger player after the acquisition of Spice and although it operates only in 16 circles now will have a pan-India presence by end 2009.

In January this year, despite RCom’s GSM launch, Idea trebled its share in the Mumbai market, albeit on a low base. Also, while churn for Bharti, both in the pre-paid and post-paid segments, had fallen to an all-time low in the December 2008 quarter, it went up again in the March 2009 quarter.

THE TONE GETS LOUDER

Source: CLSA Asia-Pacific Markets, E-Estimate
The arrival of Mobile Number Portability (MNP) too could result in some churn though it’s unlikely Bharti will lose too many customers given its strong brand equity, reach and value-added services.

The 3G kicker

Where Bharti scores over its rivals is in the scale that it has built—the telco is in a far better position than its rivals to absorb costs. Moreover, its strong balance sheet will allow it to bid for and offer 3G services without taking on too much debt. That’s why the sooner 3G spectrum auctions are held, the better for Bharti.

Analysts point out that since the lack of 2G spectrum remains an issue, 3G will probably be used mainly for voice services initially, but add that Bharti can always offer value-added services at higher charges which could offset some of the fall in the 2G arpus.

The company has said it would spend $2-2.2 billion on capex this year and finance this from internal accruals since it now generates free cash flows on a stand-alone basis; also it needs to make much smaller investments from here on since it already has a huge reach.

Peer RCom, on the other hand, has decided on a smaller outlay of Rs 10,000 crore for expanding its network in the current year, possibly because it is far more leveraged. That’s surprising given that RCom needs to expand its GSM network. Bharti’s other initiatives such as mobile commerce and mobile banking revenues will start paying off though how soon they will contribute meaningfully to the bottom line is hard to tell.

The top line for non-mobile segments, in the March 2009 quarter, was nothing to call home about—the wholesale carrier business, in fact, saw a sequential fall in revenues.

Industry watchers believe that with Idea Cellular and Vodafone putting up their own fibre networks, Bharti’s revenues in the carrier segment will be driven largely by captive usage, which in turn will be a function of how well the the wireless business does. Bharti holds a 42 per cent stake in Indus Towers and while the investment is currently a drag on profits, analysts believe the venture should make money this year.

The best bet in telecom

Of course, earnings growth for Bharti will taper off in the next couple of years –analysts are estimating a compounded 16 per cent growth in net profits between 2009-2011. In 2008-09, net profits grew 26 per cent to Rs 8,470 crore.

Concerns on over-ownership by foreign investors, RCom’s GSM rollout, company executives selling shares and the cut in termination fees have left the stock subdued in recent months. The stock is currently valued at just around 7.8 times 2009-10 EV/ebitda (enterprise value to ebitda).

Surprisingly, RCom trades at just a 14 per cent discount to Bharti–an EV/ebitda of 6.7 times, which is much too small given that Bharti has a much stronger balance sheet with a net debt to equity ratio of just 0.23 times whereas RCom’s net debt to estimated ebitda for 2009-10 is expected to be just under three times.What’s even harder to understand is why Idea Cellular trades at an even smaller discount. Although Idea has a strong balance sheet with close to Rs 5,000 crore of cash, it has neither the reach nor the scale that Bharti has and makes losses in several circles. So it’s Bharti for those who want to play telecom in India