Merger with Indus Towers outweighs most pressures for Bharti Infratel

Despite exits by smaller telcos and effects of Vodafone-Idea combining, analysts expect better growth ahead, for diverse reasons

Bharti Infratel's transition to an independent telecom tower company and higher rentals on the back of data-driven expansion by telecom companies is expected to improve its return ratios and operational performance.

Analysts believe the fall in its share price (down 31 per cent sine the October 2017 high) is unwarranted for a cash-generating business with robust long-term prospects.

The key re-rating trigger remains its move to being an independent tower owner. Recently, Sunil Mittal, promoter of its parent company, Bharti Airtel, announced it would exit the tower company business and instead focus on mobility services. This will translate into a possible merger between Bharti Infratel and Indus Towers. While a majority sale stake to investors or tower companies will help Bharti Airtel monetise its investments, the merged entity will, say IIFL analysts, lead to a simpler structure, smaller overheads and greater bargaining power with telcos.

Vivekanand Subbaraman of Ambit Capital also believes the merger will beneficial for Bharti Infratel. "The company's new owners (strategic investors) will lead Indus' leveraged buyout, pay large cash dividends/buybacks and withdraw concessions given to telcos such as rental freeze and maintenance of energy back-up," he says.

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Lower rental loading, as well as freeze on rentals, is a concession offered to telcos. This is expected to change under an independent ownership, with maintenance capex falling to two per cent of rentals from eight per cent currently and price escalation (three per cent annually) from FY21 when the contracts run out, in line with international tower company practices.

A merger also helps Bharti Infratel put its cash on the balance sheet to good use and absorb the annual free cash flow of Rs 30 billion, currently generating sub-optimal returns.

The other trigger for the company is the upside from a surge in demand for data as telcos expand their network and more people move to broadband services. The focus for telcos will be to offer better quality of service, which will necessitate more sites. IIFL analysts say Reliance Jio is likely to expand its cell site count from the current estimate of 160,000 and this will force its competition to follow, leading to an increase in the number of towers.

Data consumption, currently an average of eight gigabytes (GB) per month for 4G users, is expected to increase to 10 GB per month, congesting the networks. So far, the telcos were able to load on existing towers to cater for existing data requirements. This is expected to change over the next couple of years as demand surges and competitive pressures will ensure the companies expand their reach and look at new towers.

However, the near-term outlook is negative, given the smaller telco exists and the Idea-Vodafone merger. While the company has seven per cent exposure to smaller telecom companies, 10-12 per cent of its tenancies could be at risk due to the Vodafone-Idea merger. While there are exit penalties, brokerages have revised their earnings per share estimates downwards for FY19 and FY20. Analysts believe the pessimism related to exits is overdone and the stock, trading at 10 times its FY19 enterprise value to operating profit estimate, should bounce back sooner than expected.