Pricing environment, spectrum gains for Bharti Airtel

While spectrum payout might have near-term impact on debt, better pricing of voice services & data growth are key triggers

In line with the weakness across the telecom space, the Bharti Airtel stock has been trending downward due to concern on high spectrum payout, the Airtel Nigeria court case and uncertainty on pricing of services. While the spectrum cost of Rs 18,530 crore and potential damages for its Nigerian operations are worries for the stock, which has lost 13 per cent through the last month, the Street will track any downward pricing action due to the entry of Reliance Jio. But, there are positives as well.

Ambit Capital believes Bharti’s ability to retain its 900-MHz spectrum at reasonable prices is a key positive. Likely delays in the launch of 4G services by Jio and the lack of matching (900-MHz) spectrum scales down the adverse market impact, says the agency’s telecom analyst.

The sector has been witnessing a steady improvement in revenues per minute (RPM) through the last few quarters, with Bharti Airtel’s voice RPM improving from 35 paise in the March 2013 quarter to 37.17 paise in the December 2013 quarter, a 5.6 per cent rise. The Bharti Airtel management believes there is room for a rise in rates, as the difference between headline/retail rates and realised ones is as high as 30-40 per cent. The growth in RPM and margins, as well as an uptick in data services, are key reasons why most analysts have a ‘buy’ call on the stock.

Vinay Jaising of Morgan Stanley says an increase of every paise will add an incremental two percentage points to the company’s earnings before interest, tax, depreciation and amortisation (Ebitda). In the past year, the telecom sector’s minutes have increased seven per cent, despite a two paise rise in rates. Lower promotional and free minutes, along with higher base rates, led to the increase in RPM.

For major incumbents, the research firm estimates data revenues will rise 40 per cent, driving overall revenue growth to12 per cent a year between FY13 and FY16.

Most analysts have cut their earnings and target prices for telecom stocks, adjusting for spectrum payouts. Sunil Tirumalai and Chunky Shah of Credit Suisse have reduced Bharti’s estimated earnings 15 per cent (for Idea, it is a steep 30 per cent) and believe at 6.2 times the FY15 earnings estimate, the stock is reasonably valued compared to Idea Cellular’s 8.2 times.

From a long-term perspective, the recent policy on mergers and acquisitions is also seen in positive light for large players such as Bharti.

Better placed
While spectrum costs are a near-term dampener and will add to its debt, analysts believe Bharti is better placed than its peers. HDFC Securities’ Himanshu Shah says the company’s relatively better spectrum retention in the circles due for renewal in 2015, with lower revenue contribution of 33 per cent compared with 72 per cent for Idea and 47 per cent of Vodafone’s revenue mix, reduces exposure to market-share risks. To neutralise the impact of the payouts, the company will have to increase its additional blended RPM by four paise, says Shah. The impact on its financials, too, is manageable, with BNP Paribas estimating the spectrum payout at four per cent of its annual revenue and 0.66 times its FY14 Ebitda. Even assuming full auction spectrum payments, Bharti’s net-debt-to-Ebitda ratio, pegged at two at the end of the December quarter, is estimated to rise up to three. The company had a net debt of Rs 57,673 crore, with a net-debt-to-equity ratio of less than one. Further, with the recent acquisition of Loop Mobile, the company has consolidated its position in Mumbai, with a combined revenue market share of 27 per cent (Vodafone’s is 35.5 per cent).

Africa: Econet overhang
The company filed an appeal in the Nigerian Supreme Court, after an appeals court didn’t set aside a previous ruling on disposal of shares held by Econet Wireless in Airtel Nigeria. Econet claimed given its five per cent stake, it had the right of first refusal, even as the Nigerian operations changed hands three times since 2006. Econet is claiming damages of $3 billion from Bharti.

Analysts say Econet’s shares are held in an escrow account and do not impact Bharti’s 79 per cent stake in Airtel Nigeria. Suresh Mahadevan and Varun Ahuja of UBS say whatever the outcome of the case (reinstating five per cent to Econet), expect a limited impact on Bharti, as the dispute was in public domain long before Bharti acquired the African business from Zain. And, the sales agreement would have taken this into account.

On the operational front, while the management believes the competitive intensity seen last year is easing, UBS analysts say since it acquired the African business from Zain, Bharti has improved its quarterly revenue run-rate 39 per cent and Ebitda run-rate 55 per cent. Lower leverage and the recent improvement in Africa operations along with lower capital-expenditure-to-sales ratio for Bharti will help boost profits.