Third time lucky?

Zain: Bharti Airtel may be about to realise its dream of becoming an emerging market telecom giant. India's largest mobile phone operator has made a $10.7 billion non-binding offer to buy most of Kuwaiti rival Zain’s African assets. The deal would add 40 percent to Bharti's current enterprise value. The potential transaction has the unanimous support of Zain’s board, according to a person close to the situation. Bharti's challenge will be convincing its own investors, who wiped 9.2 per cent off the shares following the announcement, that its African adventure is worthwhile.

That reaction might seem excessive. The valuation, 8 times expected $1.3 billion Ebitda for 2010, is roughly in line with recent comparable transactions. Global giant Vodafone paid around 8 times Ebitda for South Africa's Vodacom in 2008 and emerging market operator Millicom fetched around 7 times Ebitda in November for its Cambodian operations.

Bharti could raise the funds for the purchase without breaking the balance sheet. The Indian operator currently has debt of only 0.4 times its $3.5 billion estimated 2010 Ebitda. It could raise roughly $13 billion and end up with the same leverage - three times the enlarged group's Ebitda - as smaller Indian rival Reliance Communications.

Yet that level of leverage looks high. Zain's African operations need heavy investment. In Nigeria, the continent's fastest growing market, Zain has been losing customers and is struggling to turn around the business. The management of Bharti, who are experienced in rolling out networks in low-cost markets, are well placed for the challenge, but it will be expensive and the deal does not bring operating synergies.

If Bharti decides to settle on debt of 2 times its Ebitda then the Indian telecom operator will have to raise roughly $2.4 billion, probably through a rights issue. Bharti has until March 25, when its exclusivity period with Zain expires, to try to square the financing circle. Singapore Telecom, Bharti’s second largest shareholder with an indirect 30 per cent stake, could play a role. But investors are worrying that Bharti, which twice failed to seal a deal with South Africa's MTN, will go too far to live up to its aspirations.