Bharti stock tanks on Zain takeover worries

The Bharti Airtel stock today fell 9.22 per cent to close at Rs 285.40 as investors deemed the $10.7 billion valuation the company has set to acquire Zain Telecom as too high.

Today, India’s largest telecom company by subscriber numbers announced that it had agreed to “exclusive discussions” to acquire the African assets of Kuwait-based Zain Telecom, the deadline for which expires on 25 March.

Bharti’s statement said the potential transaction does not include Zain’s operations in Morocco and Sudan and remains subject to due diligence and regulatory approvals. The statement also made it clear that there is no assurance that a transaction will be consummated.

Speaking to Business Standard Manoj Kohli, CEO and joint managing director, said: “The talks are consistent to our strategy to enter emerging markets like Africa.”

This is Bharti’s third attempt to enter Africa after two rounds of talks with South Africa’s MTN fell through in 2008 and 2009. It is not clear whether Bharti will opt for an all-cash deal, which might put pressure on Bharti’s bottom-line, or a cash-and-share deal.

Either way, some investors and analysts think Bharti may be overpaying for Zain. “On the short term, this acquisition will put a strain on Bharti's balance sheet. Apart from the $10.7 billion that Bharti is paying, Zain also has a debt of around $5 billion. And there is no clarity on whether Bharti would absorb the debt,” says Hitesh Agarwal, head of research at Angel Broking. He added that Zain is not making profits due to its high debt, though Bharti won’t have a problem raising debt.

“Bharti’s balance sheet is underleveraged as of now. Its net debt-to-equity ratio stands at 0.5 and they have room to increase debt. Zain buy will put pressure on margins but it will be a long term play,” added Harit Shah, analyst with Mumbai-based Karvy Stock Brokers.

Bharti’s attempts to enter Africa, the world’s fastest growing market, is driven by the growing competition and falling revenue per subscriber in India. But a senior executive of a leading telecom company has suggested that it is paying for assets of doubtful value.

“What Bharti is ready to pay for the assets is nearly 10 to 11 times of its EBIDTA. Even Bharti’s shares are not trading at that levels (they are at 7 to 7.5 times their EBIDTA). Also the quality of the assets is nowhere in the same class as MTN, which also included the lucrative South African market,” he said.

With over 41.9 million customers in Africa and as the number one mobile operator in 10 of the 15 countries in which it operates the Zain buy would help Bharti become a large global telecom player.

The Indian telecom operator currently has a presence in Sri Lanka, Seychelles and recently bought the Bangladesh assets of mobile company Warid Telecom. With a mobile subscriber base of over 172 million across the globe and in India (125 million in India) it will become the sixth largest telco in the globe after the Zain acquisition.

But the telecom executive pointed out that the disaggregated country-wise numbers weren’t huge. “In all other markets, Zain’s subscriber base is just one million to 2 million, numbers you can achieve in one month. So there is no logic in paying so much,” he added.

Also 35 per cent of Zain’s African revenues come from Nigeria, in which it has a 65 per cent market share. The problem, however, is that Zain is involved in litigation with local shareholders in Nigeria who have complained of mismanagement.

Other analysts, however, think the Zain buy makes good sense. For one, the market is growing at 30 per cent annually. For another, all the company’s in Africa under Zain are EBITDA positive except for Kenya where it is struggling.

In the nine month period ended 30 September, 2009, the company generated revenues of $ 2.7 billion from Africa, with an EBIDTA margin of 32 per cent but a net loss of $111 million.

Secondly, unlike in India, a large chunk of spectrum is controlled by the top three operators leaving very little scope for a new player to enter.

“Most of the spectrum in 900 MHZ is with the top three operators. So it is very difficult in Africa to start a greenfield project after getting spectrum which might take years. Zain is attractive as it controls spectrum,” the analyst said.

Further, a major disadvantage of Zain’s strategy in Africa has been to keep its tariff at a premium and not go in for mass scale acquisition of subscribers especially as penetration is very low. So the average call rate in Africa is Rs 4 a minute.

“Bharti can grow the market manifold by using the Indian model, reduce tariffs and go for volumes by keeping costs low,” said a senior executive of a leading telecom company that operates in Africa.

“It has the expertise to do so because it can negotiate large volume discounts from equipment makers by leveraging Africa with its high growth plans in India (where it wants to 100 million additional customers in three years),” he added.

Telecom companies in Africa say that the penetration in the African market is much lower than the 35 to 40 per cent that most analysts suggest. This is because most subscribers in Africa own two or three SIM cards as a result of which the subscriber penetration rates seem higher because of multiple counting. In reality, subscriber penetration is not more than 25 per cent, providing ample scope for growth.

Experts also say that unlike in the case of MTN, Bharti will not face any major regulatory issues in most of these countries. In Africa many states insist on local players to mandatorily have stakes ranging from 10 to 35 per cent in a telecom venture, which has already been put in place by Zain.

Also many of the states do not permit licence sales to a foreign operator, until after the rollout, which again is the case with Zain. “Bharti will replace Zain which has a comfortable majority in all these companies “said a telecom analyst.

Zain has invested over $12 billion to expand its operations in Africa and has substantial market share in most of the markets which include countries like Tanzania (with 39 per cent share in mobile space) , Zambia (70 per cent), Nigeria (25 per cent), Congo (45 per cent) and Chad (70 per cent).

In terms of market capitalisation Zain ($16.8 billion) is smaller than MTN ($28.30 or even Etisalat ($22.5 billion). It also has fewer customers than MTN which has over 103 million customers and operates in 21 countries.
 

DEAL MAKERS & BREAKERS

WHAT WORKS

# Price is right as new licence and spectrum are rarely available for greenfield project in Africa 

# Saves at least two to three years greenfield entry to Africa

# Penetration is as low as 25 per cent, scope for growth 

# Bharti can leverage volume discounts from equipment makers and drive costs down

# Could replicate the low-tariff, high-volumes strategy that Bharti follows in India as tariffs are high in Africa 

# No regulatory issues in any of the countries as local partners mandatorily required are already in place 

# EBITDA margins are positive in all operations except Kenya 

WHAT DOESN’T

# Assets valued at 10 times EBIDTA is higher than Bharti's own valuation

# 35% revenues come from Nigeria where Zain is involved in litigation with shareholders

# Zain’s management is weak 

# Zain asset buy will put pressure on Bharti's bottomline and margins

# Zain has a debt of $5 billion