Bharti Buy Update:

Bharti Airtel had lost $3.6 billion in market capitalization within two days of the announcement that it was in exclusive talks with Zain group for its African assets.

The primary concern of the street was that the valuation of the deal was 11.6 times the EBITDA which was at a premium of 55% to Bharti EV/EBITDA ratio.

However during a conference call with analyst the company clarified that the $1.7 billion debt component in Zain African Enterprise value is inclusive of the share attributable to the  minority shareholders.  Besides, that Zain has started operations in Ghana, and being in startup mode, the operations are running in losses even at the EBITDA level and hence lower EBITDA increasing the EV/EBITDA multiple.

Excluding Ghana, Zain African’s EBITDA margin improves to 33.3% from the reported level of 31.4%

Now if we adjust for the minority share of debt and assume zero equity value for Ghana, the EV/EBITDA valuation comes out to be 10.8 versus 11.6 times earlier. Though this still represents  a premium of 45% to Bharti’s valuation, certain factors support this valuation.

1.       Tax rates in Africa are relatively lower which justifies some premium in the valuation

2.       Zain Africa has had a capital infusion of $9 billion till date and this makes the valuation of $10.7 billion reasonable

Strategic decision:

• Zain has presence in 15 African countries with an overall subscriber base of approximately 41.9 million in September 2009. Stake in Zain will provide BHARTI entry into the high growth African market with 8 of 15 countries of operation at sub-35% tele-density, approximately 50% higher average ARPU than BHARTI’s India ARPU, and lower competitive intensity. While we believe there are long-term strategic benefits for BHARTI-Zain, integration challenges and regulatory risks are a concern.

• We believe there is considerable scope for value addition by BHARTI in Zain. Zain’s lower profitability vis-à-vis BHARTI, despite 50% higher ARPUs, indicates scope for opex rationalisation.  Management highlighted that current tariff levels in Africa are ~10x BHARTI’s\ India tariffs, while MoU is less than 1/4th of BHARTI’s India MoU. The strategy is, therefore, to emulate the domestic ‘minutes factory’ model by lowering tariffs to spur usage and improve market share and profitability.

Key Areas of concern:

• MAT increased in budget from 15% to 18%
• Spectrum charges increased from current range of 2-6% to 3-8%
• Further deterioration in industry operating metrics to reflect the recent aggressive tariff cuts
• new entrant rollouts and
• MNP introduction and imminent 3G auction cash outflow.

However, it is widely assumed that MAT and spectrum charges would affect the company’s earnings marginally and also that Bharti is most well placed to take on the competition.

Valuation

Hence we would recommend investors to start accumulating Bharti stock at current levels with the target of 400 in one year.