Idea is trading at 5.5x FY18 EV/Ebitda (close to its lifetime trough). We conduct a bear-case sensitivity analysis assuming 5% revenue growth in FY18 and 100 bps increase in S&D expenses (over and above the 150 bps, which we already built in). Peak debt-to-Ebitda rises to 4.1x (by Q4FY18) with deterioration happening through FY18, but the ratio would remain within Idea’s debt covenant limits. FCF will be positive from Q1FY18 except for spectrum auctions. On bear-case Ebitda, we apply 6x EV/Ebitda, assuming a minor rerating since: (i) Idea has traded above 6x for most of the time in the past seven years (stress period for telecom); and (ii) we expect potential rerating due to industry consolidation and lower capex requirement. However, the bear case TP of Rs 73 is extremely sensitive to the assumed multiple (TP delta is Rs 34 for 1x multiple). Tower sale could cause rerating. Bharti remains our top pick.
Bear case sees 4.1x peak debt-to-Ebitda
Our bear case assumes 5% revenue growth in FY18 vs. 10% in the base case and 100 bps increase in S&D expenses vs. base case. Given Idea’s capacity utilisation for data at 20% even by Q4FY19 we do not build in increase in BTS count in the bear case vs. the base case. This results in FY18 Ebitda margin dropping by 800 bps from the peak levels seen in FY16 and Ebitda at 13% lower levels from current estimates. Peak debt-to-Ebitda rises to 4.1x and interest coverage ratio (on Ebitda) troughs at 2.5x.
6x EV/Ebitda in bear case reasonable
Idea will cover 94% of its revenue footprint with 4G by end-FY17 or mid-FY18. JIO accelerating adoption of VoLTE will give the top four an edge over smaller players that cannot offer data or VoLTE, and will help eliminate sub-scale players. Considering Idea’s adequate capacity, capex decline in FY18 and FY19 could be sharp. In the period since June 2009 (stress period for telecom post Tata DoCoMo’s entry), Idea traded above 6x for most of the time. Based on all this, we apply 6x multiple on bear-case Ebitda. Our bear-case TP is Rs 73.
Tower sale could result in 0.4x debt-to-Ebitda relief plus rerating
Infratel trades at Rs 71 million EV/tower (Rs 640 bn EV for 90k towers). Based on Bharti Infratel’s current valuation, we estimate that sale of Idea’s 9760 towers could yield Rs 53 billion vs. annual tower Ebitda of Rs 4.8 billion. Considering higher EV/Ebitda enjoyed by towercos, tower sale could result in 0.4x relief in debt-to-Ebitda plus rerating.
Bear-case assumptions: 5% revenue growth in FY18 and 100 bps increase in S&D expenses
- FY18 revenue growth is 5% vs. the current assumption of 10%. w S&D expenses as a percentage of revenue increases further by 100bps.
- Other fixed and variable costs adjust accordingly.
- With Idea’s capacity utilisation for data at ~20% even by Q4FY19 we do not build in increase in BTS count in the bear case vs. the base case.
It can be seen that:
- In the bear case, FY18 Ebitda margin drops by 500 bps y-o-y (and 270bps drop from current estimate) to 27.5%.
- Absolute Ebitda sees 11% y-o-y decline in FY18 and 13% reduction from current estimates. Based on this, Idea trades at 6.4x FY18 EV/Ebitda.
- FY18 FCF comes to +R21 billion vs. +R33 billion (current estimate). Interest coverage (Ebitda-to-interest) hits 2.5x trough in Q2FY18. Peak debt-to-Ebitda rises to 4.1x (by Q4FY18) with deterioration happening through FY18. But this is within Idea’s debt covenant limits.
- FCF from Q1FY18 will be positive, except for spectrum auctions.
Deciding on correct multiple
Considering Idea’s high leverage, equity value and TP are very sensitive to the target multiple. In the bear case, Idea’s Ebitda per share comes to Rs 34, which means that 1x change in target multiple can swing TP by Rs 34. To determine a reasonable multiple, we look at Idea’s historical multiple. Since listing, Idea has traded above 6x for 94% of the time. Even in the period since June 2009, Idea traded above 6x for 92% of the time. Further, Idea could see rerating based on the following factors: (i)Idea will cover 94% of its revenue footprint with 4G by end-FY17 or mid-FY18. If VoLTE takes off, because of JIO’s influence, Idea will be well positioned since it has contiguous sub-1GHz spectrum covering 77% of its revenue, second only to JIO. Idea will be protected by its spectrum and 4G network footprint but it will reap the upsides. (ii) Idea’s current traffic would equate to 7% capacity utilisation. According to our estimates, Idea’s capacity utilisation would be only 21% even by Q4FY19. 3) With such high capacity and potential benefits from active infrasharing, FY18+19 capex could be lower than our current R120 billion estimate.