Trai recommendations are positive for the incumbents: The key recos include (a) Spectrum pricing—(i) 1800MHz—Pan-India base price cut 37% from the failed March-13 auctions, (ii) 900MHz– 1.6-1.7x of 1800Mhz band (Mumbai, Delhi, Kolkata) v/s 2x previously, (iii) Refarming—no reservation of 900MHz band for incumbents, and (iv) Spectrum usage charge–flat charge of 3% for spectrum acquired post-Nov-12; highest slab at 5% (3-8% previously). While these recos will have to be accepted by the DoT (high probability), we view the spectrum price cut and reduced usage charge as positive. Maintain a positive view on the sector and retain Idea as top pick.
Lower spectrum price helps reduce impact of licence renewals: Our TPs (target prices) include spectrum hits of R45/32 per share for Bharti/Idea for licence renewals. The new recos, if accepted, would help reduce the hits to R40/27 per share, respectively. The authority has recommended not setting aside any spectrum in the 900MHz band for existing holders. However, the minimum bid quantum (5MHz) should ensure that only operators with large B/S and high quality subscribers (read incumbents) would bid for this band, lowering the risk of any business disruption for the incumbents.
Spectrum usage charge should be lowered: Operators currently pay 3-8% (of adjusted gross revenues) as spectrum usage charge. Trai has recommended a flat charge of 3% for any spectrum acquired post-Nov-12 and the highest slab to be at 5%. We estimate this, if accepted, would increase fair values of Bharti/Idea by 3%.
Roll-out obligations will hurt the new entrants more: Trai has recommended that all villages with 5000+/2000+ population need to be covered within 5/7 years of allocation (2-4 years for incumbents). This is likely to impact the smaller operators more, given they are relatively more urban focused and also don’t possess the more efficient 900MHz band spectrum. However, intra-circle roaming should help cushion the impact for all.
Other recommendations: (i) Spectrum trading should be permitted; and (ii) feasibility of E-GSM should be explored and 800Mhz auction shouldn’t be carried out as of now.
Valuation: Our target price for Idea of R205 is based on: (i) core business value of R220/share based on Dec-14e DCF (discounted cash flow); plus (ii) the Indus Towers stake valued at R17/share (Dec-14e DCF); minus (iii) R32/share for the regulatory outgo.
Risks: Downside risks that could prevent the Idea stock from reaching our target price include: (i) Sustained high competitive intensity; (ii) Increase in the number of industry participants, which would increase sector capacity and lead to tariff disruption; and (iii) Adverse regulatory rulings/policies.
Valuation: Our target price for Bharti of R415 based on Dec-14e DCF comprises:
(i) Core domestic business (ex-towerco) EV (enterprise value) of R386/share; implying 8/7x FY14/ 15e EV/Ebitda ; (ii) Africa EV at R68/sh implying EV/Ebitda of 6.6/6.4x FY14/15e EV/Ebitda, (iii) Towerco value based on Infratel’s target price is at R121/share and (iv) We reduce the potential cash outgo (R45/share). We deduct R116/share as net debt to arrive at our target price of R415/share.
Risks: The key risks to our investment thesis which could prevent the shares from reaching our target price include: (i) a slower-than-expected turnaround in Africa, which would result in greater value depletion; (ii) the India business not improving due either to sustained high competition between existing operators or price disruption in voice by Reliance Industries (as and when it enters); and (iii) Adverse regulatory rulings/policies.
Valuation: Our target price of R113 comprises (i) core business value of R85/sh, based on 6.5x Dec-14e EV/Ebitda; at a 20% discount to Idea’s implied target multiple; and (ii) towerco value accretion of R28/sh based on long- term external tenancy of 1x. We believe a discount to Idea on the core business valuation is justified on account of the inherent risks of dual network and relatively inferior quality subscribers.
Risks: We assign a High Risk rating to RCom shares given that the stock is deemed to be relatively volatile by our quantitative risk-rating model. Higher-than expected benefit from potential infrastructure sharing deal and corporate action (stake sale/ business tie-up) remain the key upside risks to our target price and investment thesis on RCom.