Zain has been a tough buy for Bharti to sell to the Street with the broad consensus view that it is value-dilutive. We believe that Zain has been under-analysed and as a result under-valued.
Post-our recent visit to six countries where Zain has operations (55% of Africa Ebitda?earnings before interest, taxes,depreciation and amortisation), we believe that Bharti can do much more with Zain, which has been plagued by underinvestment in the past 1-2 years and frequent management changes over its history (4-5 times in some countries) resulting in competition (both old and new) gaining at its expense. The operations especially took a hit in the past 1-2 years both due to underinvestment as well promoters? lack of focus as they looked to sell out.
We believe that a focused network/marketing strategy can help Bharti win back some of the market share that has been lost and also help improve profitability, which deteriorated in the past 1-2 years. While it is still early days, the initial signs are encouraging:
(I) Tariff cuts in some markets have helped increase sub-adds share (3.7m net adds in Q2). Our interaction with the operators revealed encouraging signs of elasticity with operators in many countries talking about shifting their entire focus to increasing capacity, with coverage taking a back seat;
(ii) Bharti has been fairly aggressive in its network expansion plans as per our discussion with the network vendors; (iii) We see significant scope for cost efficiencies by borrowing the India model (managed services and tower sharing); and (iv) Zain has had a history of frequent management changes. A consistent feedback we received was that Zain?s acquisition had resulted in cross-cultural issues.
Bharti has refrained from doing a mass change and broadly kept the original top management across the various subsidiaries. In addition, the regulators across most countries have also been pushing for increased competition by cutting termination rates. The strategy likely to be followed by Zain will to protect profitability in countries where it has a high revenue share and be aggressive in the others (initial signs already point to this). The delta in earnings will however come from its smaller operations like Kenya and Uganda. We believe that the street is likely to start attributing some value accretion to Zain as positive news flow start from Africa over the next 6-9 months.
We estimate that Zain will contribute Rs25/share to Bharti?s TP (target price) versus Rs18 value depletion earlier?a swing of Rs43/share. The importance of Zain for Bharti can be highlighted from the fact while currently it is contributing <10% to its TP, it forms 26% of Bharti?s EV (enterprise value). As it returns to its profit potential, we believe that Zain will become one of the primary value drivers.
The core business, while still witnessing high competition, is showing signs of stabilising, though it is not completely out of the woods as yet. Our FY12e assumption of 7% decline in rev/min and flat wireless margins however do provide some cushion against any unexpected competitive intensity/adverse regulation. A further steady revenue stream of tower company (10% of EPS in FY11e and 15% in FY13e) will also provide some stability to earnings.
Media reports indicate that Trai is expected to come out with its final spectrum-related recommendations in the next 1-2 months. We believe that Trai recommendations as they stand are unlikely to be implemented in full?excess spectrum charges /licence renewal fees are most likely to get implemented, though based on a compromise rather than 3G price, but re-farming of 900Mhz spectrum, potentially the most damaging of the recommendations, is unlikely to get implemented.
As a result we upgrade Bharti to a Buy with a target price of Rs 400 (Rs 350 earlier) almost entirely on its Africa upside. TP comprises (i) domestic business at Rs 393, including tower value at Rs 82 (Rs 386 earlier) based on Sep-10 DCF (discounted cash flow), (ii) value accretion in Zain at Rs 25 (Rs18 value depletion earlier) and (iii) cash outgo from Trai recommendations related to spectrum charges and licence renewal fees based on a compromise formula at Rs18.
?Citi