Bharti Airtel?s chairman & managing director Sunil Bharti Mittal often remarks that no one has lost money on his company. Though Mittal?s statements have always been made in the context of foreign partners who have held a stake in Bharti at given points of time, he needs to prove that the investment in the African telecom assets of Kuwait-based Zain, too, will pay off. While there may be potential in Africa, Zain isn?t in the best of shape. Already, even before the deal has been consummated, premier rating agency Crisil has placed Bharti Airtel?s long-term rating on ?negative watch?.
Also, competition in the home market will keep Bharti?s margins under pressure. It?s true that Bharti Airtel has a dominant share of the Indian mobile telephony market. But the space has become highly competitive and although runaway growth in subscribers continues, over a dozen operators are fighting it out in every circle and a tariff war has broken out. For sure, there is still an opportunity since penetration is still low with more than 50% market untouched. But, even as it continues to add subscribers in the home market, Bharti is looking to grow overseas, deciding to buy out Kuwaiti telecom group Zain?s Africa operations at an enterprise valuation of $10.7 billion. That values the operations at approximately 11.6 times calendar 2009 EV/Ebitda (earnings before interest, tax, depreciation & amortisation). Geopolitical risks apart, the fact that Bharti would need to borrow heavily to push through the deal has left the markets nervous?the stock lost 14% in the first two sessions post the announcement, plunging to a low of Rs 269.
More than anything else, it?s the price India?s biggest telco is paying for the acquisition that has analysts concerned. Reena Verma Bhasin of Bank of America Merrill Lynch finds Zain?s valuation on the higher side. According to her calculations, the potential transaction values Zain?s African footprint at a 40-50% premium, compared with the South African giant MTN. ?This looks very rich to us?, she maintains.
The traded value of Zain?s closest competitor, MTN is 5-6 X EV/Ebidta based on its expected earnings for financial year 2010. Bharti is valued at 7.2 times EV/Ebidta on expected earnings for 2009-10.
While Bharti?s net debt at close to Rs 2,000 crore may not be too high, it will need to leverage its balance for the Zain acquisition. The company? s revenue growth that was in high double-digits is now under intense pressure and slowing to low single-digits. Its consolidated Ebitda margin during the December 2009 quarter remained steady at 40%, but the net profit grew only by 2% while revenue increased by a meagre 1% sequentially. With Bharti raising money to fund the acquisition of Zain, its net debt/Ebidta ratio is expected to touch 2.4. Though the level is tolerable, at under 2.5, for a financially conservative company like Bharti, the move is seen as adventurous. In the meantime, the company?s earnings could be diluted to the extent of 10-15%. The biggest concern that investors have is that the rather expensive deal would stretch Bharti?s balancesheet, at least in the short term. This would not be welcome especially when 3G auctions are around the corner.
Zain?s African assets give Bharti access to 15 regions with a user base of 40 million. Access to these growing markets certainly sounds like a good idea. However, the problem is that the acquisition target is a loss-making venture that needs to be turned around. The operations recorded a net loss of $112 million for the nine months of 2009. While Zain?s overall revenues rose 14% and Ebitda grew 16% in the first nine months of 2009, its Africa revenues fell $3,067 million in the first nine months of 2008 to $2,697 million in the same period of 2009, while Ebitda declined to $900 million from $1,046 million.
The African operations of Zain, according to Emkay Research, are not only seeing declining revenue and profit growth, but also require higher capital expenditure. Brokerage Religare believes that Zain?s African operations, after reporting strong growth in CY07 and CY08, have deteriorated in CY09. Turning around Zain?s Africa operations thus assumes critical importance for Bharti to make this acquisition value accretive.
This turnaround, Religare believes, is at least two years away. The Bharti management is known for its execution capabilities at home, but it so far has had little experience in managing cross-border operations. It?s also unclear what regulatory hazards in Africa could be but in operational terms, the African market does not seem to be too different from the Indian market. So, Bharti should be able to replicate its low-cost model in there, given the 40% teledensity and the fact that incumbents like MTN are turning in healthy Ebidta margins of 40 %plus.