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India Equity Research Telecom June 02, 2010 Telecom Sector Large potential rebound as earnings recover after Mar11 Sector Update The fall in market capitalization triggered by the TRAI proposals reflects a worst case assessment. It overlooks the robust cash flow that can manage the burden of the 3G business as well as the additional levy for 2G spectrum. FY11f would bear the brunt, with up to a 1.7% fall in EBITDA margin and 5.9% fall in net profit margin. However, the recovery is likely to begin in FY12f with a three year net profit CAGR of 66%. This could catalyze a recovery in valuations, leading to a potential upside of between 74% and 160% by end FY12. Worst may be priced in The market capitalization of the three large telecom stocks fell by up to 21% within days of the TRAI proposals, considerably more than the cuts to their earnings forecasts. The erosion in market capitalization also exceeds the present value of the potential erosion in net profits. This suggests that the worst-case assessment of the impact of the 3G business, possible investments

in BWA and the probable implementation of the TRAI proposals have been priced in. Cashflow is robust enough to absorb burden of 2G cess and 3G Should the recent TRAI proposals on additional levy for 2G spectrum be implemented, providers would need to make a one-time payment. We estimate cash outflow of INR46bn and INR15bn for BHARTI and IDEA, respectively. This would be in addition to the payments for 3G licenses and capital expenditure required to roll out 3G services. Consequently, gearing would rise by up to 1.1x. However, the operating cashflow of operators is robust enough to absorb the impact of these blows. Low impact on EBITDA margin over the medium term Continuance of subscriber-linked criteria for six more months may sustain the downward pressure on tariffs. Also, the proposed M&A guidelines contain elements that may delay consolidation. Incumbents have demonstrated their resilience to such conditions. The change in regulatory levies is likely to have low impact on EBITDA margins in the medium term. However, net profit margin is likely to fall due to increase in interest costs and amortization. Large potential upside as earnings likely to recover after Mar11f The brunt of the above developments is likely to be felt in the year ending Mar11. We foresee a rebound in net profits starting FY12f, leading to a

three-year CAGR of up to 66%. The forecasts may need to be reassessed, positively, if the TRAI proposals were to be amended. Should valuations revert to a normal range, stock prices could rebound by up to 160% by end Mar12f. (%) 1 m 6 m 12 m Nifty -3 -1 13 Telecom Index* -13 -12 -38 Source: Bloomberg, Avendus research Note* Market cap weighted index created with BHARTI, RCOM and IDEA Cashflows (INRbn) -240 -60 120 300 BHARTI RCOM IDEA Source: Company, TRAI, Avendus Research Op. cashflow - FY11f and FY12f Outflow for 3G, BWA, TRAI EBITDA margin (%) 23 29 35 41 FY10 FY11f FY12f FY13f FY14f Source: Company, TRAI, Avendus Research BHARTI RCOM IDEA 1 yr forward EV/EBITDA (x) 0 4 8

......3 Cashflow is robust enough to absorb burden of 2G cess and 3G............................com India Equity Research Telecom Sector Telecom 2 Table of Contents Investment summary..........3 Tariff war may extend....5 Significant increase in gearing may call for equity infusion ....................................................................... Bloomberg........................... 7 ..................................................12 BHARTI RCOM IDEA Source: Company...................................................................................................................................moghe@avendus............................................... consolidation may be delayed ............................................... ................................................................3 Low impact on EBITDA margin over the medium term......... Avendus Research Current Case A Case B Case C AbhayMoghe................................................................4 3G win to increase the cash outgo further.......................... potential upside as earnings recover after Mar11f .................................... 4 Incumbents may need to pay for excess 2G spectrum............................................3 Worst priced in......5 Robust cashflow can absorb the burden of increased gearing ........... 3 Cashflow is robust enough to absorb burden of 2G cess and 3G......6 Low impact on EBITDA margin over the medium term.............................. +91 022 66842857 abhay...................................................................................

.............................. 9 Forces that could hasten consolidation may be weakened .......9 Tariff war may extend....................7 Lower license fees may partly offset this impact .................10 Spectrum sharing may benefit new entrants ......................9 But incumbents have been resilient to competition till now .................................................................................................................... if linkage of spectrum to subscribers persists ..................................7 Higher interest costs and amortization may impact profitability.................................................12 Scaling back of proposals may lead to re-rating.......................................... EBITDA growth may lead to significant potential upside................................... 11 Stock prices have reacted faster than earnings forecasts .................................................................10 Worst priced in.................................................................................. potential upside as earnings recover after Mar11f ....................................................11 Low probability of complete implementation of proposals .........................11 Earnings rebound likely to begin after Mar11.........................12 Re-rating.............7 Tariff war may extend........................................................ .....................................................................................................................................Change in policy may increase recurring spectrum fees ....................................................................... consolidation may be delayed............ 15 .............................................................11 Erosion in market capitalization exceeds erosion in profits ...13 Annexure ................................................................................................................................... ROCEs to stabilize ...............

We find that the internal cashflow being generated by large telecom providers is big enough to manage the burden of both. gearing would rise by up to 1. The proposals tend to delay the end of the tariff war and. FY11f is likely to mark the bottom and net profits may report a three-year CAGR of 66%. thus. the outflow would be INR46bn for BhartiAirtel (BHARTI IN. two large cash outflows for Indian telecom providers are expenses for the 3G business and the additional levies proposed by TRAI. While. leading to a potential upside of between 74% and 160% by end FY12f.7% and net profit margin by up to 5.1x. Outflow would decrease. They would need to pay more for 3G licenses and related capital expenditure. if a part of the capital expenditure were funded by new equity. provide some relative advantage to newcomers. The TRAI proposals could pull down FY11f EBITDA margins by up to 1. Cashflow is robust enough to absorb burden of 2G cess and 3G Should the recent proposals of Telecom Regulatory Authority of India (TRAI) be implemented. This could catalyze a recovery in valuations.India Equity Research Telecom Sector Telecom 3 Investment summary Over the medium term. The market capitalization of providers may reflect a worst-case assessment of the impact of these proposals.9%. Low impact on EBITDA margin over the medium term . Buy). the operating cashflow of operators is robust enough to absorb the impact of these blows. However. Hold) and INR15bn for Idea Cellular (IDEA IN. profitability is likely to recover in the following years. It also presents an opportunity for a significant medium-term upside.

The forecasts may need to reassessed.1% for IDEA. This suggests that the worst-case assessment of the impact of TRAI proposals has been priced in. Some of the proposals may not be implementable due to physical constraints.6% for BHARTI and 1. as well as of the higher gearing resulting from funding 3G. Data for the past five quarters reveals that incumbents have held out well against such forces by preserving their share of revenue even as they lose market share in the number of subscribers. Should . EBITDA margins may recover due to a decrease in license fees. The proposals for sharing of spectrum may provide some advantage to newcomers. In FY14f. Worst priced in. the net impact of the change in spectrum and license fees on EBITDA margins is likely to be -0. Net profits for FY11f are likely to bear the brunt of the impact of these proposals. Starting FY12f.9%. The rise in interest expense would pull down FY11f net profit margin by up to 5. consolidation may be delayed The proposals may extend the tariff war by continuing to link spectrum to subscribers.A rise in spectrum fees and fall in license fee would depress the EBITDA margin for FY11f by up to 1.7%. leading to a three-year CAGR of up to 66%. positively. The norms for mergers too may be made more conservative by mandating a lower ceiling for market share and a larger number of providers. Tariff war may extend. potential upside as earnings recover after Mar11f The erosion in market value exceeds the present value of the potential erosion in net profits. if the TRAI proposals were to be amended. We foresee a rebound in net profits starting FY12f.

7 6.7 7.401 1.1 568 457 333 109 412 301 177 4 125 91 54 49 155 86 9 BHARTI .3 7.935 1.African ops 76 5.209 4 448 334 297 257 74 30 16 Source: Company.354 .8 7.3 6. B: Higher end of the lowest quartile.7 433 433 433 .valuations revert to a normal range.2 2.7 7.787 578 1. Exhibit 1: Potential upside by end Mar12f in three scenarios for 1-year forward EV/EBITDA multiple Target EV/EBITDA (x) Target EV Target mkt.968 1. Avendus Research Note: A: Lower end of highest quartile (Jan09-May10).357 1.4 1. 288 8. Bloomberg.4 1.823 1. C: Minimum during Sep08 .077 785 745 222 855 563 523 2 363 239 222 139 160 71 59 IDEA 65 8. Target price (INR) Potential upside (%) FY13f EBITDA ABCABC Net Debt ABC Shares (bn) ABC CMP (INR) ABC RCOM 101 10.Non-Africa 212 9.Mar09 India Equity Research Telecom Sector Telecom 4 Cashflow is robust enough to absorb burden of 2G cess and 3G .0 5.502 1.1 6. (INRbn) cap. the stock prices could rebound by up to 160% by end Mar12f.Cons.

Consequently. We believe the providers may consider funding a part of the outflow through infusion of new equity.2MHz in the 900MHz band is measured at 1.2MHz in the 1.800MHz band is measured at 1x the 3G winning price per MHz in the respective service area. the current price of excess spectrum is raised by 30%.Should the recent TRAI proposals on additional levy for 2G spectrum be implemented. Payment for 3G is estimated to be between 82% (BHARTI) and 129% (IDEA) of FY12f cashflow.1MHz and Reliance Communications (RCOM IN. TRAI in its interim recommendations has proposed the following criteria to measure the current price of excess spectrum: Cost of spectrum above 6. Cost of spectrum above 6. the operating cashflow of operators is robust enough to absorb the impact of these blows. respectively. gearing would rise by up to 1.2MHz allocated to an operator in a service area. IDEA has 17. However. . We estimate cash outflow of INR46bn and INR15bn for BHARTI and IDEA.5MHz.1x.8MHz. This would lead to dilution ranging between 7% and 20% of the equity capital at end Mar12f. This would be in addition to the payments for 3G spectrum and capital expenditure required to roll out 3G services. Incumbents may need to pay for excess 2G spectrum Excess spectrum is defined as the total 2G GSM spectrum above 6. The one-time payment for excess 2G spectrum is between 4 months (BHARTI) and 5 months (IDEA) of FY11f cashflow. Hold) has 1. If total spectrum is above 10MHz in Metros or above 8MHz in other service areas. providers would need to make a one-time payment. BHARTI has excess spectrum of 41.5x the 3G winning price per MHz in the respective service area.

India Equity Research Telecom Sector Telecom 5 Exhibit 2: One-time cash outgo due to excess spectrum (INRmn) BHARTI RCOM IDEA Circles 3G winning price per MHz (INRmn) Excess spectrum equivalent (MHz) Cash outgo (INRmn) . Our analysis indicates that the immediate cash outgo for BHARTI would be INR46bn and INR15bn for IDEA. with a minimum of 7 years. However. while it would be marginal for RCOM. The one-time spectrum fee for excess spectrum has to be paid again at the time of renewal of license. If the service provider chooses to return excess spectrum. GSM incumbents would have to incur incremental cash outgo at the time of renewal of license. If the regulator accepts the recommendations.The current price for excess 2G spectrum will be pro-rated for the remaining license period. The price would be calculated on the basis of the revised benchmarks available at that time (currently 3G winning price). the current price has to be paid on pro-rata basis for a minimum of 3 years. it may entail a significant cash outgo for GSM incumbents. Service providers may also choose to return 2G spectrum in service areas with a 3G spectrum win. without any modification.

.930 3.Bihar 407 3.782 Mumbai 6.9 1...036 Gujarat 2.1.8 239 .4 541 Haryana 445 . Avendus Research .088 1..0 11.Andhra Pradesh 2.1.....8 527 .7 10.089 1.4 541 .634 4.Madhya Pradesh 517 1...0 5..6 3.046 ..Maharashtra 2.746 6....501 46..0 500 .......Tamil Nadu 2.516 2....5..9 3.Orissa 194 1.Rajasthan 642 2.North East 85 .999 .730 Karnataka 3... Department of Telecommunications (DoT).Kerala 625 .8 6.1..152 ..913 ..8 648 Uttar Pradesh (East) 729 1.028 .8 686 .Excess spectrum equivalent (MHz) Cash outgo (INRmn) Excess spectrum equivalent (MHz) Cash outgo (INRmn) Delhi 6.1.0 6.Kolkata 1..8 1.160 6..8 394 Punjab 644 2..Jammu & Kashmir 61 .6 584 ...614 .194 256 15.7 5...8 326 West Bengal 247 .456 Source: TRAI. Company.Total 33.1.8 256 .748 ...494 3.....2.Uttar Pradesh (West) 1........708 .Himachal Pradesh 74 .Assam 83 ...

2x for BHARTI (excluding African operations). INR73bn for IDEA and INR87bn for RCOM. This may lead to cash outgo of INR61bn for BHARTI. Significant increase in gearing may call for equity infusion The potential one-time cash outgo for excess 2G spectrum and 3G is likely to be INR169bn for BHARTI. High gearing may compel some service providers to partly fund the capital employed in the 3G business through equity.7x for RCOM. Initially. 1.1x for IDEA and 0. This would entail a cash outgo of INR123bn. 22% for IDEA and 14% for RCOM. it may result in equity dilution of 7% for BHARTI. Exhibit 3: Impact of one-time cash outgo on net debt and gearing Net debt excl. this cash outgo is likely to be funded through debt and internal accruals. respectively. 3G winners also have to incur additional capex over the next 22 months.3G win to increase the cash outgo further BHARTI won 3G spectrum in 13 circles. IDEA in 11 and RCOM in 13. The winning price is to be paid within 15 days of the end of the 3G auctions. This may lead to an increase in the net debt/equity at end Mar11f to 0. INR29bn for IDEA and INR43bn for RCOM. If up to 50% is funded through equity till FY12. To comply with the roll-out obligations associated with the 3G spectrum win. Equity dilution may result in a decrease in the net debt/equity in FY12f. INR58bn and INR86bn. cash outgo for 2G and 3G spectrum Equity (before dilution) Net debt/ .

despite intense competition. Exhibit 4: Operating cashflow and net debt for BHARTI.5 0.2 0. Avendus Research India Equity Research Telecom Sector Telecom 6 Robust cashflow can absorb the burden of increased gearing GSM incumbents generated strong operating cash flow in FY10. Additionally.Equity (x) 2G spectrum related one time 3G spectrum win related cash outgo Net debt incl.5 0 86 310 303 414 451 0.1 RCOM 224 217 421 456 0.9 Source: Company.2 46 123 105 32 492 594 0.7 IDEA 57 43 122 132 0.1 0. cash outgo for 2G and 3G spectrum Equity (after 50% dilution in FY12f) Net debt/ Equity (x) (INRbn) FY11f FY12f FY11f FY12f FY11f FY12f cash outgo FY11f FY12f FY11f FY12f FY11f FY12f BHARTI -64 -137 505 605 -0.7 0.1 -0. RCOM and IDEA (INRbn) .3 15 58 130 116 116 133 1. continued strong operating cash flow may sustain the impact. operating cashflow generation in the next few years may further dilute the impact of the delayed one-time outgo on renewal of licenses in various service areas.5 0. While the one-time cash outgo may increase the net debt.

TRAI. the summary impact of the change in spectrum and license fees on EBITDA margins is likely to be -0. However the impact on EBITDA margins would subside after FY11f due to a decrease in license fees each year till FY14f. cash outgo related to 2G and 3G spectrum Operating cash flow/ net debt (post cash outgo) (INRbn) FY11f FY12f FY11f FY12f FY11f FY11f FY12f FY11f FY12f BHARTI 148 149 -64 -137 169 105 32 1.3 0. . In FY14f.1% for IDEA.1 0.4% (IDEA).1 IDEA 43 45 57 43 73 130 116 0. Company.7% (BHARTI) and 0.Operating cash flow.6% for BHARTI and 1.4 Source: DoT. excl. 3G operations Net debt excl. Avendus Research India Equity Research Telecom Sector Telecom 7 Low impact on EBITDA margin over the medium term The summary impact of the rise in spectrum fees and a fall in license fee would be a fall in EBITDA margin for FY11f between 1.6 RCOM 32 35 224 217 86 310 303 0.4 4. cash outgo related to 2G and 3G spectrum Total cash outgo Net debt incl. The additional burden imposed by the rise in interest expense would pull down FY11f net profit margin by up to 592-bp.

580 78.979 222.504 EBITDA 160. Avendus Research Lower license fees may partly offset this impact Currently.Change in policy may increase recurring spectrum fees TRAI has recommended a change in the recurring fees for 2G GSM and CDMA spectrum. telecom service providers pay recurring license fees as a percentage of the AGR for the wireless business. Exhibit 5: Impact of change in spectrum fees on EBITDA margins (financials as of FY10) (INRmn) BHARTI IDEA RCOM Revenues 396. i. 6.5% of the adjusted gross revenue (AGR) per MHz up to the contracted spectrum. Our analysis indicates that EBITDA margins of BHARTI and IDEA may be negatively impacted by 139-bp and 89-bp.266 33. and 1% of the AGR per MHz for spectrum in excess of that amount. The current license fee is set at 10% in Metros and Circle A.525 1. However.276 Revised EBITDA margins (%) 39 26 36 Dent on EBITDA margin -139-bp -89-bp 18-bp Impact on EBITDA (%) -3 -3 1 Source: Company.2MHz (GSM)/5MHz (CDMA).100 -406 Revised EBITDA 154.150 123.742 32.479 79. respectively.870 EBITDA margin (%) 40 27 35 Incremental Spectrum Charges 5. The spectrum usage charge is 0.e. A change in spectrum charges may have a negative impact on EBITDA margins for BHARTI and IDEA. The company s EBITDA margins are likely to be positively impacted by c18-bp. TRAI. 8% in Circle B and 6% in . RCOM may gain from the change in spectrum fees due to lower charges on CDMA spectrum.

However. This may increase interest costs and lower profitability. India Equity Research Telecom Sector Telecom 8 Higher interest costs and amortization are likely to impact net profit margins by 492-bp for BHARTI. EBITDA margins may improve. one-time spectrum-related costs are likely to lead to higher intangible assets. TRAI has recommended a gradual change to the uniform license fee of 6% over the next four years. After four years. 48-bp for IDEA and 29-bp for RCOM. EBITDA margin improvement is likely to be 48-bp for BHARTI. This is likely to reduce the recurring license fees. Hence. Currently.Circle C. Avendus Research Higher interest costs and amortization may impact profitability The one-time cash outgo due to excess 2G spectrum and the 3G win may lead to higher net debt. further lowering the profitability. these two segments do not pay any license fees. Also. . This is likely to partially offset the negative impact of the increase in spectrum fees. Exhibit 6: Improvement in EBITDA margin due to change in license fees (bp) BHARTI IDEA RCOM Year 1 -29 45 -36 Year 2 39 73 17 Year 3 19 34 5 Year 4 48 48 29 Source: Company. the improvement may be partially offset by the potential imposition of license fees on the Internet Service Provider (ISP) and Infrastructure Provider (IP) segments. 429-bp for RCOM and 592-bp for IDEA. This may lead to higher amortization.

among other such measures. New entrant New entrant Scale and 2G spectrum One-time cash outgo for excess spectrum and 51% promoter's equity lock-in for 5 years. Exhibit 8: Scenarios for M&A between two segments of the Indian telecom industry Acquirer Target Drivers for acquisition Restrictions GSM Incumbent GSM Incumbent 3G and 2G spectrum Market share should be less than 30% and the cap on spectrum at 14.502 Revised FY11f PAT 70.179 Impact on PAT margins -492-bp -429-bp -592-bp Source: TRAI.4MHz.Exhibit 7: Impact of higher net debt and intangible assets on net profits (INRmn) BHARTI RCOM IDEA FY11f PAT 91. Data for the past five quarters reveals that incumbents have held out well against such forces by preserving their share of revenue even as they lose market share in the number of subscribers.115 22. GSM Incumbent New entrant 2G spectrum Cap on spectrum at 14.661 -1. Company.323 Incremental interest and amortization (after tax) 21.574 10.688 32.217 9. Avendus Research Forces that could hasten consolidation may be weakened . Source: TRAI.877 8. New entrant GSM Incumbent Scale and 2G spectrum Cap on spectrum at 14. Avendus Research India Equity Research Telecom Sector Telecom 9 Tariff war may extend.4MHz and 51% promoter's equity lock-in for 5 years. The norms for mergers too may be made more conservative by mandating a lower ceiling for market share and a larger number of providers. consolidation may be delayed The proposals may provide a new lease of life to the tariff war by continuing to link spectrum to subscribers for another six months. The proposals for sharing of spectrum may provide some advantage to newcomers.4MHz and 51% promoter's equity lock-in for 5 years.

51% lock-in of promoter s equity for 5 years or till the completion of roll-out obligations. Tariff war may extend. Spectrum transfer fee of 5% would be levied on the difference between acquisition price and the value of excess spectrum. The acquirer s cash outgo may also increase on account of spectrum transfer fee and a one-time payment for excess spectrum. Number of service providers in a service area after a merger is recommended to be not less than 6 compared to 4 earlier. key motives for acquisition and regulatory restrictions that may apply to the merger (Exhibit 7). whichever is earlier. if linkage of spectrum to subscribers persists Exhibit 9: Trend in subscriber and revenue market share (%) . This is mainly due to the following three reasons: Maximum market share of merged entity in terms of subscribers or AGR is recommended to be lowered from 40% to 30%. One-time spectrum fee may also be levied on any excess spectrum that may result from the merger. We have analyzed four scenarios for M&A. the merger-related cash outgo may reduce the valuation of the target entity. Thus. Key recommendations that could have advanced consolidation were relaxing the promoter lock-in equity and the cap on spectrum allocation.The revisions proposed by TRAI in the M&A regulations are likely to delay consolidation. However these two factors have not been relaxed.

the revenue share of GSM incumbents such as . Avendus Research India Equity Research Telecom Sector Telecom 10 In the future. the tariff war may not bottom out for six more months. But incumbents have been resilient to competition till now Competition has increased since launch of operations by new entrants in 2009. This is likely to intensify competition further as new entrants drop tariffs while vying for more subscribers and minutes. This may compel new entrants to gain more subscribers in the next six months and apply for further allocation of 2G spectrum. the TRAI has recommended continuing the current subscriber-linked criteria for another six months. However. However. Hence. 2G spectrum is likely to be allocated on the basis of completion of 2G roll-out obligations.Subscriber market share Revenue market share (%) Mar09 Jun09 Sep09 Dec09 Mar10 Mar09 Jun09 Sep09 Dec09 Mar10 BhartiAirtel 24 24 24 23 22 33 34 33 32 31 Vodafone (India) 18 18 18 18 17 20 21 20 21 21 Idea Cellular 11 11 11 11 11 12 12 12 13 13 Reliance Communications 19 19 18 18 18 12 12 12 12 11 Tata Teleservices 9 9 10 11 11 8 7 7 7 9 Aircel 5 5 5 6 6 3 3 4 4 4 Other new entrants 0 0 0 0 1 0 0 0 0 1 Others 15 14 14 14 13 12 11 11 10 10 Total 100 100 100 100 100 100 100 100 100 100 Source: TRAI. The intensifying competition led to a sharp drop in tariffs.

4MHz. only new entrants would be able to share spectrum as incumbents possess more than 4. In Delhi.4MHz spectrum in most circles. Hence. India Equity Research Telecom Sector Telecom 11 Worst priced in. New entrants are likely to gain additional revenues by sharing spectrum with other service providers. thus. The impact of these proposals. considerably more than the cuts to their earnings forecasts. their revenue share has still not seen an uptrend after more than three quarters since launch. While new entrants are able to garner a higher share of subscribers. Market capitalization of the three large telecom stocks fell by up to 22% within days of the TRAI proposals. Thus. thus. Vodafone and IDEA has not deteriorated. be able to share spectrum with new entrants that possess spectrum and launch operations. The sharing is restricted to service providers with spectrum up to 4. potential upside as earnings recover after Mar11f The erosion in market value of telecom stocks exceeds the present value of the potential erosion in net profits. reducing their losses. incumbents have been resilient to competition till now. as well as of the higher gearing resulting from funding 3G. a few licensees have not been allocated spectrum as yet. is likely to . Based on current spectrum allocation. Spectrum sharing may benefit new entrants TRAI has recommended spectrum sharing only for 2G spectrum. This suggests that the worst case assessment of the impact of TRAI proposals has been priced in. These licensees may. such licensees may not have to wait for the government to allocate spectrum to launch services.BHARTI.

possible investments in BWA and the probable implementation of the TRAI recommendations. if the TRAI proposals were to be amended. The forecasts may need to be reassessed. RCOM and IDEA has fallen by 13%. Earnings rebound likely to begin after Mar11. 10% and 22%. Should valuations revert to a normal range. 11% for RCOM and 3% for IDEA. our ROCE estimates stabilize after FY12f with an upward bias. . the mean consensus estimates for FY11f net income have been downgraded by 1% for BHARTI. We foresee a rebound in net profits starting FY12f. Stock prices have reacted faster than earnings forecasts TRAI recommendations were released on 11 May10 and 3G auctions ended on 19 May10. ROCEs to stabilize Capital intensity of the providers is likely to rise after the investments in the 3G business.be concentrated in their FY11f performance. e. RCOM s higher downgrade in forecasts may be partially explained by the change in forecasts after its 4QFY10 results were announced on 15 May10. leading to a three-year CAGR of up to 66%. However. Some of the proposals may not be implementable.800MHz band to replace the entire 900MHz band spectrum that is sought to be taken back from operators. stock prices could rebound by up to 160% by end Mar11f. positively. the stock price of BHARTI. over the same period. Hence. stock prices have reacted faster than the downgrade of forecasts. Exhibit 9 indicates the consequent fall in ROCE. there may be insufficient spectrum in the 1. Since 11 May10.g. respectively. However.

till FY14f.The brunt of the impact is likely to be borne in FY11f. BWA and TRAI .) 11 11 11 11 3 4 4 5 3 6 7 10 Source: Company. The discounted value for BHARTI is INR92bn. We believe net profit growth would resume in FY12f. IDEA s net profit CAGR during FY12f-FY14f is likely to be 66%. We estimate the FY14f consolidated ROCE (including African operations) for BHARTI at 11%. Exhibit 10: ROCE before and after considering the impact of 3G and TRAI recommendations (%) BHARTI* RCOM IDEA FY11f FY12f FY13f FY14f FY11f FY12f FY13f FY14f FY11f FY12f FY13f FY14f ROCE (excl 3G and TRAI reco. Erosion in market capitalization exceeds erosion in profits Profits of BHARTI. respectively. We have discounted the change in profit forecasts for the period of FY11f to FY14f at a WACC of 13%. INR32bn and INR46bn. market capitalization of BHARTI. we believe the worst-case assessment of the impact of 3G. Hence.) 20 19 18 17 5 5 6 6 8 10 11 15 ROCE (incl 3G and TRAI reco. Avendus Research Note:* BHARTI s ROCE excludes the financials for African operations The inclusion of African operations is likely to reduce BHARTI s consolidated ROCE to 8% in FY11f. RCOM and IDEA during FY11f-FY14f are likely to be lower than current forecasts. We estimate the three-year CAGR in net profits. TRAI. to be 13% for BHARTI and 22% for RCOM. RCOM is INR30bn and IDEA is INR18bn. RCOM and IDEA has declined by INR142bn. The ROCE is likely to increase after FY11f due to revenue growth and margin expansion in African operations. However.

Avendus Research Note:* BHARTI s financials exclude African operations Low probability of complete implementation of proposals TRAI s recommendations are likely to impact most telecom operators negatively. unfavorable and stricter spectrum allocation criteria and 51% promoter s equity lock-in for five years are key negatives for new entrants.6 0. BWA and TRAI reco.6 Present value of the difference -92 -30 -18 Change in Mcap since 10 May10 -142 -32 -46 Source: Company. DoT.8 0.8 0.8 0.7 0. 3G. RCOM and IDEA.7 0.9 0. BWA and TRAI reco.6 0. While key negatives for GSM incumbents are one-time fee for excess spectrum and refarming of spectrum in the 900MHz band.) 58 72 79 82 19 29 29 31 -4 7 9 19 Difference -34 -28 -30 -32 -14 -6 -10 -10 -12 -4 -5 -3 Discount factor @ WACC of 13% 0.proposals has been priced for BHARTI. Exhibit 12: Key positive and negative impact of TRAI s recommendation on each segment Segment Positive Negative Public sector telcos . India Equity Research Telecom Sector Telecom 12 Exhibit 11: PV of the change in profit forecasts from FY11f to FY14f and decline in Mcap BHARTI* RCOM IDEA (INRbn) FY11f FY12f FY13f FY14f FY11f FY12f FY13f FY14f FY11f FY12f FY13f FY14f PAT (excl.9 0. Conservative M&A guidelines are negative for the overall sector.9 0. 3G.7 0.) 92 100 109 114 33 35 39 41 8 10 14 22 PAT (incl. TRAI.

Spectrum sharing . Vodafone and IDEA had filed a petition against TRAI s recommendation with the Telecom Disputes Settlement & Appellate Tribunal (TDSAT).Refarming of 900MHz spectrum . Avendus Research The TRAI recommendations have not been received well by telcos.Refarming of 900MHz spectrum .One-time fees for excess spectrum .One-time fees for excess spectrum .Reduction in license fees .Conservative M&A guidelines New entrants GSM .Increase in recurring spectrum fees .Unfavorable spectrum allocation criteria for TTSL . BHARTI. the TRAI has clarified that the proposal of linking the price of excess 2G spectrum to the 3G winning price was an interim recommendation.Conservative M&A guidelines Source: TRAI. Additionally.Reduction in license fees .Clarity on spectrum allocation .Conservative M&A guidelines Dual technology license holder . which was later withdrawn.Conservative M&A guidelines Private incumbents .Spectrum sharing .Increase in recurring spectrum fees .Stricter spectrum allocation norms . The .Minimum license and spectrum fees ..Reduction in license fees .

compared to 2G spectrum.final recommendations. interest costs and amortization.800MHz band. would be submitted to the DoT by 15 Jul10. Recommendation on refarming assumes release of spectrum in the 1. In two recent cases. Any negative outlook on the same would reduce the likelihood of replacement of spectrum in the 900MHz band with the 1. This is likely to have a positive impact on net debt. post consultation process.800MHz band by government agencies. This may reduce the one-time cash outgo for excess spectrum by 50% to 66%. the TDSAT has decided in favor of telcos in the backhaul spectrum case and given a stay on the hike of spectrum charges. there exists a shortfall compared to the spectrum to be refarmed starting 2014. Hence. if 3G spectrum is considered to be 2x to 3x more efficient than 2G spectrum. may be considered while pricing the excess 2G spectrum.800MHz band. Refarming of spectrum in 900MHz band is less probable As per current availability of spectrum in the 1. complete implementation of TRAI s recommendation is unlikely. Scaling back of proposals may lead to re rating There is a likely chance that higher efficiency of 3G spectrum. we believe. India Equity Research Telecom Sector Telecom 13 Exhibit 13: Spectrum allocated and available for refarming of spectrum in the 900MHz band (MHz) Spectrum available fortelcos Spectrum already .

allocated Spectrum yet to be allocated in 1. TRAI. Avendus Research Re rating.800MHz band Amount of spectrum to be refarmed Supply demand gap Delhi 57 54 4 22 -19 Mumbai 75 73 2 22 -20 Kolkata 78 60 18 20 -2 Maharashtra 69 65 4 20 -16 Gujarat 60 60 0 20 -20 Andhra Pradesh 84 69 14 20 -6 Karnataka 79 65 14 20 -6 Tamil Nadu 87 67 20 20 0 Kerala 89 61 28 19 9 Punjab 63 59 4 22 -17 Haryana 64 59 4 12 -8 Uttar Pradesh (West) 61 61 0 19 -19 Uttar Pradesh (East) 62 62 0 19 -19 Rajasthan 64 64 0 19 -19 Madhya Pradesh 96 63 33 19 15 West Bengal 57 53 4 19 -15 Himachal Pradesh 58 58 0 19 -19 Bihar 71 67 4 19 -14 Orissa 77 59 18 19 -1 Assam 59 55 4 19 -14 North East 58 53 4 19 -15 Jammu & Kashmir 49 49 0 19 -19 Source: DoT. EBITDA growth may lead to significant potential upside .

The potential upside is calculated including the impact of investments in the 3G business. Sep08-Mar09: During this period.We have analyzed the potential upside in BHARTI. RCOM and IDEA from the current stock prices in the following three scenarios for the 1-year forward EV/EBITDA multiples: Scenario A: Lowest 1-year forward EV/EBITDA multiple of the highest quartile from Jan09 to May10 (sorted in descending order of the values). Scenario C: Minimum 1-year forward EV/EBITDA multiple during Sep08-Mar09. telecom stocks were impacted due to the global economic crisis. the super-normal growth rates for earnings ended. Also. India Equity Research Telecom Sector Telecom 14 Exhibit 14: Potential upside till Mar12f under three scenarios for target EV/EBITDA multiple for RCOM and IDEA (INRbn) FY13f EBITDA Target EV/EBITDA . the market may have factored in competition and concerns on 3G auctions. Scenario B: Highest 1-year forward EV/EBITDA multiple of the lowest quartile from Jan09 to May10 (sorted in descending order of the values). We have considered the 1-year forward EV/EBITDA multiples for the above periods on account of: Jan09-May10: After the quarter ended Dec09. possible investments in BWA and the probable implementation of the TRAI recommendations. The potential price in Mar12f (not the Avendus target price) is calculated on FY13f financials.

Bloomberg.077 785 745 222 855 563 523 2 363 239 222 139 160 71 59 IDEA 65 8.1 568 457 333 109 412 301 177 4 125 91 54 49 155 86 9 Source: Company. Avendus Research Exhibit 15: Potential upside by end Mar12f in three scenarios for 1-year forward EV/EBITDA multiple for BHARTI (INRbn) FY13f EBITDA Target EV/EBITDA multiple (x) Target EV Net Debt Target market cap No.7 7.4 1.7 7.8 7.multiple (x) Target EV Net Debt Target market cap Number of shares Target price (INR) CMP (INR) Potential upside (%) A B C A B C A B C (bn) A B C A B C RCOM 101 10. of shares .0 5.

401 1.Target price (INR) CMP (INR) Potential upside (%) A B C A B C A B C (bn) A B C A B C Non-Africa 212 9.354 African ops 76 5. For the African business. Avendus Research Note: A: Lower end of highest quartile. at a 10% premium to its peer MTN. 288 8. India Equity Research Telecom Sector Telecom 15 Annexure In Exhibit 15 we have summarized the impact of 3G.209 4 448 334 297 257 74 30 16 Source: Company.787 578 1.823 1.3 6.357 1. B: Higher end of the lowest quartile.4 1. For BHARTI.502 1.2 2. C: Minimum during Sep08-Mar09.968 1. we have analyzed the potential upside with the target 1-year forward EV/EBITDA multiple for the non-African business under the three above-mentioned scenarios.7 6.3 7. Bloomberg. RCOM and IDEA (INRbn) BHARTI * RCOM IDEA FY11f FY12f FY11f FY12f FY11f FY12f Existing forecasts . the target 1-year forward EV/EBITDA multiple is constant. BWA and TRAI s recommendations on the FY11f and FY12f financials (assuming 50% of capital employed in the 3G business to be funded through equity).7 433 433 433 Cons. Exhibit 16: Consolidated impact on the financials for BHARTI.1 6.935 1.

Increase in net debt 46 46 0 0 15 15 Change in EBITDA margins (bp) -168 -129 -18 -1 -44 29 Change in EBIT margins (bp) -283 -244 -20 -3 -148 -75 Change in PAT margins (bp) -354 -315 -21 -4 -217 -144 Consolidated Net Debt 191 63 327 282 142 102 Revenue 442 528 242 285 164 220 EBITDA 165 190 77 93 39 56 % change from current forecasts -4 4 1 15 1 25 EBIT 89 100 28 36 9 19 % change from current forecasts -21 -17 -21 -8 -43 -4 PAT 58 72 19 29 -4 7 % change from current forecasts -37 -28 -42 -18 -147 -34 Number of shares (bn) 4 4 2 2 3 4 EPS (INR) 15 18 9 12 -1 2 .Net Debt -64 -137 224 217 57 43 Revenue 438 491 238 250 161 188 EBITDA 171 183 76 81 39 45 EBIT 112 121 36 39 16 19 PAT 92 100 33 35 8 10 Number of shares (bn) 4 4 2 2 3 3 EPS (INR) 24 26 16 17 3 3 Impact of 3G win 3G winning price 123 123 86 86 58 58 3G Capex 25 37 17 26 12 17 Revenue 4 38 4 35 3 31 EBITDA 1 13 1 12 1 11 PAT -19 -12 -13 -6 -9 -1 Potential Impact of BWA Increase in net debt 61 61 43 43 29 29 Change in EBIT margins (bp) -70 -70 -90 -90 -90 -90 Change in PAT margins (bp) -164 -164 -221 -221 -219 -219 Impact of TRAI's reco.

is or will be. This document is provided for assistance only and is not intended to be. directly or indirectly related to specific recommendations or views expressed in this document. Avendus Research Note:* BHARTI s financials exclude African operations India Equity Research Telecom Sector Telecom 16 Analyst Certification I. DoT. research analyst and author of this report. for investment in the securities referred to in this document and should consult his own advisors to determine the merits and risks of such investment. Disclaimer This document has been prepared by Avendus Securities Private Limited (Avendus). AbhayMoghe. Though dissemination to all intended recipients is simultaneous. PGDBM. including the merits and risks involved. Each recipient of this document should make such investigation as he deems necessary to arrive at an independent evaluation. the sole basis for an investment decision. This . We further certify that no part of our compensation was. This document is neither an offer nor solicitation for an offer to buy and/or sell any securities mentioned herein and/or official confirmation of any transaction. This document is meant for the use of the intended recipient only. Company. The user assumes the entire risk of any use made of this information. hereby certify that all of the views expressed in this document accurately reflect our personal views about the subject company/companies and its or their securities. The investment discussed or views expressed may not be suitable for all investors.% change from the current forecasts -37 -33 -42 -28 -147 -45 Source: TRAI. and must not be taken as. not all intended recipients may receive this document at the same time.

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