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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

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

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

two large cash outflows for Indian telecom providers are expenses for the 3G business and the additional levies proposed by TRAI. While. provide some relative advantage to newcomers. gearing would rise by up to 1.9%. leading to a potential upside of between 74% and 160% by end FY12f. profitability is likely to recover in the following years. It also presents an opportunity for a significant medium-term upside. FY11f is likely to mark the bottom and net profits may report a three-year CAGR of 66%. The TRAI proposals could pull down FY11f EBITDA margins by up to 1. However.1x. Outflow would decrease. thus. The proposals tend to delay the end of the tariff war and. The market capitalization of providers may reflect a worst-case assessment of the impact of these proposals. 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. Buy). This could catalyze a recovery in valuations. Hold) and INR15bn for Idea Cellular (IDEA IN. Low impact on EBITDA margin over the medium term . if a part of the capital expenditure were funded by new equity.7% and net profit margin by up to 5.India Equity Research Telecom Sector Telecom 3 Investment summary Over the medium term. They would need to pay more for 3G licenses and related capital expenditure. the operating cashflow of operators is robust enough to absorb the impact of these blows. We find that the internal cashflow being generated by large telecom providers is big enough to manage the burden of both. the outflow would be INR46bn for BhartiAirtel (BHARTI IN.

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. The norms for mergers too may be made more conservative by mandating a lower ceiling for market share and a larger number of providers. leading to a three-year CAGR of up to 66%. Tariff war may extend. The proposals for sharing of spectrum may provide some advantage to newcomers.7%. Should . The rise in interest expense would pull down FY11f net profit margin by up to 5. Some of the proposals may not be implementable due to physical constraints. In FY14f. This suggests that the worst-case assessment of the impact of TRAI proposals has been priced in.A rise in spectrum fees and fall in license fee would depress the EBITDA margin for FY11f by up to 1. if the TRAI proposals were to be amended. positively. EBITDA margins may recover due to a decrease in license fees. The forecasts may need to reassessed. Net profits for FY11f are likely to bear the brunt of the impact of these proposals. consolidation may be delayed The proposals may extend the tariff war by continuing to link spectrum to subscribers. We foresee a rebound in net profits starting FY12f.6% for BHARTI and 1. as well as of the higher gearing resulting from funding 3G. the net impact of the change in spectrum and license fees on EBITDA margins is likely to be -0. potential upside as earnings recover after Mar11f The erosion in market value exceeds the present value of the potential erosion in net profits.1% for IDEA.9%. Worst priced in. Starting FY12f.

288 8.African ops 76 5.Non-Africa 212 9. Target price (INR) Potential upside (%) FY13f EBITDA ABCABC Net Debt ABC Shares (bn) ABC CMP (INR) ABC RCOM 101 10.valuations revert to a normal range.8 7.935 1.1 6.4 1.077 785 745 222 855 563 523 2 363 239 222 139 160 71 59 IDEA 65 8.7 6. 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. (INRbn) cap.3 7.3 6. the stock prices could rebound by up to 160% by end Mar12f.209 4 448 334 297 257 74 30 16 Source: Company.7 433 433 433 . Bloomberg.0 5.968 1.7 7.354 .Cons.Mar09 India Equity Research Telecom Sector Telecom 4 Cashflow is robust enough to absorb burden of 2G cess and 3G . Avendus Research Note: A: Lower end of highest quartile (Jan09-May10).7 7. C: Minimum during Sep08 . B: Higher end of the lowest quartile.2 2.401 1.823 1.502 1.4 1.357 1.787 578 1.1 568 457 333 109 412 301 177 4 125 91 54 49 155 86 9 BHARTI .

providers would need to make a one-time payment.1x. respectively.800MHz band is measured at 1x the 3G winning price per MHz in the respective service area. If total spectrum is above 10MHz in Metros or above 8MHz in other service areas.2MHz in the 900MHz band is measured at 1. However. The one-time payment for excess 2G spectrum is between 4 months (BHARTI) and 5 months (IDEA) of FY11f cashflow. We estimate cash outflow of INR46bn and INR15bn for BHARTI and IDEA.Should the recent TRAI proposals on additional levy for 2G spectrum be implemented. 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 6.8MHz.5x the 3G winning price per MHz in the respective service area.1MHz and Reliance Communications (RCOM IN. gearing would rise by up to 1.2MHz allocated to an operator in a service area. This would lead to dilution ranging between 7% and 20% of the equity capital at end Mar12f. Consequently. We believe the providers may consider funding a part of the outflow through infusion of new equity.5MHz.2MHz in the 1. Incumbents may need to pay for excess 2G spectrum Excess spectrum is defined as the total 2G GSM spectrum above 6. BHARTI has excess spectrum of 41. This would be in addition to the payments for 3G spectrum and capital expenditure required to roll out 3G services. the operating cashflow of operators is robust enough to absorb the impact of these blows. IDEA has 17. Payment for 3G is estimated to be between 82% (BHARTI) and 129% (IDEA) of FY12f cashflow. Hold) has 1. . the current price of excess spectrum is raised by 30%.

while it would be marginal for RCOM. If the service provider chooses to return excess spectrum. Service providers may also choose to return 2G spectrum in service areas with a 3G spectrum win. The one-time spectrum fee for excess spectrum has to be paid again at the time of renewal of license. However. Our analysis indicates that the immediate cash outgo for BHARTI would be INR46bn and INR15bn for IDEA. GSM incumbents would have to incur incremental cash outgo at the time of renewal of license. without any modification. it may entail a significant cash outgo for GSM incumbents. 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. If the regulator accepts the recommendations. 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) . with a minimum of 7 years.The current price for excess 2G spectrum will be pro-rated for the remaining license period.

.1.Excess spectrum equivalent (MHz) Cash outgo (INRmn) Excess spectrum equivalent (MHz) Cash outgo (INRmn) Delhi 6.Andhra Pradesh 2.Madhya Pradesh 517 1..746 6.088 1...8 686 ..730 Karnataka 3.516 2...046 .8 326 West Bengal 247 ...Assam 83 ......2..028 .5.1.160 6.456 Source: TRAI.634 4..4 541 Haryana 445 ....8 648 Uttar Pradesh (East) 729 1..614 . Department of Telecommunications (DoT).501 46.North East 85 ...0 11. Avendus Research .0 5.1.194 256 15.152 ..7 10.913 .6 584 .494 3.782 Mumbai 6.8 394 Punjab 644 2.8 527 .708 .1..Tamil Nadu 2.1.0 500 .8 256 . Company.036 Gujarat 2.7 5..Bihar 407 3...930 3...Kolkata 1.999 .9 3.Uttar Pradesh (West) 1.8 239 ....Rajasthan 642 2....Maharashtra 2...748 .Jammu & Kashmir 61 ..089 1..4 541 ..0 6.....8 1.6 3...9 1.Total 33..Orissa 194 1......Kerala 625 ..Himachal Pradesh 74 .8 6.

High gearing may compel some service providers to partly fund the capital employed in the 3G business through equity. respectively.7x for RCOM. 22% for IDEA and 14% for RCOM.1x for IDEA and 0. IDEA in 11 and RCOM in 13. INR29bn for IDEA and INR43bn for RCOM. INR58bn and INR86bn.3G win to increase the cash outgo further BHARTI won 3G spectrum in 13 circles. This may lead to an increase in the net debt/equity at end Mar11f to 0. This would entail a cash outgo of INR123bn. Initially. 1. Equity dilution may result in a decrease in the net debt/equity in FY12f. The winning price is to be paid within 15 days of the end of the 3G auctions. 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. INR73bn for IDEA and INR87bn for RCOM.2x for BHARTI (excluding African operations). it may result in equity dilution of 7% for BHARTI. cash outgo for 2G and 3G spectrum Equity (before dilution) Net debt/ . Exhibit 3: Impact of one-time cash outgo on net debt and gearing Net debt excl. To comply with the roll-out obligations associated with the 3G spectrum win. this cash outgo is likely to be funded through debt and internal accruals. If up to 50% is funded through equity till FY12. This may lead to cash outgo of INR61bn for BHARTI. 3G winners also have to incur additional capex over the next 22 months.

RCOM and IDEA (INRbn) .1 0.Equity (x) 2G spectrum related one time 3G spectrum win related cash outgo Net debt incl.5 0.5 0. 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. Additionally.7 0.5 0 86 310 303 414 451 0.1 -0. continued strong operating cash flow may sustain the impact.1 RCOM 224 217 421 456 0.2 46 123 105 32 492 594 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 FY10.2 0.9 Source: Company. 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. despite intense competition. Exhibit 4: Operating cashflow and net debt for BHARTI.3 15 58 130 116 116 133 1. While the one-time cash outgo may increase the net debt.7 IDEA 57 43 122 132 0.

3G operations Net debt excl. The additional burden imposed by the rise in interest expense would pull down FY11f net profit margin by up to 592-bp.4% (IDEA).1% for IDEA.6 RCOM 32 35 224 217 86 310 303 0.1 IDEA 43 45 57 43 73 130 116 0. However the impact on EBITDA margins would subside after FY11f due to a decrease in license fees each year till FY14f. TRAI.6% for BHARTI and 1. the summary impact of the change in spectrum and license fees on EBITDA margins is likely to be -0. In FY14f. excl.4 4. cash outgo related to 2G and 3G spectrum Total cash outgo Net debt incl.3 0.Operating cash flow. Company. 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. . 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 1.4 Source: DoT.7% (BHARTI) and 0.1 0.

RCOM may gain from the change in spectrum fees due to lower charges on CDMA spectrum.504 EBITDA 160.479 79. The company s EBITDA margins are likely to be positively impacted by c18-bp. telecom service providers pay recurring license fees as a percentage of the AGR for the wireless business.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. The spectrum usage charge is 0.e.870 EBITDA margin (%) 40 27 35 Incremental Spectrum Charges 5.5% of the adjusted gross revenue (AGR) per MHz up to the contracted spectrum. and 1% of the AGR per MHz for spectrum in excess of that amount.979 222. i.266 33.580 78. 6. TRAI. Our analysis indicates that EBITDA margins of BHARTI and IDEA may be negatively impacted by 139-bp and 89-bp. Exhibit 5: Impact of change in spectrum fees on EBITDA margins (financials as of FY10) (INRmn) BHARTI IDEA RCOM Revenues 396.100 -406 Revised EBITDA 154. A change in spectrum charges may have a negative impact on EBITDA margins for BHARTI and IDEA.742 32.525 1. respectively.Change in policy may increase recurring spectrum fees TRAI has recommended a change in the recurring fees for 2G GSM and CDMA spectrum. 8% in Circle B and 6% in . However.150 123.2MHz (GSM)/5MHz (CDMA). Avendus Research Lower license fees may partly offset this impact Currently. The current license fee is set at 10% in Metros and Circle A.

the improvement may be partially offset by the potential imposition of license fees on the Internet Service Provider (ISP) and Infrastructure Provider (IP) segments. This is likely to partially offset the negative impact of the increase in spectrum fees. 48-bp for IDEA and 29-bp for RCOM. EBITDA margins may improve. India Equity Research Telecom Sector Telecom 8 Higher interest costs and amortization are likely to impact net profit margins by 492-bp for BHARTI. 429-bp for RCOM and 592-bp for IDEA. This may lead to higher amortization. This is likely to reduce the recurring license fees. EBITDA margin improvement is likely to be 48-bp for BHARTI. further lowering the profitability. 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. After four years. This may increase interest costs and lower profitability. these two segments do not pay any license fees. Hence.Circle C. However. . 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. Currently. Also. TRAI has recommended a gradual change to the uniform license fee of 6% over the next four years. one-time spectrum-related costs are likely to lead to higher intangible assets.

502 Revised FY11f PAT 70.4MHz and 51% promoter's equity lock-in for 5 years. The proposals for sharing of spectrum may provide some advantage to newcomers.574 10.4MHz. GSM Incumbent New entrant 2G spectrum Cap on spectrum at 14.Exhibit 7: Impact of higher net debt and intangible assets on net profits (INRmn) BHARTI RCOM IDEA FY11f PAT 91. Company.4MHz and 51% promoter's equity lock-in for 5 years.688 32. among other such measures.877 8. Source: TRAI.217 9.115 22. 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.179 Impact on PAT margins -492-bp -429-bp -592-bp Source: TRAI. The norms for mergers too may be made more conservative by mandating a lower ceiling for market share and a larger number of providers.323 Incremental interest and amortization (after tax) 21. New entrant GSM Incumbent Scale and 2G spectrum Cap on spectrum at 14.661 -1. Avendus Research Forces that could hasten consolidation may be weakened . 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. 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. Avendus Research India Equity Research Telecom Sector Telecom 9 Tariff war may extend. 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.

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

the revenue share of GSM incumbents such as . Avendus Research India Equity Research Telecom Sector Telecom 10 In the future. 2G spectrum is likely to be allocated on the basis of completion of 2G roll-out obligations. But incumbents have been resilient to competition till now Competition has increased since launch of operations by new entrants in 2009. The intensifying competition led to a sharp drop in tariffs. Hence. This may compel new entrants to gain more subscribers in the next six months and apply for further allocation of 2G spectrum. the tariff war may not bottom out for six more months. the TRAI has recommended continuing the current subscriber-linked criteria for another six months. This is likely to intensify competition further as new entrants drop tariffs while vying for more subscribers and minutes. However. However.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.

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

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

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

6 Present value of the difference -92 -30 -18 Change in Mcap since 10 May10 -142 -32 -46 Source: Company.7 0.8 0. 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.) 92 100 109 114 33 35 39 41 8 10 14 22 PAT (incl.8 0.8 0.7 0.6 0. 3G. 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. RCOM and IDEA. BWA and TRAI reco. TRAI. unfavorable and stricter spectrum allocation criteria and 51% promoter s equity lock-in for five years are key negatives for new entrants. 3G. DoT.6 0.) 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. BWA and TRAI reco.proposals has been priced for BHARTI. Conservative M&A guidelines are negative for the overall sector.9 0.7 0. While key negatives for GSM incumbents are one-time fee for excess spectrum and refarming of spectrum in the 900MHz band.9 0.

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

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

TRAI.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.allocated Spectrum yet to be allocated in 1. EBITDA growth may lead to significant potential upside . Avendus Research Re rating.

Also.We have analyzed the potential upside in BHARTI. the market may have factored in competition and concerns on 3G auctions. 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. Sep08-Mar09: During this period. Scenario C: Minimum 1-year forward EV/EBITDA multiple during Sep08-Mar09. 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). telecom stocks were impacted due to the global economic crisis. 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 . Scenario B: Highest 1-year forward EV/EBITDA multiple of the lowest quartile from Jan09 to May10 (sorted in descending order of the values). The potential upside is calculated including the impact of investments in the 3G business. the super-normal growth rates for earnings ended. We have considered the 1-year forward EV/EBITDA multiples for the above periods on account of: Jan09-May10: After the quarter ended Dec09.

4 1.8 7.7 7. Bloomberg.0 5. 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.077 785 745 222 855 563 523 2 363 239 222 139 160 71 59 IDEA 65 8.7 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 .1 568 457 333 109 412 301 177 4 125 91 54 49 155 86 9 Source: Company.

Avendus Research Note: A: Lower end of highest quartile.354 African ops 76 5.209 4 448 334 297 257 74 30 16 Source: Company. Bloomberg. 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). For BHARTI. the target 1-year forward EV/EBITDA multiple is constant.935 1.7 433 433 433 Cons. at a 10% premium to its peer MTN. C: Minimum during Sep08-Mar09.4 1.3 6.1 6.3 7.401 1.502 1.823 1. B: Higher end of the lowest quartile. For the African business.968 1.7 6.357 1. RCOM and IDEA (INRbn) BHARTI * RCOM IDEA FY11f FY12f FY11f FY12f FY11f FY12f Existing forecasts . 288 8. Exhibit 16: Consolidated impact on the financials for BHARTI. 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.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 9.2 2. India Equity Research Telecom Sector Telecom 15 Annexure In Exhibit 15 we have summarized the impact of 3G.787 578 1.

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. 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 .

Each recipient of this document should make such investigation as he deems necessary to arrive at an independent evaluation. 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. not all intended recipients may receive this document at the same time. This document is meant for the use of the intended recipient only. Though dissemination to all intended recipients is simultaneous. Company. the sole basis for an investment decision.% change from the current forecasts -37 -33 -42 -28 -147 -45 Source: TRAI. 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. We further certify that no part of our compensation was. This document is provided for assistance only and is not intended to be. The user assumes the entire risk of any use made of this information. This . is or will be. PGDBM. Avendus Research Note:* BHARTI s financials exclude African operations India Equity Research Telecom Sector Telecom 16 Analyst Certification I. AbhayMoghe. research analyst and author of this report. Disclaimer This document has been prepared by Avendus Securities Private Limited (Avendus). 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. DoT. directly or indirectly related to specific recommendations or views expressed in this document. The investment discussed or views expressed may not be suitable for all investors. including the merits and risks involved. and must not be taken as.

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