Bharti Infratel: High valuations limit gains

Last Updated: Tue, Dec 11, 2012 04:22 hrs

Bharti Infratel, the tower infrastructure arm of Bharti Airtel, is banking on higher data usage, incremental rollout of 2G sites, especially in smaller cities, and enhancement of 3G/4G network to improve its tenancies and profitability. The company is a leading player in the telecom tower rental business with a share of nearly 40 per cent and generates good cash flows. It is planning to raise Rs 4,000-Rs 4,500 crore to enhance its network, upgrade and replace existing towers and invest in green technology to save on energy costs.

Of the shares on sale, 22.75 per cent is an offer for sale by existing shareholders. However, the initial public offering (IPO) valuations are high, leaving little room for upside in the near term. Hence, only long-term investors looking to play the growth in the tower rental business might consider the offer at the lower price band of Rs 210.

The company, which owns 34,000 towers and has a 42 per cent stake in Indus Towers, believes that its relationship with its parent (Bharti Airtel) and its partners in Indus (Vodafone and Idea Cellular), the long-term nature of the contracts with tenants and a strong balance sheet should ensure steady revenue generation. Unlike other players in the tower infrastructure sector in India, which have been struggling to make money and are highly leveraged, Bharti Infratel has been cash flow-positive with minimal debt.

In Rs crore FY11 FY12 H1'FY13 FY13E
Number of towers 78,442 79,064 80,656 81,088
Tenancy (x) 1.75 1.85 1.90 1.93
Net sales 8,508 9,452 4,972 9,777
Change y-o-y (% ) 20.90 11.10

Ebitda 3,128 3,539 1,844 3,677
Ebitda (%) 36.80 37.40 37.10 37.60
Net profit 551 751 460 852
Change y-o-y (%) 118.00 36.10

E: Estimates Source: Company, analyst reports

Says Bhavesh Gandhi of India Infoline Ltd (IIFL), "Despite being a capital intensive business, Bharti Infratel has enjoyed free cash flows to the tune of Rs 960 crore in H1FY13 and we expect the company to remain so over the next two years. Estimated leverage at 0.2 times in FY13 is likely to remain in comfortable territory."

Size (Rs crore)& 4,000-4,500
Price band (Rs)&& 210-240
Opens on 11-Dec
Closes on 14-Dec
Crisil IPO grading 4/5
& includes offer for sale
&& Retail investors will get a discount of Rs 10

While the company is on a strong wicket on this count, the valuations it is asking are high. On an expanded capital base, it is asking for a valuation of 10-12 times enterprise value (EV)/earnings before interest, taxes, depreciation and amortisation (Ebitda), and 45-50 times the price-earning ratio (P/E) for FY14 at a price band of Rs 210-240. This is at a discount to global majors who are trading at EV/Ebitda upwards of 14 times and P/E of 47 times. While foreign players have a more mature business model, they score high on most parameters, be it higher tenancies, Ebitda margins or return ratios. According to Ambit Capital analysts, led by Ankur Rudra, who have an avoid' on the IPO, the discount is warranted due to weaker economics compared with global peers, likelihood of pricing pressure, a suboptimal capital structure and medium term growth drivers.

One of the reasons for the discount is the higher Ebitda margin of US-based companies. Bharti Infratel's Ebitda margin is 37 per cent, while those of US-based tower companies are upwards of 64 per cent. While the relatively lower tenancy ratio is one reason, energy costs, which are just five per cent of US-based tower companies' operating costs, accounts for 50 per cent of the costs in India due to the need for power back-up (diesel generators). And, energy costs aren't going to come down anytime soon. Excluding energy costs, Ebitda margins are at 58 per cent.

Not surprisingly, most analysts believe that the management should have left more on the table, and recommend that only long-term investors subscribe to the issue and that too, at the lower end of the price band.

Going ahead, the key for Bharti Infratel is to increase its tenancy ratio and thus, rentals on its towers. This is because the tower business is capital-intensive, with operating costs (rentals, security and maintenance) fixed in nature.

Additional tenancies come with minimal incremental costs helping companies boost their profitability. Currently, Bharti Infratel has a tenancy ratio of 1.9 (up from 1.57 in FY10) and it gets average monthly rentals of Rs 35,000 per tower.

The company hopes it will be able to increase tenancy further to 2.5 on the back of data driven growth, incremental spends on 3G as well as expansion of current and new network of recent operators (especially in smaller cities and towns, which have not yet reached saturation levels). However, that may take some time.

While research firm Analysys Mason expects India's tower base to grow two per cent during FY12-FY17 (against an average 10 per cent annually during FY08-FY12), it pegs the tenancy ratio to move from 1.7 to 2.4 between FY12 and FY17, on the back of a jump in data traffic and capacity enhancement, and 3G/4G deployment. All these, though, are contingent on data-driven growth taking off, which may not happen in the short- to medium-term, given that smart phone penetration as well as share of data in overall revenues is just about five per cent.

With the introduction of 3G/4G, which is now at a nascent stage, there could be a jump in the number of users necessitating more towers. However, it could take time. Also, with the sector in consolidation mode, tower revenue lost from cancelled licences and poor financials of most telecom operators, 3G/4G expansion could be a slow affair. Further, given the overcapacity (376,000 towers with tenancy ratio of just 1.7) and competition, growth in both tenancies and pricing (rentals) are likely to be muted.

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