xlri student fund_ telecom sector outlook_july14

The XLRI Student Fund Telecom Sector

Equity Research Report # 1July 2014

Vishap [email protected]

[email protected]

The XLRI Student Fund 1

Sector outlook


Going rural Mobile (wireless) penetration increased significantly from 2001 to 2011, but it has moderated in the last 2-3 years

Given that there is still immense difference between the urban (140%) and rural (44%) penetration levels, there lies considerable headroom for expansion in the rural areas

We believe the incremental subscriber addition will be weighted towards rural areas, but limited affordability of all the telecom services in these regions implies slower pace of growth

Growth lies in data but with associated trade-offs Data revenues constitute only a small portion of the wireless revenues (10-12%) and the data penetration is also far lower than other

comparable economies, implying significant growth potential in data usage

We believe that though data usage will accelerate, the downward pressure on pricing of these data services will limit the telecom companies from realizing the benefits from increased data usage

Most of the Indian telecom companies hold 3G spectrum in the inferior 2100 MHz band, in addition to low quantity of spectrum (5MHz per circle), implying non-scalability of the data services

We believe that the telecom companies will need significant capital expenditures to install more base transceiver stations (BTS) to drive data penetration in high population density markets of India

We believe there will be a trade-off between voice and data revenues because as subscribers will start using higher proportion of data, they will tend to use data for voice and will decrease their voice usage, implying cannibalization of voice revenues

Though data usage is expected to proliferate, we believe the revenue and profit contributions from the increased data usage will be constrained because of the increased capital expenditure requirements to improve coverage, from the downward pressure on pricingof data services, and from the cannibalization of voice revenues by data services

Reliance Jios entry The competitive nature of Indian telecom industry has moderated post the cancellation of telecom licenses of various operators in Feb

2012, however the entry of Reliance Jio (services expected to be rolled out in 2015) is an imminent risk to competitive intensity

We believe that Reliance Jio entry is likely to be disruptive for incumbents because we think data standalone on 4G/LTE will not be a viable business in the near to medium term and thus Reliance Jio will foray into voice services through VoLTE

Valuations Given the structural headwinds ahead, we believe the markets have not corrected themselves and the three major telecom companies

(Bharti Airtel, Idea Cellular and Reliance Communications) are trading expensively than what they deserve

For the poor quality of business (as measured by ROTC) and low growth (as measured by growth in EBIT), the Indian telcos are overpriced (as measured by EV/EBIT), and we dont see any upside from their current valuations

22.9%

18.5%

15.1%

11.9%

10.1%

7.9%

6.9%

4.2%

2.5%

Bharti Airtel (22.9%)

Vodafone (18.5%)

Idea (15.1%)

Reliance (11.9%)

BSNL (10.1%)

Aircel(7.9%)

Tata (6.9%)

Telewings (4.2%)

Others (2.5%)

Telecom sector - Subscription data


Wireless market share (based on number of subscribers as of May 2014)

Top 5 wireless players (as of May 2014)

Telecom subscription data (as of May 2014)

Company Subscribers (mn) Market share

Bharti Airtel 208.2 22.9%

Vodafone 168.3 18.5%

Idea 137.7 15.1%

Reliance 108.3 11.9%

BSNL 91.6 10.1%

Total (top 5) 714.2 78.5%

Total (all players) 910.2

Particulars Wireless Wireline

Total subscribers (mn) 910.2 28.2

Urban subscribers (mn) 533.9 22.3

Rural subscribers (mn) 376.2 5.9

Overall teledensity 73.2% 2.3%

Urban teledensity 139.7% 5.8%

Rural teledensity 43.7% 0.7%

Broadband subscribers (mn) 50.4 15.0

Source: TRAI database

Company overview

Integrated telecom services provider with operations

in India, Sri Lanka, Bangladesh and 17 countries in

Africa

Has 22.9% subscriber share in India and 31% revenue

market share (mobile services)

Acquired Zains African assets in 15 countries and

100% of Telecom Seychelles in June 2010

Key operating divisions include:

Mobile: Offers GSM technology services

Telemedia: Includes broadband (DSL), data and

telephone services

Enterprise: Provides communications services to

large enterprise and carrier customers

Passive infrastructure: Provides telecom tower

infrastructure services through Bharti Infratel

Key performance indicators

Bharti Airtel CMPRs. 335.40

Target

Rs.320

Rating

Sell


Investment thesis

Though the sector has seen consolidation in the

recent past which may provide an opportunity for

Bharti to raise effective tariffs (ARPM), we believe

negative price elasticity may come in picture

(implying cut in MOU) soon which may slowdown the

revenue growth

We believe data services will cannibalize voice

revenues as smart-phone penetration improves and

data services gain meaningful size and scale

We believe accelerated data growth will require

Bharti to increase its capex and network opex,

impacting cash flows and margins

Reliance Jios entry is the key risk for the industry and

Bharti over the medium to long term

Key risks (upside)

No negative price elasticity resulting from no

significant moderation in MOU with increasing ARPM

No data-voice trade-off

Decrease in debt levels from the monetization of the

tower assets in Africa (Bharti has recently entered

into sale and lease back agreement with Helios

Towers for 3,100 towers in four African countries)

Supportive policy environment from the new

government

Reliance Jios entry restricted to data services over

medium to long term

Key operating metrics 4QFY13 1QFY14 2QFY14 3QFY14 4QFY14

EOP subscribers (mn) 188.2 190.9 193.5 198.5 205.5

qoq growth 3.5% 1.4% 1.3% 2.6% 3.5%

MOU (mins/sub/month) 455 455 437 434 437

RPM (Rs) 0.42 0.44 0.44 0.45 0.45

ARPU (Rs) 193 200 192 195 196

qoq growth 4.3% 3.6% (4.0%) 1.6% 0.5%

Wireless Revenue (Rs mn) 107,179 113,727 110,586 114,337 119,045

Monthly Churn (%) 3.2% 3.2% 3.2% 2.7% 2.4%

Voice RPM (Rs) 0.35 0.36 0.37 0.37 0.37

Data subscribers (mn) 43.5 46.6 50.6 54.4 58.1

qoq growth 4.8% 7.1% 8.7% 7.5% 6.7%

Data ARPU (Rs) 55 63 70 75 79

Data revenues as % of wireless revenues 6.5% 7.4% 9.2% 10.3% 11.1%

Non-data VAS revenues as % of wireless revenues 10.8% 9.9% 7.3% 7.0% 6.4%

Trading multiples

Date 11-Jul-14

Market Cap. (INR) 1,341 bn

Enterprise value (EV, INR) 2,030 bn

52 wk Low/High (INR) 279/374

P/E (LTM) 48.7x

EV/EBIT (LTM) 16.7x

Promotors 65.3%

Institutions 24.2%

Others 10.5%

Stock performance (%) Airtel Nifty

1 month (5.3%) (2.2%)

3 months 4.2% 10.1%

12 months 11.8% 25.7%

Shareholding pattern (31-Mar-14)

Source: Company filings

Bharti Airtel-Financial Summary CMPRs. 335.40

Target

Rs.xxx

Rating

Sell

Income Statement

Ratio Analysis

Balance sheet


% unless specified 2010A 2011A 2012A 2013A 2014A

EBITDA margin 40.4% 34.0% 33.4% 31.1% 32.4%

Operating margin 25.0% 16.6% 14.5% 11.7% 14.1%

Net profit margin 21.5% 10.2% 6.0% 2.8% 3.2%

Sales growth 12.0% 42.3% 20.0% 12.4% 6.8%

Sales per share growth 12.1% 42.2% 20.0% 12.4% 2.5%

Net profit growth 14.2% (32.6%) (29.6%) (46.6%) 20.9%

EPS growth 14.3% (32.7%) (29.6%) (46.6%) 16.1%

Interest coverage (x) 13.7x 4.9x 3.4x 2.3x 2.5x

Net debt to equity 5.4% 116.4% 122.1% 118.5% 101.1%

Sales/assets 58.9% 40.6% 45.5% 48.0% 46.8%

Assets/equity 159.0% 283.8% 294.2% 307.5% 286.4%

ROE 20.1% 11.7% 8.0% 4.2% 4.3%

ROCE (pretax) 19.8% 9.4% 10.1% 8.1% 10.2%

ROA 12.6% 4.1% 2.7% 1.4% 1.5%

Rs in millions, FYE March 2010A 2011A 2012A 2013A 2014A

Revenues 418,472 595,383 714,508 803,112 857,461

% growth 12.0% 42.3% 20.0% 12.4% 6.8%

EBITDA 169,127 202,571 238,314 249,497 277,778

% growth 9.4% 17.2% 17.2% 17.2% 17.2%

EBIT 104,801 98,944 103,850 94,130 121,274

% growth 0.9% (5.6%) 5.0% (9.4%) 28.8%

Interest expense (7,626) (20,378) (30,608) (41,098) (48,380)

PAT 89,768 60,467 42,594 22,757 27,520

% growth 14.2% (32.6%) (29.6%) (46.6%) 20.9%

Diluted WASO (mm) 3,794 3,795 3,796 3,796 3,955

Diluted EPS (Rs) 23.66 15.93 11.22 5.99 6.96

% growth 14.3% (32.7%) (29.6%) (46.6%) 16.1%


Assets

Cash and cash equivalents 77,587 15,799 38,432 84,746 112,073

Accounts receivable 35,711 54,929 63,735 66,430 62,441

Inventories 484 2,139 1,308 1,109 1,422

Other current assets 23,903 39,210 44,609 50,619 47,921

Total current assets 137,685 112,077 148,084 202,904 223,857

LT Investments & LT Receivables na na na na 36,341

Net fixed assets 482,629 651,426 674,932 688,430 596,429

Total assets 710,940 1,465,064 1,570,616 1,673,232 1,831,772

Liabilities

Short term debt 20,424 84,370 193,078 114,123 209,039

Short term payables 102,303 239,684 232,650 273,134 283,981

Other short term liabilities 25,715 45,791 63,145 63,164 75,030

Total current liabilities 148,442 369,845 488,873 450,421 568,050

Long term debt 81,474 532,338 497,154 615,485 549,919

Other LT liabilities 33,799 46,650 50,781 63,223 74,141

Total liabilities 263,715 948,833 1,036,808 1,129,129 1,192,110

Shareholders' equity 447,225 516,231 533,808 544,103 639,662

Diluted BVPS 117.88 136.03 140.62 143.34 161.72


Rs.320

Company overview

Pan-India integrated global system for mobile

communication (GSM) operations and has its own

national long distance (NLD) and international long

distance (ILD) operations

Has 15.1% subscriber share in India and 15% revenue

share (mobile services)

Operates through three segments: Mobility Services,

ILD and Passive Infrastructure (through Indus Towers)

Also offers a range of high-speed mobile broadband

devices including 3G smartphones, dongles etc and

high-end data services such as Idea TV etc.

Has a network of over 100,000 2G and 3G cell sites,

spread across over 55,000 towns in India

Ranks among the top 10 country operators in the

world with a traffic of over 1.5 billion minutes per day

Trading multiples


Idea Cellular CMPRs. 134.20

Target

Rs.145

Rating

Hold


Investment thesis We believe Idea is still the best defensive play among

Indian telcos, given its market share gain prowess and solid execution

Operational strength of Idea is evident from consistent market share gains, however sector specific concerns are likely to outweigh superior relative performance of Idea

We believe ARPM vs. MOU trade-off is likely to come in picture (from negative price elasticity) in the medium term implying moderate growth

Ideas spectrum holding in seven circles which accounts for 62% of revenues, is due for renewal in late FY15, implying hefty capital expenditures and thus shrinking margins

Idea must retain this spectrum to continue operating on the 900 MHz band or else has to invest in shifting to 1800 MHz

Increase in capex for data services expansion also implies pressure on profit marginsKey risks (upside)

No negative price elasticity resulting from no

significant moderation in MOU with increasing ARPM


Supportive policy environment from the new

government

Reliance Jios entry restricted to data services over

medium to long term

Key operating metrics 4QFY13 1QFY14 2QFY14 3QFY14 4QFY14EOP subscribers (mn) 121.6 125.0 127.2 128.7 135.8qoq growth 6.8% 2.8% 1.8% 1.2% 5.5%MOU (mins/sub/month) 406 398 368 376 397RPM (Rs) 0.41 0.44 0.45 0.45 0.44ARPU (Rs) 167 174 164 169 173qoq growth 5.7% 4.2% (5.7%) 3.0% 2.4%Wireless Revenue (Rs mn) 59,067 64,377 62,056 64,912 68,476Monthly Churn (%) 4.3% 5.1% 5.3% 5.6% 4.2%Voice RPM (Rs) 0.35 0.37 0.38 0.38 0.36Data subscribers (mn) 26.2 30.9 33.6 25.5 25.3qoq growth 20.5% 17.9% 8.8% (24.1%) (1.0%)Data ARPU (Rs) 55 54 55 91 104Data revenues as % of wireless revenues 6.6% 7.2% 8.7% 9.5% 10.1%Non-data VAS revenues as % of wireless revenues 8.6% 8.8% 7.4% 6.6% 6.4%

Date 11-Jul-14

Market Cap. (INR) 476 bn

Enterprise value (EV, INR) 679 bn


P/E (LTM) 24.2x

EV/EBIT (LTM) 18.7x

Promotors 42.9%

Institutions 26.2%

Others 30.9%

Stock performance (%) Idea Nifty

1 month (6.5%) (2.2%)

3 months (6.2%) 10.1%

12 months (4.6%) 25.7%


Idea-Financial Summary CMPRs. 134.20

Target

Rs.xxx

Rating

HoldRs.145

Income Statement

Ratio Analysis

Balance sheet



Revenues 123,979 154,384 194,887 224,074 264,320

% growth 22.4% 24.5% 26.2% 15.0% 18.0%

EBITDA 33,714 37,584 50,484 59,597 81,430

% growth 19.2% 17.2% 17.2% 17.2% 17.2%

EBIT 13,565 13,610 20,671 24,819 36,236

% growth (4.8%) 0.3% 51.9% 20.1% 46.0%


PAT 9,539 8,987 7,230 10,109 19,678

% growth 8.2% (5.8%) (19.6%) 39.8% 94.7%

Diluted WASO (mm) 3,116 3,309 3,316 3,319 3,325

Diluted EPS (Rs) 3.06 2.72 2.18 3.05 5.92

% growth 1.8% (11.3%) (19.7%) 39.7% 94.3%


EBITDA margin 27.2% 24.3% 25.9% 26.6% 30.8%



Sales growth 22.4% 24.5% 26.2% 15.0% 18.0%

Sales per share growth 15.1% 17.2% 26.0% 14.9% 17.7%

Net profit growth 8.2% (5.8%) (19.6%) 39.8% 94.7%

EPS growth 1.8% (11.3%) (19.7%) 39.7% 94.3%



Sales/assets 52.7% 51.1% 59.7% 61.6% 56.8%

Assets/equity 206.8% 245.6% 250.1% 254.3% 281.7%

ROE 8.4% 7.3% 5.5% 7.1% 11.9%

ROCE (pretax) 7.5% 6.4% 9.2% 9.5% 10.5%

ROA 4.1% 3.0% 2.2% 2.8% 4.2%


Assets



Inventories 536 659 926 726 683



LT Investments & LT Receivables 0 0 0 0 0

Net fixed assets 170,945 212,003 208,103 217,758 332,827

Total assets 235,138 302,117 326,352 363,781 465,575

Liabilities

Short term debt 11,734 30,757 38,150 22,391 25,065




Long term debt 67,412 89,948 95,222 118,047 181,284

Other LT liabilities 2,142 7,155 14,251 22,269 32,348

Total liabilities 121,415 179,117 195,850 220,728 300,305


Diluted BVPS 36.50 37.17 39.36 43.10 49.70


Company overview

Integrated telecommunications service provider with

a pan-India presence and is flagship company of

Reliance Group

Has 11.9% subscriber share in India (mobile services)

Offers a chain of wireless (CDMA and GSM including

3G services), wireline, national long distance,

international, voice, data, video, direct-to-home

(DTH) and Internet based communications services

The company also owns through its subsidiaries, a

global submarine cable network infrastructure and

offers managed services, managed ethernet and

application delivery services

Recently raised Rs 6,100 crore from India's largest

private sector share sale to institutions and a

preferential issue of warrants to promoters to cut

debt

Trading multiples


Reliance Communications CMPRs. 122.70

Target

Rs.110

Rating

Sell


Investment thesis On an operational front, RCom is continuously losing

market share (it lost 2 mn subscribers in May 2014) and its balance sheet continues to be stretched, even after the repayments

Net debt/EBITDA for RCom is at 6.0x, highest among the telcos , which remains an overhang on the company

We believe that it will be difficult to deleverage the balance sheet further in absence of the generation of organic cash flows

We believe that the declining market share and the companys inability to reduce leverage organically will limit RComs ability to invest for growth

The de-growth in the subscriber number and relatively slower growth in voice traffic comes in as a deterrent and the high debt levels will keep the downward pressure on its stock price

Key risks (upside)

We may see interim spikes on account of news flows

on de-leveraging

Monetization of the non-core assets (such as cable

assets business) can drive the stock upwards


Key operating metrics 4QFY13 1QFY14 2QFY14 3QFY14 4QFY14

EOP subscribers (mn) 124.2 127.0 117.5 118.5 112.1

qoq growth 3.7% 2.3% (7.5%) 0.9% (5.4%)

MOU (mins/sub/month) 290 282 277 288 296

RPM (Rs) 0.40 0.42 0.43 0.44 0.43

ARPU (Rs) 117 119 120 125 128

qoq growth 4.5% 1.7% 0.8% 4.2% 2.4%

Monthly Churn (%) 4.8% 4.6% 5.9% 3.4% 5.5%

Voice RPM (Rs) 0.31 0.32 0.33 0.34 0.33

Data subscribers (mn) 29.4 31.1 34.0 36.2 37.4

qoq growth 6.5% 5.8% 9.3% 6.5% 3.3%

Non voice as % of telecom revenue 23.4% 24.0% 23.1% 23.0% 23.5%

Date 11-Jul-14

Market Cap. (INR) 296 bn

Enterprise value (EV, INR) 660 bn


P/E (LTM) 28.2x

EV/EBIT (LTM) 31.3x

Promotors 58.3%

Institutions 18.1%

Others 23.6%

Stock performance (%) RCOM Nifty

1 month (17.2%) (2.2%)

3 months (7.6%) 10.1%

12 months (13.3%) 25.7%



RCOM-Financial Summary CMPRs. 122.70

Target

Rs.xxx

Rating

Sell

Income Statement

Ratio Analysis

Balance sheet



Revenues 206,851 220,890 187,160 192,940 209,400

% growth (0.3%) 6.8% (15.3%) 3.1% 8.5%

EBITDA 69,905 96,740 70,630 59,090 66,430

% growth (19.9%) 17.2% 17.2% 17.2% 17.2%

EBIT 32,440 31,700 30,850 20,640 21,080

% growth (36.6%) (2.3%) (2.7%) (33.1%) 2.1%


PAT 46,893 13,450 9,280 6,720 10,470

% growth (22.5%) (71.3%) (31.0%) (27.6%) 55.8%

Diluted WASO (mm) 2,153 2,153 2,104 2,064 2,065

Diluted EPS (Rs) 21.78 6.25 4.41 3.26 5.07

% growth (22.4%) (71.3%) (29.4%) (26.2%) 55.7%


EBITDA margin 33.8% 43.8% 37.7% 30.6% 31.7%



Sales growth (0.3%) 6.8% (15.3%) 3.1% 8.5%

Sales per share growth (0.2%) 6.8% (13.3%) 5.1% 8.5%

Net profit growth (22.5%) (71.3%) (31.0%) (27.6%) 55.8%

EPS growth (22.4%) (71.3%) (29.4%) (26.2%) 55.7%



Sales/assets 22.3% 23.3% 20.3% 21.4% 23.2%

Assets/equity 210.3% 229.2% 248.3% 260.8% 272.5%

ROE 10.7% 3.3% 2.5% 1.9% 3.2%

ROCE (pretax) 5.0% 5.2% 4.6% 3.3% 3.5%

ROA 5.1% 1.4% 1.0% 0.7% 1.2%


Assets



Inventories 5,446 5,170 5,660 4,970 4,150



LT Investments & LT Receivables 1,200 1,180 1,330 1,110 1,180

Net fixed assets 534,139 558,870 485,770 482,030 664,430

Total assets 925,686 947,230 922,650 901,820 903,520

Liabilities

Short term debt 91,683 197,580 86,570 128,690 89,090




Long term debt 205,471 193,130 296,460 286,780 279,130

Other LT liabilities 991 17,850 30,590 34,900 37,490

Total liabilities 485,496 534,000 551,090 556,070 572,000


Diluted BVPS 204.44 191.92 176.59 167.51 160.54

Rs.110


Jargon buster


ARPU: Average revenue per user per month, computed by dividing total telecom operations revenue for the relevant period by average customers and dividing the result by the number of months in the relevant period

Voice ARPU: Computed by dividing total voice revenue for the relevant period by average customers and dividing the result by the number of months in the relevant period

Churn: Computed by taking average monthly disconnections divided by opening monthly subscriber base in the relevant period; expressed as a percentage

MOU: Total minutes of usage; calculated as sum of all incoming and outgoing minutes used on the access network by all customers in aggregate

ARPM: Average revenue per minute; calculated as ARPU divided by the average voice usage customer per month

VAS: Value added services, include SMS, MMS, caller tunes, voicemail services etc

LTE: Long-Term Evolution, commonly marketed as 4G LTE

VoLTE: Voice over LTE

EBITDA: Earnings Before Interest ,Tax, Depreciation and Amortization

EBIT: Earnings Before Interest and Tax (operating profit)

ROTC (pretax): Return on tangible capital, calculated as EBIT/tangible capital

Tangible capital: Net fixed assets + net working capital

EPS: Earnings Per Share

WASO: Weighed average shares outstanding

PAT: Profit After Tax

P/E: Market Price / EPS of Trailing Twelve Months

BVPS: Book value per share

Disclosures


Rating key

1 year return greater than 10% Buy

1 year return between (5%) and 10% Hold

1 year return less than (5%) Sell

General disclaimer

This report has been prepared by The XLRI Student Fund and is meant for sole use by the recipient and not for circulation

The document at best represents the opinion of The XLRI Student Fund

The information and opinions contained herein have been compiled or arrived at, based upon information obtained in good faith from sources believed to be reliable

Such information has not been independently verified and no guaranty, representation of warranty, express or implied, is made as to its accuracy, completeness or correctness

All such information and opinions are subject to change without notice

This document is for information purposes only

Descriptions of any company or companies or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as an offer or solicitation of an offer, to buy or sell any securities or other financial instruments

xlri student fund_ telecom sector outlook_july14

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