UPDATE REPORT Q1 FY2012 BHARTI AIRTEL LIMITED. Research Analyst

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1 UPDATE REPORT Q1 FY2012 Key Highlights: BHARTI AIRTEL LIMITED Target Price: ` Revenues in line with estimates Profits below estimates EBIDTA estimates raised Cut EPS estimates citing high interest and depreciation charges CMP: ` Previous Rating: HOLD Current Rating: BUY (On the basis of annualized returns) 2011 Entered into Rwanda Step expanded presence into 17 countries in Africa and 20 regions worldwide Research Analyst Nitin Prakash Daga AVP Research 1

2 HOLD Market Data Current Market Price (`) Target Price (`) Upside (%) 8.1% 52 Week High / Low (`) / Market Capitalization (In ` Mn) 1,465, Bharti Airtel Rise in tariffs boosts optimism Bharti Airtel Limited Sector Telecommunication Services Bharti Airtel Limited (Bharti) announced its Q1 FY2012 results on 03 August The company s revenues came in line with our as well as Bloomberg consensus estimates. However, the bottom line came below expectations for the quarter. A highlight of the results vis-à-vis our and Bloomberg estimates, is reflected in the tables below: Shareholding FIIs 17.59% DIIs 8.48% Non Institution s 5.64% Actual Q1 FY2012 Results versus Estimates (All data in ` Mn unless specified) Particulars Actuals Estimates Variation from Microsec Bloomberg Microsec Bloomberg Revenues 169, , , % 0.6% EBIDTA 56, , , % -0.2% Net Profit 12, , , % -18.2% EPS % -19.9% Source: Company,, Bloomberg Promoter and Promoter Group 68.29% BSE Code NSE Code BHARTIARTL Bloomberg Ticker BHARTI IB Reuters Ticker BRTI.BO Face Value (`) 5.00 Diluted EPS FY11 (`) 15.9 Current P/E (based on FY2011 EPS) 24.2x Average P/E 16.5x Beta vs Sensex 0.86 PEG Ratio 0.73 Dividend Yield 0.26% Average Daily Volumes 546,690 Return (%) STOCK SCAN 13-Sep Jan May Sep-11 Bharti Sensex Bharti reported higher than expected revenues from the passive infrastructure services during the quarter. Consequently, the company s top line slightly differed from our estimates. The segment clocked revenues of `22,767 Mn while we estimated the same at `21,588 Mn for Q1 FY2012. Bharti reported better than expected sharing revenues per operator for both Indus Towers and Bharti Infratel, which pushed Passive Infrastructure Services sales above anticipated levels. Despite Bharti s top line coming in line with our estimates its bottom line stayed below projections. The prime reasons for the same were more than expected Depreciation and Interest Expenses. In addition, the company s effective tax rate increased 260 bps y-o-y to 29.9% during the quarter. Depreciation came above expectations due to amortization costs related to 3G spectrum. Result Analysis Bharti reported a 4.4% sequential increase in revenues to `169,749 Mn whereas its bottom line reduced 13.2% q-o-q to `12,152 Mn in Q1 FY2012. On y-o-y basis the numbers are not strictly comparable as the year earlier quarter included just 23 days African operations. However, the performance in Africa continues to toll high on the company s profitability with shaving off 442 basis points (bps) of its Earnings before Interest Depreciation Tax and Amortization (EBIDTA) Margins. Bharti s EBIDTA Margins stood at 33.6% in Q1 FY2012 compared with 38.0% in Q1 FY2011. The company s performance stayed red in the African region leading to a 40.6% y-o-y decline in the quarterly earnings. An overview of Bharti s q-o-q and y-o-y performance and variance of the same from our estimates is reflected in the following exhibit: 2

3 Q1 FY2011 results Quarterly Performance (In ` Mn) Particulars Q1 FY12A Q1 FY12E Q4 FY11A Q1 FY11A Growth Variance from Q-o-Q Y-o-Y Estimates (%) Revenues 169, , , , % 57.9% 1.0% EBIDTA 56, , , , % 39.6% -2.7% Net Profit 12, , , , % -40.6% -29.1% EPS % -40.6% -29.1% Source: Company, Recent Industry / Company Developments Post Q1 FY2012, the industry witnessed a series of events, some of which came positive for the industry including Bharti and its peers declared price hikes. The price hikes implemented by operators, apart from seasonality, remained key reason for the slowdown in subscriber additions during the month of July. We believe that the industry may not witness subscriber additions of more than 12 Mn here on. However, tariff hikes are likely to improve Bharti s profitability, going forward. This factor, together with other industry and company developments, is described as follows: As expected, Bharti raised tariffs during Q1 FY2012 As mentioned in our update report on the company dated 22 July 2011, Bharti raised tariffs by 20% in selected circles. The company increased tariffs on two of its prepaid plans Advantage and Freedom. Under the Advantage plan, the consumers now have to pay 60 paise per minute on on-net calls compared with 50 paise earlier. Under the Freedom plan the rates are revised to 1.2 paisa per second from 1 paisa per second for calls on own network. This move came in line with its peer Tata DOCOMO, who raised local SMS tariffs from `0.60 to `1.00 per SMS on 01 July It also upped national SMS rates to `1.50 per share from `1.20 per SMS on the same date. Furthermore, it intends to double national long distance call rates to two paisa per second from second year of subscription. Bharti s move to raise tariffs was also followed by other incumbents including Vodafone, RCOM, and Idea. The step to raise tariffs clearly reflects the shift of industry s focus from just subscriber numbers to quality subscribers. We believe that the hike in tariffs will continue to pressurize the growth in net subscriber addition numbers, like it did in the month of July. The industry added just 6.67 Mn new users during the month. The move, in our view, is also expected to reduce the dual sim phenomenon and likely to result in higher VLR based users in the industry. Furthermore, this may strengthen back the relationship between subscribers and minutes of use parameters. The move will help Bharti report improvement in EBIDTA Margins in the upcoming quarters, in our view. However, adjusting the below expected performance in Q1 FY2012, our revised EBIDTA estimate may not reflect a significant difference from our earlier estimates. Launch of new Tablet adds value Beetel Teletech, Bharti s handset making and distribution arm recently launched the lowest price tablet in the market. The tablet, Beetel Magiq, is priced at `9,999. The company launched the tablet exclusive of sim. As a result, the customers will be able to make calls on the same from any sim card, irrespective of service provider. The tablet s lower price compared with other products available in the market and features similar 3

4 with the same are likely to generate healthy demand for the product. The sim exclusivity is also expected to add on to demand. Moreover, Bharti is considering the launch oftablet to promote its data plans and 3G services. The company is packing the tablet with 2GB free data per month for two months. We believe that Beetel, bundled with data plans, may help Bharti demonstrate its 3G offerings to existing as well as new customers. Consequently, it is expected to help the company capture prospective customers in the 3G space. African Safari on the right path Bharti s total subscriber base in 16 African countries increased to more than 46.3 Mn users in Q1 FY2012. The company added 2.1 Mn users during the quarter. Bharti continued to report expansion in EBIDTA margins in the region, which stood at 26.7% in Q1 FY2012 compared with 26.4% a quarter earlier. With impacts of lower MoU and customer registration norms easing, the company reported healthy 5.9% sequential growth in top line from the region. Bharti s African revenues sequentially grew just 1.4% in Q4 FY2011. With acquisition of license to offer 2G and 3G services in Rwanda, Bharti entered into 17 th region in the African continent during September With this, the company became third operator to enter into the country s telecom space after MTN Rwanda and Tigo Rwanda. Rwanda, with penetration of just 38.4% (~3.7 Mn users) proposes healthy growth opportunities. Sighting the same, Bharti plans to invest $100 Mn in Rwanda during next three years in the region. The company s aggressive investments in Africa are expected to reap healthy growth, going forward. We continue to anticipate the African operations to become EPS accretive in Q3 FY2012E. Among other developments in the region, Bharti is planning to call off communication agreement with UTL in Uganda due to failure of debt repayment. The latter owes the company a sum of $3.5 Mn in outstanding fees and court fines. On a negative note, ownership norms in Kenya may toll on the company s 4G plans in the region; a rule considered for the license mandate 20% of local ownership. However, we believe that these factors may have an insignificant impact on Bharti s performance in the near term. VLR Data continues to show strength According to TRAI s recent Visitor Location Register (VLR) report, just Mn (~70%) of the Mn reported subscribers were active for the month of July The ratio was different across the service providers. Bharti with 89.9% active subscribers remained second. Idea had the highest proportion of active subscribers at 93.3% of total user base. If we consider the market share of Bharti based on VLR data, it stands at 25.5% compared with 19.9% as per reported numbers. Market Share based on Reported Subscribers Data Bharti Others 19.9% 80.1% Market Share based on VLR Subscribers Data Others 25.5% Bharti 74.5% Source: TRAI,, Data as on July 2011 Given the recent hike in tariffs by most of the service providers, we believe that the future VLR data may reflect higher percentage of subscribers as active in the upcoming quarters. This will be led by reduction in 4

5 dual sim phenomenon, in our view, as similar tariffs across the operators may make the additional sim unattractive. Proposed stake sale of tower unit bodes well Bharti s Chairman Mr. Sunil Mittal stated that the company is considering fund raising options through sale of stake in its tower subsidiary Bharti Infratel. According to its plans, Bharti intends to raise ~$1 Bn through an initial public offer, paring 10% of its tower unit equity in the primary market. Thus, the offering is expected to value the arm at $10 Bn, 20% lower than the valuations it attained in February While the IPO can be seen as an exit option for the private equity investors, it may also include fresh equity issuance by the company. Bharti Infratel had 32,942 towers at the end of Q1 FY2012. It also holds 42% stake in Indus Towers, which had 108,922 towers at the end of the quarter. We believe that the value unlocking from the issuance of new shares could help Bharti reduce its debts; thereby can lead to reduction in interest expenditure. Consequently, the step would be EPS lucrative in our view. In addition, the company s parent Bharti Enterprises plans to sell its software unit Comviva as well, which is present in 85 countries providing software for mobile music and video applications. Industry developments The telecom industry progressed to come off various issues prevailing in the industry. The 2G spectrum case took a U turn when Telecom Regulatory Authority of India (TRAI) stated that it was hard to predict the losses from 2G spectrum allocation. Furthermore, TRAI is expected to resolve the issues of pesky calls by the end of September 2011 with effective implementation of National Customer Preference Registry (NCPR). TRAI also plans to allocate new 140 number series to telemarketers and limit the calls from them between 9.00 AM to 9.00 PM, failing which, they have to pay hefty fines. Additionally, Department of Telecom s (DoT s) initiatives to free spectrum from the players, who have not roll out their services is expected to bring in consolidation in the industry through an automatic route. Moreover, the introduction of New Telecom Policy, 2011 is expected to make the scenario, of the industry, clearer in our view. Outlook Bharti again portrayed its leadership while hiking tariffs in the industry. The company was first among the incumbents to raise prices. Justifying the move, Group Chief Financial Officer Bharti Enterprises Limited, Mr. Manik Jhangiani, in the company s conference call stated that, Another very important achievement was the tariff corrections that we have initiated; telecom is probably the only industry where despite increasing inflation, tariffs have been falling unabatedly. Continuous decline in margin, high 3G and BWA auction prices and constrained spectrum left us with little choice but to make some price corrections. Bharti s Chairman, Mr. Sunil Mittal also stated in the annual report of the company, that he foresee the competition in the market, easing. Furthermore, he insisted that the consolidation is inevitable in the industry which currently comprises of more than 15 players. The government s move to cancel licenses on roll out terms and / or providing exit opportunities to the players, who find their operations unviable, may bring in consolidation in an indirect manner. The move is likely to reduce the number of players in the industry through exits. Bharti continued to focus on data segment offerings. Launch of Beetel Magiq was in line with the company s initiatives to promote its 3G services. During the quarter, Bharti completed roll out of 3G services in all the 13 5

6 circles, where it has 3G licenses. The company, in association with Apple, also launched iphone4 in the country in Q1 FY2012. In the digital TV business, Bharti introduced interactive services such as idarshan, igoodlife, and ikisaan. Furthermore, it launched 3D ready HD recorder during the quarter. These developments coupled with Airtel movies, in partnership with BigFlix and new broadband plans with minimum limit of 2 mbps are expected to support the company s top line growth in the upcoming quarters. We continue to anticipate Africa, DTH, and Passive Infrastructure businesses to form an integral part of Bharti s top line growth in upcoming quarters. Furthermore, we believe that the company will start reporting profits in Africa from Q3 FY2012E. However, citing higher than expected interest outgo and depreciation charges, we cut the EPS target for upcoming quarters and FY2012E and FY2013E. The following exhibit reflects our estimates for Q2 FY2012E results of Bharti. Particulars Q2 FY12E Q1 FY12 Q2 FY11 Q-o-Q Y-o-Y Revenues 175, , , % 15.1% EBIDTA 61, , , % 19.9% Net Profit 14, , , % -15.1% EPS % -15.1% Source: Company, Valuation Target price raised citing recent rate hikes We continue with the comparable valuation methodology to value Bharti on EV / EBIDTA basis. Based on FY2012E EBIDTA of ` Bn and industry s historical EV / EBIDTA of 8.60x; we arrived at a target price of ` for the stock for a 7 month time horizon. This represents a 8.1% upside from the CMP of ` On an annualized basis this represents an upside of 14.7%. Our new target price reflects an increase from our earlier target price of ` Upward revision of FY2012E EBIDTA remained the sole contributor for increase in target price. The increase in EBIDTA primarily reflects current rate increases. Considering the expected returns, we rerate the stock from HOLD to BUY. Earlier: The stock has already achieved our previous target of ` on 25 July As our valuation is based on EV / EBIDTA methodology, a below expected bottom line did not impact our target. Furthermore, the recent hike in tariffs could help the company report improvement in EBIDTA Margins in the upcoming quarters. We expect the full impact of the same to be witnessed in Q3 FY2012E. As a result, we raise our target price for the stock to ` from earlier target of `

7 : Phone No.: Ajay Jaiswal: President, Investment Strategies, Head of Research: Fundamental Research Name Sectors Designation ID Nitin Prakash Daga IT, Telecom & Entertainment AVP-Research Naveen Vyas Midcaps,Market Strategies AVP-Research Nitesh Goenka BFSI,Metal & Mining Sr. Research Analyst Sanjeev Jain BFSI Research Analyst Sutapa Roy Economy Research Analyst Gargi Deb Agriculture & Pharma Executive Research Soumyadip Raha Midcaps Executive Research Technical & Derivative Research Vinit Pagaria Derivatives & Technical VP Ranajit Saha Technical Research Sr. Manager Institutional Desk Rajiv Lilaramani Institutional Equities Sr. Manager Dhruva Mittal Institutional Equities Manager PMS Division Siddharth Sedani PMS Research AVP Research: Financial Planning Division Shrivardhan Kedia FPD Products Manager Research Research-Support Subhabrata Boral Research Support Executive MICROSEC RESEARCH IS ACCESSIBLE ON BLOOMBERG AT <MCLI> Rating Scale Recommendation Expected absolute returns (%) over 12 months Strong Buy >20% Buy between 10% and 20% Hold between 0% and 10% Underperform between 0% and -10% Sell < -10% 7

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