India Telecom Strategy

Transcription

1 India Telecom Strategy It s all about THE Spectrum!! PhillipCapital (India) Pvt. Ltd. TELECOM: Sector Update 30 September 2014 The Indian Telecom industry is at a critical juncture as it is witnessing a paradigm change in product offering and industry structure. The sector over the next four years will witness 1/ Mega 900MHz spectrum auctions, 2/Launch of Reliance Jio 3/Bifurcation of operators in terms of data capability, 4/ Rise in capex requirements for data and 5/ Level playing field after 700MHz auctions. The outcome of all these events is uncertain but we believe the following will be the key deciding factors to position the telecom portfolio over the medium and long term: RJio impactful launch at least 1 year away; Compelling voice proposition critical: RJio ambitious project with start up investment of US$ 8bn requires scale; and without compelling voice proposition, network reach and scalable technological platform, RJio has limited market. We believe RJio will have to target 850MHz spectrum to provide compelling and competitive voice offering. The availability of this spectrum will depend of 800MHz spectrum auctions on which there is no clarity. Thus we surmise that RJio s pan India (rather impactful launch) is at least 1 year from now. 900MHz auctions will lead to bifurcation of operators in terms of data capability; Advantage Bharti, Vodafone: The 900MHz auctions in February will lead to clear bifurcation of players between sub Giga Hertz and higher frequency data operators. Bharti, Vodafone and RJio (likely) will become sub Giga Hertz data players while Idea, RCOM, Aircel and others will move to higher frequency for data services. This will translate to Bharti, Voda and RJio having higher data reach and capacity capabilities while Idea and others would have constricted reach, capacities and in turn capabilities to offer data services. 700MHz auctions will provide level playing field: 700MHz spectrum has both reach and capacity capabilities but since India has opted Asia Pac Telecom (APT) band, the ecosystem is still limited. The ecosystem is developing and 700MHz spectrum will come for auction in the next four years. Also, the amount of spectrum available in the 700MHz band is abundant and 5 6 players could be accommodated. Thus once 700MHZ comes up auction more operators will own sub Giga Hertz frequencies and have a level playing field in terms of reach and capacity. Market consolidation continues; Pricing growth continues: With Jio launch 1 year from now and market consolidation continuing, pricing growth will continue. We believe pricing growth will continue in FY15 and FY16 and incumbents will create a pricing cushion before RJio s launch. Thus pricing over the medium term is more likely to surprise positively. Capex to rise for incumbents: There is significant scope for improvement in Quality of Services (QoS) for mobile broadband in India. With the launch of Jio, inevitably data pricing will come down and also operators will compete on quality of service. This twin concoction will lead to higher capex requirements for the incumbents. Advantage Bharti; Idea operationally strong but upside likely to be capped: Over the next months both Idea and Bharti will deliver on operational parameters. However, Bharti has significantly higher re rating potential. Bharti s data spectrum assets are unparalleled and India business execution and operating performance have improved significantly. Idea, with depletion of 900MHz spectrum assets and significant gearing post auctions will see lowering of its business flexibility impacting its growth prospects over the next 3 4 years. Hence, our top sector pick is Bharti Airtel. Companies Covered Bharti Airtel CMP Reco Target Price Idea Cellular CMP Reco Target Price Naveen Kulkarni, CFA, FRM ( ) nkulkarni@phillipcapital.in Vivekanand Subbaraman ( ) vsubbaraman@phillipcapital.in Rs405 BUY Rs515 Rs163 BUY Rs200 Please refer to Disclosures and Disclaimers at the end of the Research Report.

2 RJio launch likely to be delayed; Compelling voice proposition critical RJio s 2300MHz product strategy suffers coverage issues and it will be largely an urban product. Voice capability is another shortcoming of this band on account of the ecosystem and regulation. In 1800MHz the company will launch FD LTE which is again a data product but without a compelling voice proposition RJio will find it difficult to execute a churn based strategy. As we had discussed in our Ground Zero cover story on RJio, the current and seemingly straightforward options of VoLTE, VoIP, leasing a 2G network or buying a 2G operator (lack of options here) are all suboptimal choices. The best possible plan for RJio at this juncture is 850MHz (India 800MHz, currently known as CDMA band) 3G voice and data strategy. We outline the following advantages and execution plan for the strategy: 850MHz propagation characteristics are similar to 900MHz and the device ecosystem is the most evolved ecosystem. With 850MHz the reach and capacity for voice and data apart from the ability to compete on operating and capital costs are significantly enhanced. 850MHz is available with RCOM in contiguous format in 12 circles and it is valid for 7 years. Thus upfront payout is likely to much lower than any other spectrum. 850MHz needs to establish a benchmark price based on auction. The auctions could be held over the next 12 months but the spectrum coming up for auction is noncontiguous and the price is likely to be much lower than contiguous 900MHz. Once a benchmark price is established for the band, RJio can acquire RCOM s contiguous spectrum based on a non contiguous benchmark which will translate to significantly lower payout for such a high quality spectrum band. RJio using RCOM s 43,000 towers gets access to 20,000 towns and 400,000 villages on formidable 3G and voice platforms apart from an urban offering in 2300MHz and 1800MHz bands. RJio will then go for a churn based strategy and in most likelihood it could be a device led strategy. RJio will target 20% revenue market share over the next five years and will be very aggressive across products including voice and data. RCOM has carved out its CDMA business into a separate segment. This provides some indication of the company s intentions to sell the business at some point in time. 850MHz economic value is similar (if not higher) to 900MHz as the device ecosystem, equipment availability and capex requirements are fully evolved. It is also important to note that spectrum allocation on this band is significant but the utilisation of this band has been inefficient on account of spectrum being marked for CDMA technology. As operators have migrated to GSM and the mainstream path of wireless technology evolution, the revenues from the band have been de growing. The 850MHz spectrum is held by RCOM, Tata Teleservices, Sistema, BSNL, MTNL and HFCL. The subscriber base on this band is insignificant and revenue contribution is meager. If this band is liberalized through open market auctions then the utilisation of this band will improve significantly. 2 of 33

3 Revenue contribution by spectrum bands Spectrum allocated between 850 MHz and other bands 800/850MHz Other bands 800/850MHz Other bands Source: Company, PhillipCapital India Research We find that 850MHz contiguous band is available in most circles either through RCOM or through market auction route. The table below provides the spectrum distribution across the 22 circles. 850MHz spectrum distribution Allotments Spectrum allotted (MHz) TTML Rcom SSTL HFCL BSNL/MTNL Free Guard bands Total spectrum Metros Delhi Mumbai Kolkata A' Circle A.P Gujarat Maharashtra Karnataka T.N B' Circle Haryana M.P Punjab Rajasthan Kerala U.P.(E) U.P.(W) W.B C' Circle Assam Bihar H.P J&K N.E Orissa Total Source: TRAI, PhillipCapital India Research RCOM has contiguous spectrum in 12 circles and in other circles also contiguous spectrum could be made available by combining blocks with existing holder or from freed up spectrum. In several circles, there is free spectrum which is adjacent to the blocks of RCom/TTSL. We include these free blocks & determine the 5MHz contiguous spectrum contiguous blocks available in each circle (as shown below). Band 3 of 33

4 800/850MHz spectrum contiguous block analysis Circles Who has 5MHz contiguous blocks? TTML/TTL Rcom Others Free/vacant spectrum (MHz) How many contiguous blocks can be created if we use free slots & combine with that of Rcom/TTSL? Metros Delhi Mumbai Kolkata A' Circle A.P Gujarat Maharashtra Karnataka T.N B' Circle Haryana M.P Punjab Rajasthan Kerala U.P.(E) U.P.(W) W.B C' Circle Assam Bihar H.P J&K N.E Orissa Total Source: TRAI, PhillipCapital India Research Note: Media reports mention that Tata Teleservice will surrender spectrum in excess of 2.5MHz in all circles except Mumbai & Kolkata Device ecosystem on 850MHz is one of the most advanced The 850MHz equipment as well as the handset ecosystem is one the most evolved ecosystem with almost all the smartphones being compatible on this band. This makes the product very much mainstream and highly competitive. It is important to note that RCOM suffered from limited device ecosystem which led to the company adopting mainstream GSM ecosystem. 4 of 33

5 Device ecosystem comparison of UMTS (3G) 850MHz versus FDD 1800MHz Source: Capitel Partners, PhillipCapital India Research RJIO network plan According to Capitel Partners a leading telecom consultant RJio s network plan will be based on Triband spectrum and technology model aligned to geographies. Reliance Jio Network plan Mobile broadband context (as per Capitel Partners) Source: Capitel Partners, PhillipCapital India Research So Strategy execution will be a time taking process: While this seems to be the panacea for RJio at the current juncture but the execution is likely to be fraught with significant regulatory and practical issues. TRAI has suggested auction of E GSM band (850MHz) along with 900MHz band to make more spectrum available which will ensure optimal utilisation and pricing for the band. This is a very strong argument in the current environment of mad scramble for sub Giga Hertz frequencies. Auction dates are not yet finalized and time taken for auctions is very uncertain. RCOM s intent for selling the CDMA business is still not clear and depending on the auction price for 900MHz, the acquisition cost could go up significantly. 5 of 33

6 Time to launch network on 850MHz and product testing will take around 12 months. As we are now witnessing, allocation of national resources has become a very critical issue with multiple stakeholders, NGOs etc being very vigilant. Any allocation of such resources at prices less than fair value could become contentious. The government within the first year of coming to power would ideally avoid unnecessary controversies. The choices for RJio are not straight forward and execution issues are galore. All these point to further delays on product roll out. In this scenario the incumbents Bharti, Idea and Vodafone have a relatively lesser competitive environment and will be backed with more data spectrum to make further headwinds in consolidating their position. 6 of 33

7 Bifurcation of operators between sub Giga Hertz and higher frequency data operators: As we know that 900MHz spectrum is scarce and there is room only for 2 players in most circles for contiguous 5MHz blocks. The upcoming auctions could lead to either fragmentation of market on spectrum holding or consolidation. We strongly believe that the market will consolidate further on spectrum holdings. The market is already divided into between Telcos that offer mobile broad and Telcos that cannot. The upcoming auctions will lead to further bifurcation of operators into two sets: 1. Operators winning sub Giga Hertz contiguous frequencies will have enhanced reach and capacity for mobile broadband services. 2. Operators winning non contiguous sub Giga Hertz frequencies will move to higher frequencies of 1800MHz and 2100MHz for providing mobile broadband services. This furthering of bifurcation will have an incisive impact on the competitive landscape of the Indian Telecom sector. Further consolidation of the market will translate to improvement in profitability for the sector over the long term. Feb 2015 auction a mega 900MHz auction across 18 circles limited spectrum availability is the key challenge The Feb 2015 auctions will see auction of 900MHz & 1800MHz spectrum in 18 of India s 22 circles. Most circles have 2 or less blocks of contiguous 900MHz spectrum available which will be keenly contested by Bharti, Vodafone and Idea Cellular. RJio may contest for 900MHz in some circles but it may not be a serious bidder in most circles. 900MHz spectrum provides un matched coverage in both voice and data and its importance in category A circles with mix of urban and rural coverage necessities is significantly higher than metros. Another critical factor is the in building coverage of 900MHz which cannot be matched by 1800MHz or 2100MHz. Thus, operators with sub Giga Hertz data frequencies (contiguous spectrum) will have an edge in both coverage and capacity. Considering the past auction experience and importance of 900MHz spectrum in Category A circles, it is very likely that operators like Vodafone will bid for 2 slots in most circles in the initial rounds and in dominant position circles like Gujarat will try win 10MHz. 7 of 33

8 Feb 2015 auctions available spectrum Circle Expiring licenses in MHz Band Available spectrum (MHz) No. of 5MHz 1800 MHz Band contiguous blocks No. of 5MHz contiguous blocks Renewing licenses of operators Delhi Mumbai Kolkata Maharashtra Idea, Vodafone Gujarat Idea, Vodafone AP Bharti, Idea Karnataka Bharti, Idea TN Vodafone Kerala Idea, Vodafone Punjab Bharti, Idea Haryana Idea, Vodafone UP (W) Idea UP (E) Vodafone Rajasthan Bharti, Vodafone MP Idea, RCom WB RCom HP Bharti, RCom Bihar RCom Odisha RCom Assam RCom NE Bharti, RCom J&K Source: TRAI, Company, PhillipCapital India Research The prices for 900MHz spectrum will soar and spectrum footprint for operators like Idea Cellular will change meaningfully. It is likely that Idea Cellular might have to give up spectrum in circles like Gujarat and Karnataka while it will face a tough challenge in Andhra and Haryana from Vodafone and Airtel respectively. Reliance Communications on the other hand is likely to lose 900MHz spectrum in all the category B and C circles. Feb 2015 auctions operators face a Hobson s choice in several circles Operator Licences due for expiry in Circles where Telco has already acquired spectrum. Circles where Telco needs to acquire spectrum to sustain ops % of revenue exposed Circles where operator has to win spectrum for service continuity Idea UP(W), Gujarat Vodafone Maharashtra, Rajasthan & TN RTL 7 7 Assam, Bihar, HP, MP, NE, Odisha & WB Airtel 6 6 Total Source: TRAI, Company, PhillipCapital India Research 8 of 33

9 Several circles might see realignment of sub GHz operations Revenue exposure Revenue market share Bharti Vodafone Idea Rcom Bharti Vodafone Idea Rcom A' Circle Maharashtra Gujarat A.P Karnataka T.N B' Circle Kerala Punjab Haryana U.P.(W) U.P.(E) Rajasthan M.P W.B C' Circle H.P Bihar Orissa Assam N.E J&K Notes: Colour coding of cells for 900 & 2100MHz Only 900MHz Only 2100MHz Potential aggressor 900MHz position vulnerable Cells in bold indicate that the operator is facing renewal of 900MHz spectrum. Source: TRAI, Company, PhillipCapital India Research Currently the 900MHz band is split between Bharti, Vodafone, Idea and RCOM. After the Feb 2015 auctions 900MHz holding will be largely concentrated amongst three players. This is significant consolidation of spectrum holding especially in times of high mobile broad band services growth where coverage, capacity and in turn quality of services will be the key drivers of growth. The sub Giga Hertz spectrum owners will grow ahead of the market and market consolidation activity will gather further pace. Operators with patchy spectrum footprint will need to focus their efforts and resources in circles of strength and exit circles where incumbents are in a dominant position. 900MHz position by # of blocks (prior to Feb 15 auction) MHz position by # of blocks (after Feb 15 auction) Bharti Vodafone Idea Rcom Source: Company, PhillipCapital India Research Bharti Vodafone Idea Rcom Bharti and Vodafone could possibly own 77% of pan India 900MHz contiguous spectrum blocks. Even on value terms the spectrum holding will be highly concentrated amongst the top 3 players with Vodafone having the most valuable spectrum. 9 of 33

10 RJio may not be an aggressor in the 900MHz auctions as it is likely to rely more on 850MHz spectrum strategy. 900MHz position by value of spectrum (prior to Feb 15 auction) 900MHz position by value of spectrum (after Feb 15 auction) Bharti Source: Company, PhillipCapital India Research Vodafone Bharti Vodafone 10 of 33

11 So, what happens in Feb 2015? Business continuity will be the focus? Our assumptions: Idea to shift to 900MHz GSM in Gujarat & Karnataka We note that Bharti & Vodafone could target winning one block each of 5MHz contiguous spectrum in the 900MHz band for 3G services in Gujarat & Karnataka circles where these operators offer GSM voice on 1800MHz spectrum and their revenue market share is slipping. Moreover, in Gujarat & Karnataka, Bharti & Vodafone don t have 2100MHz spectrum implying that the ONLY way for them to provide 3G services in these important circles (accounting for ~6 8% of India mobile revenue each) is by acquiring 5MHz of contiguous spectrum in the 900MHz band. Circle Likely price (Rs mn/mhz) 1800MHz price Feb 2014 (Rs mn) Spectrum value (Rs mn) Multiple to 1800MHz price (x) Bharti Vodafone Idea Comment Delhi 7,410 3, Mumbai 5,631 2, Kolkata 1, AUCTION 2015 expectations Maharashtra 9,000 2, ,000 45,000 Idea and Vodafone retain their spectrum Gujarat 8,500 2, ,500 42,500 34,000 Idea wins 4MHz non contiguous spectrum & Bharti wins 5MHz contiguous spectrum AP 6,000 1, ,000 30,000 Status quo Bharti, Idea retain Karnataka 6,000 1, ,000 30,000 24,000 Idea wins 4MHz non contiguous spectrum & Vodafone wins 5MHz contiguous spectrum TN 7,500 2, ,500 Status quo Vodafone retains Kerala 2, ,000 10,000 Status quo Idea & Vodafone retain Punjab 1, ,000 8,000 Status quo Bharti, Idea retain Haryana 1, ,000 6,000 Status quo Idea & Vodafone retain UP (W) 2, ,500 Status quo Idea retains UP (E) 2, ,500 Status quo Vodafone retains Rajasthan 1, ,500 5,500 Status quo Vodafone retains MP 1, ,500 7,500 Idea retains, Bharti wins at the cost of Rcom WB 1, ,000 Bharti wins at the cost of Rcom HP ,500 Bharti wins at the cost of Rcom Bihar 1, ,000 Bharti wins at the cost of Rcom Odisha ,000 Bharti wins at the cost of Rcom Assam 1, ,500 Bharti wins at the cost of Rcom NE ,500 Bharti wins at the cost of Rcom Total 151, , ,000 Source: TRAI, PhillipCapital India Research We expect Bharti & Vodafone to retain their 900MHz spectrum & use 5MHz contiguous spectrum for data & the balance for GSM voice. C category circles as well as Madhya Pradesh are seeing a renewal of RCom's spectrum. We believe that RCom won't be able to retain its spectrum due to the onerous Rs 40bn payout needed. Bharti, which is a market leader in all these circles (except MP) is likely to be go hammer & tongs to acquire this spectrum. 11 of 33

12 Market consolidation resulting in continued pricing growth Reducing competition showing in increased sector HHI The Indian telecom industry continues to witness consolidation as evinced by improvement in Herfindahl Hirschman Index (HHI) for industry revenue market share. Movement of HHI revenue market share (Indian telcos) HHI movement & heat map (revenue market share) FY08 FY09 FY10 FY11 FY12 FY13 FY14 1QFY15 Change in FY14 (bps) Delhi (0.32) Mumbai Kolkata Maharashtra Gujarat AP Karnataka TN (0.11) Kerala Punjab (0.53) Haryana UP(W) U.P.(E) Rajasthan MP WB HP Bihar Odisha Assam NE J&K PAN INDIA Source: Company, TRAI, PhillipCapital India Research Barring a few circles like Delhi, Tamil Nadu & Punjab, the revenue market share HHI of Indian telecom has increased in FY14; indicating across the board decline in competitive intensity. In FY14, new entrants continued to scale down their footprints while focusing on their strong circles Aircel curtailed its footprint in Gujarat, Haryana, Kerala, MP & Chhattisgarh and some areas in Punjab, as it chose to focus on circles such as Kolkata, Tamil Nadu, Karnataka, Rajasthan and the C circles, where it has held on or improved it revenue market share in FY14. After closing operations in three circles: Assam, J&K & North East, Tata Docomo scaled its operations in HP, Rajasthan and West Bengal. The company has chosen to bolster its operations in Gujarat, Karnataka, Maharashtra & Punjab, where it has maintained or improved its revenue market share. Uninor is the only new entrant which is aggressive in all its six circles of operations. Additionally, the operator has also won 1800MHz spectrum in Assam and will soon start its operations there. Incumbents continue to grab lion s share of the sector s incremental metrics Incumbents continue to dominate the Indian telecom space reflecting in their continued improvements in revenue, active subscriber and minutes market share in FY14 & Q1FY of 33

13 Incumbents continue to gain market share (%) Reflecting in improving incremental market share as well (%) 80.0 Revenue market share Minutes market share Revenue Minutes Active subscribers 75.0 VLR market share Source: Company, TRAI, PhillipCapital India Research FY12 FY13 FY14 Q1FY15 Allowing them to exercise pricing power, which we believe is likely to continue till RJio s launch The increased concentration of the Indian telecom industry is allowing incumbents to increase voice tariffs Bharti and Idea have managed annual voice RPM increases during each quarter of FY14. In past five quarters, viz. from Q4FY13 to Q1FY15, Bharti and Idea have managed to take tariffs up by 3 paise per minute and 2.2 paise per minute respectively. We believe that incumbents will preempt the competitive threat posed by Reliance Jio s FY16 17 market entry by building a tariff cushion. Thus we assume 4 paise per minute cumulative tariff increase over FY15 & FY16 our expectation in keeping with the trend witnessed in the past five quarters. Subsequently we assume marginal ~0.5% tariff increases for both Bharti & Idea. YoY change in voice RPM (%) Bharti Idea Voice RPM (Rs/min) to see continued improvement Bharti Idea ps/min tariff cushion pre empting Jio's launch Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Source: Company, PhillipCapital India Research FY12 FY13 FY14 FY15E FY16E FY17E 13 of 33

14 We believe that market is underestimating the ability of incumbents to take sustained tariff increases till R Jio s launch. Thus pricing could be a key positive surprise till R Jio s entry in the Indian telecom market. Our prior voice RPM assumptions were conservative and didn t incorporate the ability of incumbents to take sustained tariff increases. We raise our FY15/16 voice RPM assumptions by 3 8% for both Bharti & Idea (as shown below). YoY change in voice RPM (%) Change in assumptions (Rs/min) FY15 FY16 Bharti Earlier New Change (%) Idea Earlier New Change (%) Source: Company, PhillipCapital India Research 14 of 33

15 700MHz auctions will provide level playing field 700MHz: the best sub GHz frequency band; both from a capacity & coverage standpoint 700MHz spectrum is an enigma for Indian telecom companies. 700MHz band is the panacea for Indian telecom companies for solving all the coverage and capacity related problems for the Indian telecom companies as there is abundant spectrum in this band and the propagation characteristics of band are superlative. However, the 700MHz band in India will have a few takers at this juncture because of the following reasons: India has opted for APT band. The device and equipment ecosystem is not fully evolved for the band plan. Thus, pricing of a band higher than 900MHz will find a few takers at this juncture. 900MHz is coming up auctions which will put significant pressure on resources for incumbents and hence the appetite for this band for the incumbents will be limited. 700MHz also has implications for Rjio. Rjio has gathered spectrum assets which provide it with a window of circa 4 years to establish itself as a data player with superior offering. As 700MHz with 4 5 blocks of spectrum is made available then market will be abundant with operators (4 operators at least) with capacity and reach. Thus at current juncture most operators are unlikely to push for 700MHz auctions owing financial and strategic constraints. Nonetheless, it is important to understand the implications and strengths of this band. Being a sub gigahertz frequency band, 700MHz spectrum possesses the following advantages: Better propagation characteristics implying that signals travel farther, hence lower cell sites needed for coverage; better in building coverage & lower capex for network setup, Lower power requirement, These characteristics make 700MHz among the best frequencies to reach rural & far flung areas for broadband reach. Compared to 1800/2100MHz spectrum, sub GHz frequencies, viz. 700MHz & 900MHz, offer much superior coverage characteristics. Wideband Code Division Multiple Access (WCDMA or 3G) sub GHz voice spectrum offers 3x & 4.4x coverage compared to 2100MHz WCMDA (3G) & 1800MHz GSM (2G) spectrum. Even in data, sub GHz WCDMA offers unique advantages compared to 2100MHz spectrum with nearly 2.7x cell site reach. 15 of 33

16 Sub GHz frequency propagation characteristics (km 2 ) WCDMA sub GHz voice ~3x WCDMA 2100 GSM sub GHz voice WCDMA 2100MHz voice GSM 1800 voice WCDMA sub GHz data(1mb/s) ~2.7x WCDMA 2100 WCDMA 2100MHz (1Mb/s) Source: TRAI, GSA, PhillipCapital India Research India has chosen APT700, FDD band plan for 700MHz spectrum The National Frequency Allocation Plan 2011 has made an allocation of MHz for International Mobile Telecommunications (IMT) Advanced broadband wireless access. As per the Wireless Planning & Coordination Wing (WPC), India s 700MHz allocation is in accordance with the Asia Pacific Telecommunity band, implying that there is 90MHz of spectrum (2x45MHz spectrum) for frequency division duplexing. Of the 90MHz, 2x15MHz has been assigned with to the Defence & the balance 2x30MHz is planned to be auctioned. 700MHz frequency configurations Frequency arrangements Mobile station transmitter (MHz) Paired arrangements Centre gap (MHz) Base station transmitter (MHz) Duplex separation (MHz) Un paired arrangements (MHz) A None A None A None A A None A6 None None None Source: TRAI, PhillipCapital India Research Note: Row highlighted in YELLOW represents India s choice frequency arrangement for 700MHz 700MHz spectrum adequate, but auctions not before FY17 due to digitization delay As pointed out above, 2x30MHz spectrum in the 700MHz band will be auctioned and there are likely to be four serious bidders Bharti Airtel, Idea Cellular, Reliance Jio & Vodafone India. Even if two operators acquire 10MHz of unpaired spectrum each, the other two operators can bid for 5MHz block of unpaired spectrum each. This clearly shows that the quantum of 700MHz is adequate for the number of serious operators in the Indian telecom market. Adequate spectrum is one thing, but the timeline of auction of 700MHz spectrum is the key issue. 700MHz band is also being used for analog television broadcasting, specifically for ultra high frequency analog television broadcasting. The two year delay in implementation of digital addressable systems by the Information and Broadcasting Ministry also delays the auction of 700MHz spectrum. The new deadline of digitization, viz. Dec 2016, implies that 700MHz auctions will not happen before end FY17 or FY of 33

17 Delay implies that telcos are unlikely to wait for 700MHz for serious data rollouts From the perspective of incumbents, it makes more sense to upgrade existing customers to 3G on 900MHz, which will allow them to effectively cover semi urban and rural markets along with dense urban coverage, which can be achieved with 1800/2100MHz spectrum. Even for Jio, waiting for 700MHz spectrum would mean that the operator would get spectrum 7 years after it won 2300MHz spectrum. This implies that incumbents and Jio will have no choice but to opt for liberalized 850/900MHz spectrum to extensively rollout broadband wireless services. 17 of 33

18 FCF yield Bharti scores over Idea Incumbents to see robust operating performance; prefer Bharti due to 8% FCF yield With 8% FCF yield for FY16 and FY17, Bharti scores over Idea We highlight that Bharti will hit its peak debt (including deferred spectrum payment liabilities) of Rs 819bn (2.4x EBITDA) in FY15, following the Feb 2015 spectrum auctions. Idea will also reach its peak debt of Rs 288bn (2.7x EBITDA) in FY15. As shown in the below table, Bharti's FCF yield post cash payout for spectrum is 8.1% in FY16 & FY17, compared to Idea which generates 4.0% & 3.8% respectively. Note that the FCFE yield prior to spectrum capex of both operators are comparable, but Bharti scores over Idea in being able to acquire spectrum and generate free cash flow. Idea Cellular Bharti Airtel FCF profile (Rs bn) FY14 FY15E FY16E FY17E FY14 FY15E FY16E FY17E EBITDA O/w: India O/w: International Non spectrum capex Tax O/w: India O/w: International Interest cost FCFE FCFE yield (%) Spectrum payout (including capitalisation) Spectrum cash payout FCFE post spectrum cash payout 1.2 (12.4) FCFE yield post spectrum payout (%) 0.1 (0.8) Net debt (adjusted) India (99.4) Non spectrum debt (60.7) (133.8) Spectrum debt (36.7) (137.0) (283.4) (445.8) Africa debt Net debt/ebitda (x) Net debt/equity (x) Source: Company, PhillipCapital India Research FY14 16: margin accretive growth period for incumbents Tariff increases will be key to the operating performance of incumbents from FY We believe that both Bharti Airtel & Idea Cellular will be key beneficiaries of pricing power & will be able to growth EBITDA at 20 22% CAGR from FY14 17 leading to ~500bps EBITDA margin expansion during this period. The EBITDA growth trajectories of Bharti's India business and Idea Cellular are likely to be similar considering the improvement in Bharti's execution & superior data growth profile as it launches 3G using 900MHz spectrum in a bigger footprint (covering ~90% of its revenue versus 70% for Idea in our base case model). 18 of 33

19 ~500bps EBITDA margin improvement over FY14 17 (Bharti/Idea) Robust EBITDA growth (% ) for both Bharti & Idea EBITDA margin (%) FY14 FY15E FY16E FY17E Bharti India Bharti Consol Idea Source: Company, PhillipCapital India Research EBITDA growth (%) 20% EBITDA CAGR FY14 17E Bharti India 22% EBITDA CAGR FY14 17 Idea FY14 FY15E FY16E FY17E Bharti India Bharti Consol Idea Expectations from Africa are muted We also point out that our expectations for Bharti's Africa business are muted & the company is unlikely to disappoint on them. Below is a snapshot of our expectations for Africa. Bharti Africa our expectations are muted Africa details abridged (US$ mn) FY14 FY15E FY16E FY17E Revenue 4,491 4,937 5,469 6,248 EBITDA 1,171 1,234 1,382 1,678 EBITDA margin (%) Interest Interest cost (%) Tax Capex FCFE (146) (346) (267) (39) Net debt 9,799 10,145 10,411 10,450 Source: Company, PhillipCapital India Research 19 of 33

20 Bharti Airtel Leveraging on superior data assets PhillipCapital (India) Pvt. Ltd. TELECOM: Company Update 30 September 2014 Bharti Airtel is our top sector pick as we expect it to benefit the most from high growth in data services and continued improvement in pricing over FY Bharti s capital structure has largely stabilized and de leveraging will start from FY16 onwards. We significantly upgrade our FY15 and FY16 revenue and earnings estimates based on likely delays in pan India RJio launch translating to continued creation of pricing cushion, improvement in data growth trajectory with enhanced spectrum assets and robust execution. Apart from improvement in domestic business, reduction in negative carry of the Africa business could translate to further upside. We value the company on DCF based model with a price objective of Rs 515. Our key arguments are as follows: Enhanced spectrum assets to improve data consumption: Bharti has unparallel data spectrum assets and with the acquisition of 900MHz contiguous blocks in the metro circles capacity and coverage (especially in building) are significantly enhanced. We believe Bharti will start utilizing these assets in 2015 which will lead to improvement in data consumption. We also contend that Bharti will acquire more 900MHz data spectrum assets in February 2015 auction which will further boost its data services capabilities. Improved execution under new management: Our channel checks indicate that Bharti s execution is improving with renewed go to market strategy. We understand that significant changes have been made at circle level management with infusion of young blood. Now quite a few circle COOs are high performing young (under 40) executives. The renewed go to market strategy has started yielding results and we strongly believe that Bharti s growth will be significantly ahead of market in the forthcoming quarters as strategic initiatives take time to mature for a large company. Africa business gaining traction; Deleveraging to provide further impetus: Our valuation incorporates a negative carry of Rs 57 for Africa business but we believe that Africa business is gaining traction with focus on plugging the gaps in branding, network coverage and enhancing geographic reach by leveraging on the existing management capabilities. Africa business in the near term could surprise negatively on EBIDTA margins as the business is in an investment phase but revenue growth is likely accelerate in the forthcoming quarters. Bharti is in the process of divesting the African tower assets to deleverage the balance sheet and focus on core activities of active network deployment and marketing of services. The management has indicated divesting of assets will be PBT positive and improve the time to market. Estimates higher than consensus: Our EBIDTA estimates for Bharti are significantly ahead of consensus for FY15 and FY16 respectively by 3.5% and 10% respectively. Our higher estimates are primarily because of our expectations in price improvement in FY15 and FY16. Pricing improvements are rarely linear in nature and pin pointing the quarter of take off is difficult but considering the past precedence, we believe that Q1FY16 could see major impact of price hikes. BUY BHARTI IN CMP RS 405 TARGET RS 515 (+27%) Company Data O/S SHARES (MN) : 3997 MARKET CAP (RSBN) : 1611 MARKET CAP (USDBN) : WK HI/LO (RS) : 420 / 282 LIQUIDITY 3M (USDMN) : 28.9 FACE VALUE (RS) : 5 Share Holding Pattern, % PROMOTERS : 65.4 FII / NRI : 22.9 FI / MF : 7.2 NON PROMOTER CORP. HOLDINGS : 3.3 PUBLIC & OTHERS : 1.3 Price Performance, % 1mth 3mth 1yr ABS REL TO BSE Price Vs. Sensex (Rebased values) Apr 11 May 12 Jun 13 Jul 14 Bharti BSE Sensex Source: PhillipCapital India Research Other Key Ratios Rs bn FY14 FY15E FY16E Net Sales ,091 EBIDTA Net Profit EPS, Rs PER, x EV/EBIDTA, x P/BV, x ROE, % Debt/Equity (%) Source: PhillipCapital India Research Est. Naveen Kulkarni, CFA, FRM ( ) nkulkarni@phillipcapital.in Vivekanand Subbaraman ( ) vsubbaraman@phillipcapital.in Please refer to Disclosures and Disclaimers at the end of the Research Report.

21 30 September 2014 / INDIA EQUITY RESEARCH / BHARTI AIRTEL COMPANY UPDATE Best in the sector spectrum assets We expect Bharti to have the biggest spectrum portfolio among telcos. As per our base case model, Bharti will be able to secure 5MHz contiguous in circles contributing to ~90% of its revenue. We believe that Bharti will rollout 3G services on 900MHz spectrum using a 5MHz contiguous block and use the rest of the spectrum for GSM voice (due to the coverage advantage). Bharti to have the most comprehensive spectrum footprint Current footprint After Feb 2015 auctions % of Spectrum (MHz) revenue Delhi Mumbai Kolkata Maharashtra Gujarat AP Karnataka Tamil Nadu Kerala Punjab Haryana UP West UP East Rajasthan MP West Bengal HP Bihar Orissa Assam North East J&K Total Source: Company, PhillipCapital India Research Note: Highlighted cells indicated circles where Bharti has over 5MHz of contiguous 900MHz spectrum which can be used for 3G deployments Africa negative carry has started reducing, improving revenue growth a sign of relief Our valuation incorporates a negative carry of Rs 57 for Africa business 5x FY16 EBITDA of US$ 1.38bn. We find that the Africa business is gaining traction with focus on plugging the gaps in branding, network coverage and enhancing geographic reach by leveraging on the existing management capabilities. Africa business in the near term could surprise negatively on EBIDTA margins as the business is in an investment phase but revenue growth is likely accelerate in the forthcoming quarters. 21 of 33

22 30 September 2014 / INDIA EQUITY RESEARCH / BHARTI AIRTEL COMPANY UPDATE Bharti Africa negative carry is reducing 10 0 NPV (Rs/share) Q2FY12 Q3FY12 Q4FY12 Q1FY13 Q2FY13 Q3FY13 Q4FY13 Q1FY14 Q2FY14 Q3FY14 Q4FY14 Q1FY15 Source: Company, PhillipCapital India Research Bharti is in the process of divesting the African tower assets and has already done two deals hiving off 6,600 of its ~15,000 African towers. The company is doing so to deleverage its balance sheet and focus on core activities of active network deployment and marketing of services. While, the company hasn t commented on valuations, we believe that deals are likely to have happened at replacement value of US$ mn/tower implying deleveraging of US$ 700 1,200mn and are PBT positive. Bharti Africa tower deals Period No. of towers Countries Expected value unlocking (US$ mn) Comment Jul 14 3,100 Ghana, Tanzania, DRC & others Deal with Helios Towers Sep 14 3,500 Ghana, Kneya, Nigeria, Uganda & others Deal with Eaton Towers Source: Company, PhillipCapital India Research 22 of 33

23 30 September 2014 / INDIA EQUITY RESEARCH / BHARTI AIRTEL COMPANY UPDATE Implied valuation according to current market price: We estimate the market implied values for various businesses with Bharti Airtel. As detailed in the earlier section, the NPV of Bharti s Africa operations work out to a negative Rs 57 and Infratel and DTH businesses are valued at Rs 79 and Rs 10 respectively. Taking these into consideration we arrive at a value to the domestic business of Rs 378 implying a FY16E EV/EBIDTA of 6.3x as compared to Idea Cellular trading at 6.7x FY16E EV/EBIDTA. Bharti s domestic business has superior assets and margin profile compared to Idea Cellular but Bharti generates superior FCF. Hence, Bharti Airtel should trade at a premium to Idea Cellular. Market implied valuation for the Bharti Airtel ~6.3x FY16 EV/EBITDA Implied valuation of domestic biz x of FY16 Consensus EBITDA 79 Derived from Infratel CMP 10 benchmarked with Dish TV x FY16 EV/EBITDA Africa business Infratel DTH CMP Source: Company, Bloomberg, PhillipCapital India Research Estimates Our valuation (~8.0x FY16 EV/EBITDA) is a marginal premium to Idea Cellular s valuation (7.6x FY16 EV/EBITDA). We value the company at Rs 515 which implies an upside of 27% from the current levels. Even on our conservative estimates for Africa, the DCF valuation for Africa works out to a negative Rs 57 NPV similar to market implied valuation. We concur with consensus on the valuation of Infratel & DTH. Our target valuation for the domestic business Derived from Infratel CMP 10 our EV/Sub value for Airtel DTH Implied multiple of ~8x FY16 EV/EBITDA x FY16 EBITDA x FY16 EV/EBITDA OUR valuation Africa business Infratel DTH Target price of domestic biz. Source: Company, PhillipCapital India Research Estimates 23 of 33

24 30 September 2014 / INDIA EQUITY RESEARCH / BHARTI AIRTEL COMPANY UPDATE Derivation of Enterprise value 2018 (excluding intermediate FCF) Sales FY14 Fair Value Calculation We look at Bharti Airtel with a 6 year horizon to clock revenue CAGR of 8%. Bharti s execution is improving & the company is driving market growth & is likely to gain higher market share in data. Our estimates for Bharti s Africa business are conservative and have the potential to surprise positively as the company s investments bear fruit. Segmental Growth Profile Sales CAGR (6 year %) Sales FY20E EBIT margin (%) EBIT (N) EV 2020 calculation Yield required (%) P/E EV/EBIT EV (2020) Wireless services 484, , , ,283,001 Telemedia services 39, , , ,530 Enterprise carrier services 63, , , ,837 Tower business services 111, , , ,568 Africa 272, , , ,366 Intersegment 80, , (89,403) (625,823) Total 891, ,395, , ,315,480 Source: Company, PhillipCapital India Research Below we outline the derivation of our DCF valuation showcasing the multiples we assign to the businesses. We also roll forward our DCF vis à vis our prior computation to arrive at a September 2015 target price of Rs 515. The regulatory outgo is included in our DCF computations. Intermediate cash flow generation Cash Flows (Rs mn) FY15E FY16E FY17E FY18E FY19E FY20E EBIT 154, , , , , ,340 NOPLAT 106, , , , , ,472 Depreciation 174, , , , , ,044 Capex 160, , , , , ,722 FCF 120,254 5, , , , ,794 % conversion Discount factor PV 120,254 5, , , , ,263 NPV 120, , , , , ,916 Source: Company, PhillipCapital India Research Rs mn/ Rs per share Value Enterprise value ,315,480 NPV Intermediate FCF 859,916 Net cash end of FY2015 (794,257) Return requirement 12% EV Future value end of FY2015 2,741,209 Target value end of FY2015 1,946,952 Target value per share (end of Sep 2015) 515 CMP 405 Upside (%) 27 Source: Company, PhillipCapital India Research 24 of 33

25 30 September 2014 / INDIA EQUITY RESEARCH / BHARTI AIRTEL COMPANY UPDATE Financials Income Statement Y/E Mar, Rs bn FY13 FY14 FY15E FY16E Net sales ,091 Growth, % Total income ,091 Other Operating expenses EBITDA (Core) Growth, % (5.7) Margin, % Depreciation EBIT Growth, % (27.1) Margin, % Interest paid Other Non Operating Income Pre tax profit Tax provided Profit after tax Others (Minorities, Associates) Net Profit Growth, % (68.2) Net Profit (adjusted) Unadj. shares (bn) Wtd avg shares (bn) Balance Sheet Y/E Mar, Rs bn FY13 FY14 FY15E FY16E Cash & bank Debtors Inventory Other current assets Total current assets Gross fixed assets 1,964 2,085 2,454 2,701 Net fixed assets 1,317 1,286 1,488 1,556 Non current assets Total assets 1,592 1,832 1,892 2,029 Current liabilities Total current liabilities Non current liabilities Total liabilities 1,048 1,192 1,158 1,171 Paid up capital Reserves & surplus Shareholders equity Total equity & liabilities 1,592 1,832 1,892 2,029 Source: Company, PhillipCapital India Research Estimates Note: FY13 onwards revenue, costs and EBITDA numbers exclude Indus Towers, whose contribution is included under the share of income from associates. Consequently balance sheet and cash flows also exclude Indus numbers Cash Flow Y/E Mar, Rs bn FY13 FY14 FY15E FY16E Pre tax profit Depreciation Chg in working capital Total tax paid Other operating activities Cash flow from operating activities Capital expenditure Chg in marketable securities Cash flow from investing activities Equity raised/(repaid) Debt raised/(repaid) Other financing activities Cash flow from financing activities Net chg in cash Valuation Ratios & Per Share Data FY13 FY14 FY15E FY16E Per Share data EPS (INR) Growth, % (68.2) Book NAV/share (INR) FDEPS (INR) CEPS (INR) CFPS (INR) Return ratios Return on assets (%) Return on equity (%) Return on capital employed (%) Turnover ratios Asset turnover (x) Sales/Total assets (x) Sales/Net FA (x) Working capital/sales (x) (0.3) (0.5) (0.4) (0.4) Fixed capital/sales (x) Working capital days (113.7) (167.5) (137.1) (141.5) Liquidity ratios Current ratio (x) Quick ratio (x) Interest cover (x) Total debt/equity (%) Net debt/equity (%) Valuation PER (x) Price/Book (x) EV/Net sales (x) EV/EBITDA (x) EV/EBIT (x) of 33