Why Motilal Oswal handpicks Bharti, Idea over Rel Comm

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Why Motilal Oswal handpicks Bharti, Idea over Rel Comm

Motilal Oswal has come out with its report on telecom. The research firm recommends to buy Bharti Airtel & Idea Cellular.

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Motilal Oswal has come out with its report on telecom. The research firm recommends to buy  Bharti Airtel &  Idea Cellular .

While our recent industry interactions suggest strong 3Q business momentum, we downgrade EBITDA estimates for Bharti/Idea by 2-5% and target prices by 7-10% led by 1) lower visibility on near-term margin expansion despite the companies entering seasonally strong period, 2) poor 3G uptake which will likely lead to higher marketing spends and data tariff cuts, and 3) likely higher competitive intensity within the top-3 operators as manifested in divergent subscriber addition and market share trends. However post recent ~15% stock price correction and expected resolution of near-term regulatory issues, we believe valuations for Bharti/Idea at ~6x FY13E EV/EBITDA are attractive. Maintain Buy on Bharti Airtel/ Idea Cellular and Neutral on Reliance Communication.

Our recent interactions with Bharti, Idea and other industry participants reconfirm strong traffic growth rebound in 3Q, along with continued RPM increase, led by tariff hikes getting effective for subscribers coming up for renewals. Both traffic growth and RPM trends appear broadly in-line; we do not see much room for positive surprise in the near-term. Our interactions also indicate that industry discipline might be getting weaker at the margin, with net subscriber additions getting skewed in favor of a few operators and disparate revenue market share trends amongst the top-3 operators, with Bharti continuing to lose revenue market share while Vodafone and Idea have maintained their share.

Idea has been posting the highest net subscriber additions among the incumbents post the tariff hikes in July, which might be an indicator of relatively higher aggression v/s other players. Some part of this outperformance might also be due to the fact that Idea has raised tariffs only in its leadership circles while operating at a discount in other circles. Margin commentary remains mixed. While operating leverage should kick in, the impact is being diluted by 3Grelated costs as well as pressure on SG&A in case of some operators. During 2HFY12, we expect 80bp EBITDA margin improvement for Idea (4QFY12 v/s 2QFY12) and 180bp improvement for Bharti. Higher margin improvement assumption for Bharti is driven by tighter cost control post recent restructuring and lower SG&A. 3G uptake remains weak, largely due to lower device penetration (estimated at early double-digits for Bharti and mid single digits for other players) and high data tariffs (~INR0.5/MB on promotional basis for lower denominations of monthly packs). While 3G is unlikely to be a significant revenue driver in 2HFY12, we expect significant cut in 3G tariffs over the next few months and continued increase in 3G handset penetration to drive 3G revenue from FY13. Regulatory visibility has increased in the near term, with media reports indicating crystallization of final policy decision on excess spectrum and M&A rules. We highlight that the liability/share for excess spectrum (INR4/share for Idea and INR10/share for Bharti) is much lower than the potential liability for spectrum renewal; our target prices incorporate 50% of this. Uniform pan-India licence fee of 8% and similar licence fee on tower rentals are likely to have largely offsetting impact on EBITDA for Bharti/Idea. Resolution of other issues like spectrum renewal and re-farming could also happen with a lag, since first licence renewals would happen only in late 2014. Policy for providing exit to distressed new entrants is also unlikely to be addressed, as TRAI is starting a fresh consultation process on the same.

During the current quarter the INR has depreciated against the USD by ~9%. We have modelled 3QFY12 forex loss of INR2.5b for Bharti and INR 0.2b for Idea. Assuming net forex exposure of USD10b we estimate net worth impact of INR47b (INR12/sh) on Bharti. We are downgrading our FY12/13 EBITDA estimates for Bharti by 2/4% and Idea by 3/5%, largely on lower margin assumptions. We are reducing our target price for Bharti from INR515 to INR465 and for Idea from INR135 to INR125. Post the recent ~15% correction in Bharti/Idea, we believe valuations at ~6x FY13E EV/EBITDA are attractive. Maintain Buy on Bharti Airtel/ Idea Cellular and Neutral on Reliance Communication .

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