Analysts differ on Bharti-Zain valuations, rating

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Analysts differ on Bharti-Zain valuations, rating

There seem to be no respite for shareholders of Bharti Airtel. The stock has fallen over 11% in the past two days after Bharti and Kuwait's mobile telecom firm Zain announced yesterday that they are in exclusive talks till March 25 for a deal which values the latter's Africa assets at USD 10.7 billion.

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There seem to be no respite for shareholders of Bharti Airtel . The stock has fallen over 11% in the past two days after Bharti and Kuwait's mobile telecom firm Zain announced yesterday that they are in exclusive talks till March 25 for a deal which values the latter's Africa assets at USD 10.7 billion. It is currently trading 22.35% above its 52-week low of 229.50.

Increased competition in the telecom space resulting in a fall in tariffs to as low as half a paise per second and fall in the company's average revenue per user, has seen its fall for its all-time high of Rs 592.

Valuations: Costly or cheap
What's worrying the street is the high valuation that Bharti is shelling for Zain's African business, which is loss making at the profit after tax level. Zain's African subscribers stand at 41.89 million, so the deal at USD 255 per subscriber seems expensive.

Brokerage firm Macquarie and Motilal Oswal feel the deal looks expensive on first look. "The deal enterprise value of USD 10.7 billion would imply a valuation of USD 320 per proportionate subscriber, 3.6 times revenue, and 11.6 times EBITDA, a 30-70% premium versus Bharti's current valuations. Zain's peer, MTN is currently trading at 5.5-6 times EV/EBITDA," MOST stated in its report post the deal.

However, MOST feels Zain's Africa unit is an attractive acquisition candidate for Bharti given its relatively low penetration (36% versus 44% in India) and high ARPU of USD 7.5 as against USD 5 for Bharti. "Bharti could export its minutes factory-based business model. Only three out of 15 countries in Zain's Africa portfolio have a mobile penetration in excess of 50%. Moreover, Zain is a market leader in most of its operations, with 50-75% market share in seven out of 15 countries and 25-50% share in six nations," the report stated.

Like Motilal, AnandRathi too sees the strategic sense in the deal. But in its report post the deal says valuations are expensive despite the growth and turnaround potential. "Based on Zain Africa's attributed/proportionate CY09 estimated EBITDA of USD 925 million, implied transaction EV/EBITDA of 11.6 times is at 60% and 120% premium to Bharti (7.2 times) and MTN (5.2 times), respectively. Low aggregate penetration (35% versus India's 40% in September 2009) and depressed EBITDA margin (32% as against Bharti/MTN 40%/43%) would justify some premium (30-40%), despite the higher risk profile of African assets," it explained. Sanjay Chawla of AnandRathi says the fair EV/EBITDA valuation of Zain would have been 9-10 times.

Most of the street is still awaiting details of the deal and will revise their rating on the stock as and when details emerge. In an interview to CNBC-TV18 on Monday, Manishi Raychaudhuri, MD and Head of Research, BNP Paribas Securities, and Nilesh Shah, MD and CEO, Envision Capital, stated it was too early to draw any conclusions on whether this deal is valuable or not. Shah says the African market has a high potential for telecom and that Bharti may have synergies with Zain. "We will remain neutral on Bharti till the deal dynamics are known."

But Raychaudhuri cautioned that some of Zain's African assets are in geopolitically sensitive countries and could turn out to be a challenge for Bharti. "It is likely to be a challenge for Bharti at least in the near-term." Echoing a similar sentiment, Ambareesh Baliga, Vice-President, Karvy Stock Broking, told Reuters that growth for Bharti will come only in 5-8 years.

Earnings impact:
Assuming a full debt funding and post-tax finance cost of 5%, and zero earnings of acquired operations, MOST expects Bharti's earnings to be impacted by 20-25%. Similarly, GV Giri, Analyst, IIFL- Institutional Equities, too expects an EPS dilution of around 25% post acquisition. However, AnandRathi's Chawla sees a dilution of around 15-20% in the first year post-acquisition. "Dilution would be limited from the second year onwards." And, Macquarie is not changing its earnings estimate on Bharti for the time being.

Should you buy or sell?
Macquarie and MOST are still maintaining their price target of Rs 280 and Rs 286 per share and buy recommendation. Both brokerages say they will review its rating post consummation and when clarity on the deal emerges. Ambareesh Baliga of Karvy Stock Broking is buying Bharti at current levels. "We feel in the long-term there is surely value. We expected the market not to like this deal because it strains the balance sheet at least in the short- to medium-term."

Sharmila Joshi, Co-Head, PCG Sales, Emkay, advises investors to hold the stock. "I don't think this is really a price at which one can sell Bharti. We have seen time and again the stock coming down to this level. My advice is really to hold. Let whatever developments are to happen play out and let a couple of quarters pass."

Sell, screams AnandRathi. It says implied valuations in the proposed Zain transaction suggest a 5-8% downside for Bharti shareholders. "We maintain a sell for now given the lack of catalysts." Chawla says Idea Cellular is preferred play in relative terms.