Is Bharti Infra IPO a good bet? Experts differ in opinion

The Rs 4,500 crore Bharti Infratel (BIL) IPO from one of the largest tower infrastructure companies, has been subscribed 1.21 times on its third day of issue.  The issue of 16.05 crore shares (excluding anchor portion), closes on December 14 and has so far received bids for 19.46 crore equity shares.

Sanju Verma MD & CEO of Violet Arch Capital Advisors however, is not very bullish about the Initial Public Offering (IPO). According to her, Indian telecom companies are short of cash by around Rs 18,000 to Rs 20,000 crore and at the moment, the cash-strapped sector should certainly not feature in an investor's radar, she feels.
"When you value a tower company, everything else is irrelevant. What you need to look at is the tenancy ratio. The tenancy ratio for Bharti Infratel is 1.7 times whereas the tenancy ratio for most international majors is anywhere between 2 times to 5 times depending on whether they have roof top towers or ground based towers. Bharti Infratel is clearly not a buy if you look at the poor tenancy ratio," reasons Verma.
Therefore, Verma advises investors against subscribing to the Bharti Infratel IPO. Instead, she suggests enhancing the portfolio with stocks like Bharti Airtel.
But, Sanjay Chawla, senior telecom analyst at JM Financial is of the opinion that it might be a good bet to apply for the IPO. He believes, if an investor takes a six to twelve month time frame, Rs 210 to Rs 240 could be a fair value. Therefore, applying at around Rs 210, which is at the lower end of the price band will be beneficial for the subscriber, he added.
Chawla also said, "Based on our outlook, today one should not expect more than 5 to 10 percent upside if the issue is priced at Rs 230." Here is the edited transcript of the interview on CNBC-TV18. Q: A word from you on the Bharti Infratel (BIL) issue and how you have rated that, whether it’s subscribe or avoid? Chawla: Our view is that one should subscribe to the Initial Public Offering (IPO) at the lower end of the IPO price band because we believe that although, on a 6 to 12 month basis the fair value is within the price band of Rs 210-240, if you apply a 5 to 10 percent margin of safety then one should apply closer to Rs 200 per share. That is Rs 210 at the lower end of the price band. Q: That may not happen because yesterday the Qualified Institutional Buyer (QIB) book got discovered above Rs 230 and Rs 10 discount to that is Rs 220. So it doesn’t look like we are going to get the issue at Rs 200 as you are suggesting or Rs 210. From that top end of the band, from Rs 230 can the given valuations justify upside over the next one year? Chawla: There is a very modest upside, 5 to 10 percent at best from a fair value basis. But, as I said, one will have to see what kind of risk perception the clients and investors have with regards to the business and that is something which will evolve over a period of time. Based on our outlook, today one should not expect more than 5 to 10 percent upside if the issue is priced at Rs 230. Q: Let me ask you about the new spectrum reserve price which seems to have been slashed by 30 percent. Is that good enough to excite bidders you think? Chawla: No, our view is that government is going in the opposite direction. They are lowering the price and then trying to see whether it clears or not but, the idea should be to cut the price to a very low level and then let the market take it up. So, the government is getting it wrong again and we don’t expect too much of demand even at these prices in the Mumbai and Delhi circles. Q: The criticism for BIL is that compared to a lot of its global peers, it seems to have gotten priced pretty expensive. Can you share what your own estimates are in terms of what kind of revenue or earnings per share (EPS) potential this issue has, this business has? Chawla: One will have to look at BIL and compare it to let us say the domestic mobile business of Bharti and Idea, that’s one way to look at it. On that basis we believe that BIL should trade at 40-50 percent premium in terms of EV to EBITDA to the mobile business.
There are two main reasons for that. One is the risk profile of the business is lower because the tower company makes money based on long-term contracts and there is revenue visibility. Secondly, the profile of cashflow that is generated is superior to a mobile business because mobile business will have to make spectrum payments, will have to do technology upgrade over the next 5-10 years whereas this business relatively will keep generating a steady amount.
_PAGEBREAK_ Q: I believe you would not be so charitable with the Bharti Infratel initial public offering (IPO) and would you give it a pass? Verma: Yes. I will certainly give it a pass because going back to the question about whether it makes sense to invest in the telecom space at all we have to find out certain things. If yes, do we need to invest in mobile operators, telecom operators or do we need to invest in tower companies? I have always maintained that I am very circumspect of investing in the telecom space per se.
For instance, today the government has said that the reserve price for 1800 megahertz spectrum will now be Rs 12,000 crore and not Rs 14,000 crore. Assuming, Rs 12,000 crore for 5 megahertz worth of spectrum and assuming that 900 megahertz of spectrum is then available at Rs 26,000 crore given that the government has said that, 900 megahertz will be priced twice that of the 1800 megahertz price. Now assuming these price points today, if you multiply the available spectrum which is there with all telecom operators into these various price points, the total sum of that is equal to Rs 180,000 crore.
What I am trying to say is that the total spectrum holdings of all key telecom operators in India is worth Rs 18,000 crore. Out of that if you deduct 10 percent by way of license fees, you are removing from the spectrum holding something like Rs 18,000 crore, leaving spectrum holdings with a valuation of Rs 162,000 crore.
You and me are aware that the net debt of the telecom industry today is Rs 180,000 crore. If you want to remove Rs 180,000 crore from Rs 162,000 crore, it is not possible and that is the point I am making. You are actually out of money and there is a scarcity of around Rs 18,000 crore in the Indian telecom industry.
I am not even adding financing cost, amortization cost, spectrum usage charges, interconnect charges so on and so forth. I have just deducted the upfront financing cost and the overall debt. The telecom space in India is still out of money to the tune of anywhere between Rs 18,000 crore to Rs 20,000 crore. This clearly tells you that telecom is not a space to be in at this point in time.
But, suppose one were to be charitable and say, I want to invest in Bharti Infratel because tower companies going forward, will have a better go at things rather than telecom operators, my point is simple, you cannot say that, buy Bharti Infratel because it is cheaper compared to international majors. The key thing to note here is that we are simply comparing apples and oranges.
Look at the market cap of most international telecom operators, look at the market cap of American towers, it is at USD 29 billion. Look at the market cap of Crown Castle which is at USD 20 billion and assuming Bharti Infratel gets listed even at the upper end of the price band, it will barely be a billion dollar, actually sub that. There is no question of comparison here.
Look at the return of equity of Bharti Infratel, 6.5 percent whereas the medium for most international majors including smaller companies based out of Taiwan and Indonesia is nothing less than 25 to 30 percent. I think the economics simply does not gel.
When you value a tower company, everything else is irrelevant. What you need to look at is the tenancy ratio. The tenancy ratio for Bharti Infratel is 1.7 times whereas the tenancy ratio for most international majors is anywhere between 2 times to 5 times depending on whether they have roof top towers or ground based towers. Bharti Infratel is clearly not a buy if you look at the poor tenancy ratio.
Also a moot point that everyone should ask is, why is return on equity for Bharti Infratel just 6.5 percent? What is the key reason? The reason is simple. In India most tower companies only managed to get one anchor tenant. It is difficult to find a second anchor tenant and until you find a second anchor tenant for your tower business to get optimal returns on the investments you have made it is certainly not going to happen anytime soon.
I think these are the key things that nobody is talking of. We all know that in February-March this year, the Supreme Court cancelled 122 2G licenses, that puts almost 4700 locations with respect to Bharti Infratel’s tower business at risk, 4700 tenancies are at risk and nobody is talking about that. When you say that Bharti Infratel has 86,000 towers, you should also be talking about the fact that the number is not 86,000, that number is far lower if you were to look at the locations that are at risk because of regulatory measures taken earlier this calendar year.
My point is simple, tower business anywhere in the globe is very lucrative and profitable provided you have a very benign ecosystem with respect to data services. But, it is common knowledge and I am not saying anything new when I say that most of the business for telecom operators in India even today is voice revenues. True, Bharti has 20 percent coming from data revenues but that is still at the lower end of the spectrum whereas globally data forms about 80 to 90 percent of the business. Q: What do you think is value for price then? Are you going with the complete avoid on the issue or do you think if they manage to price it with discount, it would be worth it? Verma: My point is simple; I would rather buy Bharti than buying Bharti Infratel. The question is not about price. Like I said, at Rs 210 the enterprise value for Bharti Infratel is USD 7.7 billion, at Rs 240 the enterprise value for Bharti Infratel is USD 8.7 billion. It is USD 8.7 billion assuming Rs 240 is where the stock opens on the day of the listing.
Now, after doing the back of the envelope calculation, that translates into a price of Rs 100 or so. If you deduct Rs 100 from Bharti’s current price of Rs 320, you are basically saying that you are getting the core business of Bharti. If you buy it today for Rs 220, at this rate the EV/EBITDA for Bharti works out to just 4.5 times. So why should I not buy Bharti at 4.5 times its core business rather than buying a tower company at 11 times or 13 times or 14 times EV/EBITDA? That is the point I am making.
The trade-off is not between Bharti Infratel and XYZ, because there is no real benchmark for comparison yet. The comparison has to be, am I better off as an investor buying Bharti Infratel or am I better off buying Bharti Airtel? My point is, you are better off buying Bharti Airtel and not Bharti Infratel because I see no reason why you should be paying 3.5 times price to book, 11 times EV/EBITDA and 40 to 50 times price to earnings assuming Bharti Infratel gets listed at Rs 240. The valuations are very steep.

More to come.