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Bharti Airtel 1QFY2010 performance highlights and result update

Contributed by Angel Broking

By Angel Broking

For 1QFY2011, Bharti Airtel posted robust top-line performance, up 13.8% qoq, aided by the acquisition of Zain Africa. However, margins declined due to high SG&A, network operation and access costs, while the bottom line was severely affected due to the loss reported by its African operations.

Robust top line aided by higher MOUs, but strong erosion witnessed in margin: Bharti Airtel’s net revenue grew 17.4% yoy (13.8% qoq), which included revenue contribution of Rs958cr from Zain Africa, which has been accounted for 23 days (June 8–June 30, 2010) in 1QFY2011. The company’s global subscriber base stood at 177mn as of 1QFY2011. The company reported a 518bp yoy (189bp qoq) drop in EBITDA margin in combined operations. Further, a) the net interest payable of Rs420cr v/s net interest income of Rs128cr and Rs36cr in 1QFY2010 and 4QFY2010, respectively, b) higher depreciation cost and c) higher tax rate, resulted in a 32% yoy (18% qoq) decline in the bottom line of combined operations (including Africa) to Rs1,682cr. This was mainly due to a net loss of Rs224cr incurred in its African operations. However, comparing its India and South Asia financials, the company’s top line grew 8.2% yoy (4.9% qoq) to Rs11,273cr, while posting a 360bp yoy (80bp qoq) margin decline. Thus, the bottom line, excluding Africa, declined by 23% yoy (6.8% qoq) to Rs1,905cr.

Outlook and valuation: We expect Bharti Airtel’s top line to witness a 28.5% CAGR over FY2010–12E, with strong addition in its subscriber base, including that of Zain Africa. However, RPM is expected to decline at a 15% CAGR in the same period. Thus, the bottom line is expected to decline at a 5.1% CAGR over FY2010–12E, mainly due higher interest outgo on debt raised for Zain and 3G BWA and opex required for integrating Zain’s operations during this period. In view of the recent underperformance on the PAT and RoE fronts, we have valued Bharti Airtel at ~17x FY2012E EPS of Rs21.3, in line with our Sensex target multiple of 17x (Bharti has traded at an average premium of 12% to Sensex average PE multiple during 2005–2010). Thus, we recommend an Accumulate rating on Bharti Airtel and maintain our Target Price of Rs360.

Robust top line aided by the acquisition of Zain Africa

Bharti Airtel recorded 17.4% yoy (13.8% qoq) growth in net revenue for 1QFY2011 mainly on account of strong growth of 16% yoy (17.6% qoq) in its mobile business, aided by additional revenue contribution of Rs958cr from Zain Africa. The company’s telemedia business also witnessed 4.8% yoy (5.3% qoq) growth. Further, the tower business and other businesses (DTH and IPTV) witnessed declines on a sequential basis, registering growth of 28.1% and 89.8% on a yoy basis, respectively.

Growth in the company’s mobile business was supported by 35.3% yoy (10.2% qoq) growth in total MOU in its Indian and South Asian operations, which stood at 1,90,396mn minutes (480 MOU per user per month), as the subscriber base in India and South Asia grew by 7.1% qoq each. Zain Africa’s operations added 36.4mn subscribers during 1QFY2011; however, Zain Africa has lower MOUs of 103 minutes per user per month compared to India and South Asia. Thus, the company’s total subscriber base (including that of India, South Asia and Zain Africa) stood at 177mn at the end of 1QFY2011.

Bharti Airtel’s average revenue per user per month (ARPU) in India and South Asia continued to decline by 22.7% yoy (2.3% qoq) to Rs215, while ARPU of Zain Africa stood at US $8 (~Rs365) during the quarter. The company’s RPM continued to fall by 23% yoy (4.6% qoq) to Rs0.45 on account of the ongoing competitive tariff wars and new low-cost pricing plans during the quarter.

High SG&A, network operation and access costs impact margin

Bharti Airtel reported a 518bp yoy (189 qoq) drop in EBITDA margin during 1QFY2011 mainly on account of the 300bp yoy (130bp qoq) increase in SG&A expenses. Network operating costs also increased by 190bp yoy (down 40bp qoq) due to the expansion in overseas operations and the 70bp yoy (90bp qoq) increase in access costs. Moreover, the company made a provision of ~Rs104cr for additional spectrum payment expected to be made to the government on the expected revision in TRAI’s 2G spectrum-related recommendations. This led to a 90bp margin decline in 1QFY2011. Thus, the company’s overall margins (inclusive of India, South Asia and Zain African operations) during 1QFY2011 were affected due to its expansion and integration activities and lower RPM.

Low margins and high interest, depreciation and tax erode PAT

During the quarter, Bharti Airtel’s net interest payable (inclusive of interest cost on borrowings, investment income and derivative and exchange fluctuation expenses) stood at Rs420cr (inclusive of India, South Asia and Zain Africa) v/s net interest income of Rs128cr and Rs36cr in 1QFY2010 and 4QFY2010, respectively. The interest cost of Rs46cr attributable to 3G and BWA loans, however, stands capitalised due to its pending commercial launch. The net other income (inclusive of other income, share of associates profit and non-operating expenses) was slightly up at Rs24.4cr in 1QFY2011 v/s Rs18cr in 4QFY2010 and net loss of Rs2.1cr in 1QFY2010. The additional capex of Rs1,836.1cr incurred during the quarter resulted in higher depreciation cost, which was up by 32% yoy (14.8% qoq) in 1QFY2011. Further, the tax rate moved up at 18% in 1QFY2011 v/s 14.6% in 1QFY2010 and 14% in 4QFY2010. Thus, the company reported a 32% yoy (17.8% qoq) decline in the bottom line, including African operations, to Rs1,682cr; however, excluding African operations, the bottom line declined by only 23% yoy (6.8% qoq) to Rs1,905cr.

Like-to-like operational performance comparison in 1QFY2011

During the quarter, on a like-to-like basis, the company witnessed top-line growth of 8.2% yoy (4.9% qoq) to Rs11,273cr, while Zain Africa, which has been accounted for 23 days (June 8–June 30, 2010) in 1QFY2011 contributed Rs958cr to the top line. The EBITDA margin, excluding African operations, contracted by 360bp yoy (80bp qoq), which was lower as compared to a contraction of 518bp yoy (189bp qoq) witnessed in the margin of the combined operations (including Zain Africa and other holding companies in Africa). Therefore, higher acquisition-related costs incurred in 1QFY2011 had a major impact on the EBITDA margin of the company’s combined operations.

Further, higher interest costs on borrowings related to Zain’s acquisition impacted the company’s profit before tax, which was down by 22% yoy (6% qoq) in India and South Asia on a like-to-like basis v/s a 30% yoy (15% qoq) decline in profit before tax of combined operations in 1QFY2011. Thus, mainly on account of Zain’s acquisition and net loss of Rs224cr incurred in Africa in 1QFY2011, the bottom line declined by 32% yoy (18% qoq) in combined operations, while the bottom line on a like-to-like basis declined by 23% yoy (6.8% qoq).

Investment arguments

Expansion to give Bharti a strong foothold amongst peers

Bharti Airtel has successfully acquired Zain Africa’s operations, the integration of which is expected to be completed by December 2010. Through Zain Africa, Bharti Airtel has acquired 3G spectrum licenses in five out of the 16 African countries. Thus, the company sees Zain Africa’s operations comprising 16 African countries (including the newly acquired Seychelles for a cost of US $62mn, having US $19,500 GDP/Capita with a large roaming revenue base and EBITDA margin of 40%) as a strong opportunity.

Bharti Airtel has also successfully expanded its footprint in Sri Lanka and Bangladesh (through Warid Telecom) and plans to replicate its minute factory model combined with a low-cost structure in the newly acquired geographies of Sri Lanka, Bangladesh and Africa. The company will work on infrastructure sharing and forge contracts on a network utilisation-based model, much like it does in India to improve productivity and, thereby, the profitability of its African operations, which are currently reporting losses.

Un-tapped opportunities in the domestic market to aid growth

In the domestic market, the company plans to tap the less penetrated areas (value-added services) and the huge broadband space, as well as focus on the data and non-voice services in the mobile business segment. Management also plans to expand DTH and its newly launched digital media business operations. Further, the company is strongly focusing on growing its presence in rural areas and small towns, where the current tele-density is still low at ~20%.

Survival of the fittest, as hyper competition looms over the industry We believe the status of the Indian telecom sector would continue to remain challenging if operations continue at lower tariffs to combat hyper competition. Currently, on an average, there are 10–12 telecom operators per circle in India compared to 4–5 in the developed markets of US and Europe. The final verdict on the new 2G spectrum-related recommendations by TRAI is yet to be out, while the MNP has still not been implemented. Thus, we believe consolidation would be the right way ahead for the industry, and telecom service providers (TSP) such as Bharti Airtel that have strong market positioning and healthy financials would sustain the blows better than the smaller players, discarding unhealthy competition and promoting steady growth of the sector.

We believe the inflow from the 3G rollout would be a reliever to the current pain that the Indian telecom industry is going through; however, the same would take some time to add to the TSPs’ profitability in the earlier months once the rollout begins. The rollout is expected to happen from December 2010, with no clarity on the exact date of the rollout.

Outlook and valuation

We expect Bharti Airtel’s top line to witness a 28.5% CAGR over FY2010–12E, with strong addition in its subscriber base, including that of Zain Africa. However, RPM is expected to decline at a 15% CAGR in the same period. Thus, the bottom line is expected to decline at a 5.1% CAGR over FY2010–12E, mainly due higher interest outgo on debt raised for Zain and 3G BWA and opex required for integrating Zain’s operations during this period. In view of the recent underperformance on the PAT and RoE fronts, we have valued Bharti Airtel at ~17x FY2012E EPS of Rs21.3, in line with our Sensex target multiple of 17x (Bharti has traded at an average premium of 12% to Sensex average PE multiple during 2005–2010). Thus, we recommend an Accumulate rating on Bharti Airtel and maintain our Target Price of Rs360.