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Bharti-Zain deal: Conference call extracts - Views on News from Equitymaster

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Bharti-Zain deal: Conference call extracts
Feb 26, 2010

The management of Bharti Airtel held a conference call yesterday to discuss matters relating to its proposed acquisition of Zain Telecom's African assets. The management touched upon matters relating to the rationale for the acquisition, why it believes the price it has offered is justified, and some of the plans it has to transform Zain's African operations. Rationale for entering Africa: Not long ago, in one of its earnings call, the management of Bharti Airtel had mentioned that the company had crossed its peak capex level in India. This was on the back of the company already having a pan India presence and as such costs and expenses towards the expansion and networks would not be similar to what they were in the past. In fact, Bharti Airtel has reached a position where it is now generating good amount of free cash flows. It is believed that the company is the only telecom service provider in India at present, which is in this position of generating excess cash from its business.

This is precisely one of the key reasons for Bharti to enter a new region. If all goes as planned, this would be the next growth phase for Bharti, which is currently trying to maintain its leadership position in India. The management has been studying the African market for a while now given that it has attempted to acquire another African telecom major MTN twice over the last one year.

Now, whether Bharti is in a position to make such a large acquisition is one key question that has been bothering investors in recent times. The company's management certainly believes so! In fact, the Chairman Mr. Sunil Mittal is of the view that the senior management at Bharti is competent enough to take its expertise, experience and knowledge of the Indian markets and use them to transform the operations of Zain Africa.

Bharti is the largest telecom player in India. It has been in existence for over a decade and a half, which gives it a good amount of experience. Plus, it is Bharti who pioneered the IT and network outsourcing model as well as the infrastructure sharing model, thus allowing the company to have one of the highest margins in the world (amongst telecom operators) despite offering the lowest tariffs in the world.

As per the company's management, this model is now being followed by many telcos – in India and in Africa. The 'minutes factory model', a model which aims at generating more minutes (of usage) by lowering tariffs (and in turn ARPUs) is something that the company would be trying to replicate in Africa. It must be noted that ARPM (average revenues per minute) in Africa are nearly 10 times of what they are in India. On the other hand, the average MOUs in that market stand at about 100 minutes as opposed to 440 odd minutes for Bharti in India. Thus there clearly is a huge amount of room for improvement!

In addition, it would also make sense for Bharti to acquire an already running and well established company rather than looking at starting from scratch (as it did in Sri Lanka). And this is especially for a large part of a whole continent, as opposed to just one country. As Bharti's management puts it, green field opportunities (in the telecom sector) in any part of the world are now history. This is indication for the new service providers in India who are trying to grow their subscriber bases purely by way of fighting a deadly price war. This we believe is unsustainable.

Rationale for Zain Africa's valuations: One reason Bharti is ready to pay an enterprise value of US$ 10.7 bn for this acquisition is that this will give Bharti full control of Zain's African operations as against the partnership deal that was intended to take place with MTN. Secondly, there is a huge amount of scope for improving the operations of Zain Africa. Thirdly, Zain Africa has strong presence in almost all the countries it is present. In ten out of the fifteen nations (that it is present in Africa), Zain is the market leader. In four countries, it is amongst the top three players. In Ghana (the fifteenth nation), it is the smallest player as it recently entered the market.

Another reason for such a valuation is the growth opportunity that Africa offers. Low penetration levels, higher tariffs and low usage (which the company plans to reverse going forward) are somewhat similar to what India was a few years ago. Africa is not really known for its high standard of living. As such, lower tariff rates would only increase affordability in the continent. This would lead to higher usage and a strong increase in subscriber base. In addition, as per the management, the assets that Zain Africa possesses are of high quality. Celtel, a company that was acquired by Zain, is considered to have the first mover advantage in the continent.

The synergies that this deal could offer would mainly be aimed at improving Zain's operations. The introduction of the 'minutes factory model' would be the main aim. This would be possible through cost optimisation at the capex and opex level, sharing of passive infrastructure model and overall rationalisation of overheads. These are likely to be the main areas of focus in order to transform Zain's operations. One should not ignore Bharti Airtel's marketing skills.

Funding the acquisition: Bharti is looking at funding this acquisition through a mix of debt and equity though nothing has been finalized as yet. However, as the management believes that the company has always been 'averse' to taking on big debt, over time it plans to reduce the same through internal accruals and equity. It must be noted that the latter (the equity portion) is only a possibility and not a confirmed plan. The company is also considering reducing the debt through listing its passive infrastructure company, Bharti Infratel. But again, this still remains a possibility.

Expansion into other African nations: Focus on expanding presence in other nations will only occur once the company has full charge of Zain's operations.

Africa versus India

  • The fifteen nations in which Zain Africa has a presence cover a population of about 500 m people. India's population is in excess of 1 bn.
  • Average penetration levels stand at about 35%, while in India they stand relatively higher.
  • ARPUs in Africa stand at about US$ 7 per month, as compared to about US$ 4.9 in India.
  • The ARPMs in Africa are nearly 10 times that of India.
  • The maximum number of operators present in a country is five as against over ten operators present in India.

What to expect?

Bharti's management is aiming at full integration within a period of about six months once the deal goes through. Apart from cost rationalisation, Bharti would also be looking to copy other aspects of its operations run in India. These include improving the distribution network, deeper network coverage, cost effective and better quality of customer service, product innovation (although Zain has a good product portfolio).

All in all, we believe that this acquisition could be the next growth driver for the company. As the company's management put it, it would prefer entering a under penetrated region such as Africa over acquiring some other telcos in India as it already has a pan India presence.

While the impact on the financials would be influenced by the debt the company takes on its books, it would be too difficult to say how things would look a year from now. We will discuss the financial aspects of this deal as and when more details are available. As of now, the management has just indicated that the combined entity has the potential to reach sales and operating profits of US$ 13 bn and US$ 5 bn respectively one year from now. Bharti's latest sales and operating profit figures are estimated at US$ 8.7 bn and US$ 3.4 bn respectively. It must be noted that the deal is still not final yet. However, the management does seem optimistic about it going through.

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