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Bharti: First mover advantage backbites! - Views on News from Equitymaster

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Bharti: First mover advantage backbites!
May 12, 2010

As we write this article, telecom major Bharti Airtel's stock is trading lower by around 8%. Considering that we have been positive on the prospects of the company from a long term perspective, the only logical thing we believe for you to do is to take advantage of this decline. But anyways, this time it can be somewhat tricky. Before we get into our view on the stock, let us discuss what hit Bharti's stock today.

The 3G spectrum auctions have been a success so far. This has led the government now getting to know the ‘real worth' of spectrum! The Telecom Regulatory Authority of India (TRAI) has thus suggested to price 2G spectrum at similar levels of 3G spectrum. This in itself is a big question mark in terms of the price justification. This we say because the services that the 3G spectrum can offer would be far better than what services a telecom operator can offer with 2G spectrum. By services here, we are talking about the overall data transferability, clarity, amongst others.

Secondly, incumbents such as Bharti Airtel, Idea, Vodafone which have been in operation for a while now hold spectrum in excess of the startup spectrum (6.2 MHz) that is allotted for free on acquiring a telecom license. Now since these companies hold spectrum in excess of 6.2 MHz in many circles, the TRAI has recommended that they fork out a one-time fee to continue holding this excess spectrum. This is more of a retrospective effect. A leading business daily has reported that this amount could be in the range of Rs 112 bn.

In addition to this, the licenses for players such as Bharti and Vodafone are due to expire in some circles in 2014. As such, not will they only have to bid for new spectrum at high prices, but also for the additional spectrum that they wish to hold.

Apart from these proposals, the TRAI has also tried to make changes to the 2G spectrum allocation procedure. The allocation for 2G spectrum has been on hold as there have been some alleged irregularities in the allotment of 2G spectrum in 2008. The CBI is currently investigating this matter.

Earlier, spectrum was being allocated to operators based on the numbers of subscribers they had. The TRAI is now proposing an allocation method depending on the roll-out plans of telecom companies. This means that those companies (mainly the new entrants), who hold less that 6.2 MHz of spectrum will be allotted spectrum at no additional costs. It is believed that most of the new companies hold spectrum of 4.4 MHz. Second preference will be given to the incumbents and third to the players who hold licenses but no spectrum.

Any company wishing to hold spectrum in excess of 6.2 MHz will have to shell out more depending on the 3G spectrum prices. As obvious as it may be, for operators to grow revenues, they will have to increase their subscriber base. Once they have a large enough subscriber base, they would require more spectrum. This would lead them to pay a huge amount, keeping in mind the price that 3G spectrum is currently garnering.

The TRAI has also recommended changes to the merger and acquisition (M&A) policy of the telecom sector. As per the recommendation, it has removed three-year lock in period for promoters. This comes in as good news for the industry. Good news because this measure would lead to consolidation, thereby lowering the number of players to a lower single digit from the current situation of about 10 players in various circles. However, there's a certain clause to this. The total spectrum held by the combined entity cannot exceed 14.4 MHz/10 MHz (for GSM/CDMA respectively). And if it holds spectrum in excess of 6.2 MHz, the applicable one time charge would have to be paid.

It may be noted that Bharti Airtel in its latest conference call had said that it would not be interested in acquiring a domestic company for one key reason – the financial performance. While it would allow the company to garner some spectrum, it would not add a huge amount of subscribers to its subscriber base (this is considering it would be looking to buyout a small sized player). As it is the company has its hands full with the Zain Africa acquisition.

The TRAI has also said that there should be a restriction on the combined entity getting over 30% of the total subscribers or revenue in any circle. Another reason why Bharti would not qualify for M&A as it has a revenue market share of about 32%.

However, this measure does open up options for other mid to large sized players such as Idea and Reliance Communications.

Conclusion

First of all, it must be noted that these recommendations are only proposals. As such, whether the Department of Telecom accepts all or certain recommendations is something that needs to be seen. However, in the mean time, the main question is whether one should take advantage of this sharp decline in Bharti's stock.

The fact that Bharti is a positive cash flow generating company is a big advantage for it. Yes, there are large expenses that the company needs to make in the short term. This includes the Zain acquisition cost and the cost for acquiring 3G spectrum. And if it has to pay an extra amount for usage of 2G spectrum, it would definitely put an additional burden on the company. For meeting all of these obligations it would have to take on a substantial amount of debt, which will somewhat strain its balance sheet and its future financial performance.

However, we still believe that from a long term perspective i.e., 3-4 years, it is Bharti that will continue to lead the telecom market and will remain the strongest player. We would thus advise investors with a similar horizon to take advantage of the decline in the stock's price.

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