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Can Bharti reconnect with investors again? - Views on News from Equitymaster

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Can Bharti reconnect with investors again?
Nov 5, 2009

"The industry is currently at an inflection point." This is how the management of Bharti Airtel chose to describe the current environment of the India’s telecom sector. We believe it described the situation in such a way given the intensive price war that the industry is facing currently. In simple terms, the commotion within the industry is on account of the following reasons –

  • Falling tariffs (the price war between players),

  • Increasing competition (new players stealing the limelight),

  • Introduction of per second billing plans,

  • Continuous (and sharp) decline in the key industry figures - average revenue per user (ARPUs), average rates per minute (ARPMs), minutes of usage (MOUs), and

  • Monsoon effect (on rural India) leading to lower consumption and subscriber additions.
With so many factors coming into play, it is quite obvious that the dynamics of the industry have changed. This especially holds true when compared to the scenario that was prevailing about five to seven years ago, when the now well-established players ruled the roost, as they spread their presence across India at a steady pace.

Now, the newer entrants are trying to do something similar. But all this at a much quicker pace! With spectrum available and funding not being much of a problem (selling stake in their businesses or tying up with international players), they have been launching their services in various circles, trying to get their share of the pie.

But what good would a pie be if it is already gobbled up by someone else? What we are referring to is that the newer players are offering services in areas where the penetrations levels are quite high. If they were not, why would the bigger boys increase focus on the rural markets?

As put by Bharti’s management, all that the new entrants have to offer is the lower price as opposed to a complete customer experience. And if one thinks about it, it does make sense. Why would one want to shift to another service provider if he or she already has an existing connection? It would only be to take advantage of the cheaper outgoing call rates that the new operators are offering. No one can really be compared to service providers like Bharti and Vodafone when it comes to value added services.

This is where the factor of customer quality comes in. The newer players have launched their services mainly in larger cities or urban markets. Naturally, customers in these circles would be relatively less price conscious as compared to those from the rural markets. With call rates of the industry already being at such low levels (lowest amongst the world in fact), the amount a consumer would end up saving would not be a substantial. As put by the Bharti’s management, the new players are getting hold of subscribers which are low on the value chain – those that will change loyalty at the drop of a hat.

This doesn’t seem sustainable and is likely not to augur well for the new players in the long run. In addition, the high ARPU customers still lie with the incumbents such as Bharti and Vodafone.

One should also not ignore that fact a handful of new operators are facing operational losses. Key reasons for the same include offering very affordable (and unviable) tariff plans and high marketing and branding costs in order to spread awareness. Industry veterans expect these small players to phase out over time as their losses will mount and eventually they will end up being acquired or end up shutting down. As such, the phase of industry consolidation is not very far away. And it is very likely, or let us say, it is only possible for well established players such as Bharti to emerge fitter and stronger from this.

Impact on Bharti of the price war
Considering all that is happening in the telecom space, we have had to rework our forward estimates for Bharti, though not by a meaningful extent. We expect the company’s subscriber base to increase at a compounded growth rate of 23% over the next three years, which remains same as our earlier estimates. However, we have taken a significantly large hit on ARPUs. We expect a 20% reduction on blended monthly ARPUs for FY10 and a 10% YoY fall in the year after. In absolute numbers, we believe that company will clock average ARPUs of about Rs 240 a month during FY10 and Rs 216 in FY11.

With all these factors put together, we assume Bharti’s mobile revenues to grow at an average annual rate of 11% over the next three years. While most of the growth of this segment will be driven by volumes, we expect the company to maintain the highest operating margins within the sector. As mentioned by the company’s management, it is not looking to match the lowest denominator in terms of tariffs. Instead, it will compete with the top three players.

As far as the other businesses are concerned, we believe they will grow at a steady pace going forward. With revenues of these segments (enterprise and broadband services) dependent on the business environment, as and when the activity picks, so will their demand.

Considering the above-mentioned rationales, we have revised our numbers for the company. We now expect the company to grow its revenues at an average annual rate of 13% over the next three years. We have downgraded our revenue assumption by approximately 11% to 14%. In addition, we have also assumed a slight hit on margins and expect Bharti to clock operating margins of around 39% during the next three years. As far as the net profit growth goes, we expect the same to grow at an average annual rate of around 13% over the next three years as compared to our earlier estimate of an average annual rate of 16%.

What to expect?
At a price of Rs 315, Bharti’s stock is trading at a multiple of just about 10.7 times our estimated FY12 earnings. We believe this is a fantastic opportunity, especially for long terms investors to get their hand on a great and well established business such as Bharti. We recommend investors to take full advantage of the recent drop in share prices and buy the stock at these levels.

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