Bharti’s move seen as risky

Concerns include its funding for deal that could top US$20b if bidding war erupts

Bharti Airtel’s mooted African expansion will look to franchise a model that has made it the leader in the world’s fastest-growing mobile market, and diversify its exposure from an increasingly tough Indian market.

But analysts also see risks in buying into South Africa’s MTN Group – potentially India’s biggest foreign acquisition – with a lack of clarity over Bharti chairman Sunil Mittal’s plans adding to the uncertainty.

Concerns include: How would Bharti fund a deal that could top US$20 billion if a bidding war broke out; how would it integrate a similar-sized company and deal with regulators and customers in 21 countries; and will it be distracted from its home market just as significant changes are underway?

‘MTN is not a small company, and it’s not a cheap acquisition,’ said Rishi Sahay, director of IndusView Advisors.

‘The synergies are difficult to value as they’re different networks, different geographies, and they’re nearly the same size. So you may have to run it like two independent companies, and Mittal doesn’t have much international experience.’

Bharti Airtel, valued at around US$40 billion and more than one third-owned by Singapore Telecommunications Ltd and investment company Temasek Holdings, says it is in exploratory talks with MTN, but has not submitted an offer.

The Financial Times has reported Bharti has bid 165 rand per MTN share for a 51 per cent stake, valuing MTN at about US$37 billion, and has secured US$12 billion in financing.

‘It is more expensive to raise money today than it was a year ago, but maybe because M&A is cooling off elsewhere, it’s a good time for Indian companies to look at opportunities,’ said S Subramanian, head of investment banking at Enam Securities.

India’s wireless market, the world’s biggest after China in user numbers, grew 25-fold between 2002-07, ringing up record profits for telecom firms and attracting global players such as Vodafone, which last year bought a controlling stake in India’s third-largest mobile operator for US$11 billion. Local rival Reliance Communications Ltd is also expanding.

That stellar growth is expected to slow as the percentage of the population with a mobile phone tops 40 per cent by 2010 from 22 per cent now. As the telcos have to seek users in poorer rural areas to increase customer numbers, average revenue per user is likely to fall.

‘There has to be a natural limit to all this, because after a certain point of time, everybody who you think needs and can afford a phone, will have one,’ said Mahesh Uppal, director at telecoms consulting firm Com First.

‘We will have half a billion users by 2010, and after that I suspect the growth has to slow, because you are talking about really marginal users who will come into play.’

Competition is also getting tougher in India. The government recently awarded 120 new telecom licences and wants to allow users to retain their mobile number if they switch operators.

‘A few years down the line, growth opportunities in the Indian market could dry up and, therefore, the telecom companies will have to look overseas for expansion,’ said Yogesh Kirve, sector analyst with Anand Rathi Financial Services. ‘If you go for organic growth overseas, it will be very time consuming.’

If Bharti bought into MTN, which operates in Africa and the Middle East, the combined entity would today have 130 million subscribers, giving it significant leverage with equipment suppliers and handset vendors, UBS analysts said.

MTN had 68.2 million subscribers as of March, compared with Bharti’s 62 million. The South African firm’s annual revenue is US$9.6 billion, against Bharti’s US$6.7 billion, according to Citigroup.

‘We see little by way of synergy benefits,’ said Kawaljeet Saluja and Rohit Chordia, analysts at Kotak Securities.

‘More importantly, growth rates of MTN would be significantly lower than Bharti,’ they said, adding consensus forecasts point to 16.7 per cent annual growth in MTN’s operating profit over three years, compared with a compound annual growth rate of 31.7 per cent for Bharti over the same period.

One Mumbai-based analyst said that could be an opportunity Bharti was looking to exploit, leveraging on its success in India’s emerging market.

‘Bharti is one of the pioneers in bringing down tariffs sharply … yet maintaining strong margins,’ said the analyst, who asked not to be named because of company policy. ‘Once Bharti uses its own efficiency in MTN, the South African firm’s numbers will look much, much better.’

Exporting a business culture to another firm is easier said than done. IndusView’s Sahay said there were not many examples of successful mega telecom deals.

‘Look at Sprint, Nextel,’ he said. ‘However, if Mittal wants to play in the big league, he has to do a big deal. Telecom is so regulated, there aren’t many opportunities. So you don’t know when and where the next one will be.’ – Reuters

Bharti goes safari hunting

Bharti eyes 51% stake in MTN

The Financial Times reported that Bharti (SingTel’s 30.5% associate) has made a bid for control of Johannesburg-listed MTN, a major telco player in 21 countries across Africa and the Middle East. Bharti is said to have tabled an indicative bid of R165/share (MTN’s closing price at May 5 was R150/share) for a 51% stake. This values the 51% stake at US$19bn.

The acquisition will be funded by US$12bn in debt and the balance US$7bn by issuance of equity either to MTN shareholders or to institutions. Financial Times reported that the debt financing has been secured from Goldman Sachs and Standard Chartered. Merrill Lynch and Deutsche Bank are advising MTN, while Bharti is being advised by Standard Chartered. SingTel is being advised by Goldman Sachs.

MTN which has a market cap of US$37.3 bn operates across 21 countries across Africa and Middle East, serving 68m subscribers (Bharti has 62m subscribers). It has a revenue base of US$9.8 bn (almost 50% larger than Bharti) of which 66% comes from its operations in South Africa and Nigeria.

Comments

Positive move. While the initial market reaction to the deal was negative – Bharti’s share price fell 2.9% at market open on concerns of risk of overpaying and overstretching of balance sheet, we believe the deal should eventually prove to be positive for Bharti and ultimately for SingTel based on available information. Key reasons for our view: 1) Bharti evolves into an emerging market telco powerhouse; 2) accretive acquisition at fair valuations; 3) higher debt levels are manageable.

I. Bharti becomes an emerging market telco powerhouse. If the deal is successful, Bharti’s earnings base will potentially swell by 50% to US$2.5bn (2007 pro-forma) which at current trailing PE of 25x, translates into a multinational emerging market telco with a hefty US$61 bn market cap. The MTN acquisition will give Bharti strategic access to a robust portfolio of 21 telco markets in Africa and Middle-East. MTN’s 6 largest markets which contribute 82% to its total revenues enjoy a “top 2” market position (market shares range between 23-52%) in their respective markets. Growth opportunity is attractive. Blended penetration rate of markets
MTN operates in is 33% (ex-South Africa)/51% (including South Africa).

II. Accretive acquisition at fair valuations. At R165/share, MTN is valued at 15x CY09 PE (consensus estimates) and 7x CY/09 EV/EBITDA (consensus estimates). We do not consider these valuations excessive for a controlling stake. The deal is also likely to be accretive, ex-potential synergies. The 51% stake in MTN should increase Bharti’s earnings base by around 50% and this will offset the potential 15% dilution from the share issuance to finance the deal. We believe there are synergies and improvements that Bharti can bring to MTN based on its experience/track record in competing in a competitive but high-growth Indian market.

III. Higher debt levels manageable, not excessive. Bharti and MTN are currently under-leveraged with 2007 net debt/EBITDA ratios of 0.35x and 0.5x respectively. The US$12bn implies a proforma of the enlarged Bharti 2007 net debt/EBITDA of around 2.0x which we believe is manageable. EBITDA for Bharti and MTN are expected to grow by 18-33% respectively over the next two years according to consensus estimates. In addition, capex for Bharti and MTN have historically been internally-funded from free cashflow.

Is SingTel on board? We believe so. As a 30.5% stakeholder in Bharti, SingTel clearly has avenues to block the deal especially given the size of the acquisition. However, we believe that Bharti has obtained SingTel’s blessings before pursuing MTN. The appeal for SingTel would be an expanded footprint into Africa and Middle East via a leading player in the region, i.e. MTN.

SingTel’s top priority likely to be preservation of its 30.5% We expect SingTel to negotiate for a deal structure that will not be dilutive to SingTel’s stake in Bharti, i.e. no equity issuance to MTN shareholders but rather a capital raising exercise from current shareholders to co-fund the deal. Under this scenario, SingTel will be required to contribute US$2 bn (30.5% of US$7bn). SingTel has sufficient flexibility to make the contribution by raising debt. This could potentially raise SingTel’s net debt/EBITDA to around 1.5x (from 1.0x currently), at the low end of guided target range of 1.5-2.0x.

Potential walk-away price of R210/share. In a competitive bidding scenario, we do not rule out the possibility that SingTel may not be opposed to Bharti paying up to R210/share (27% above current offer of R165/share) for MTN where the deal is no longer earnings accretive on an ex-synergy basis. This is on account of SingTel’s position as a strategic investor and may be prepared to give up some near-term gains for attractive long term growth & synergistic opportunities.

Valuation and recommendation

Maintain Outperform with unchanged target price of S$4.45. The deal is a potential catalyst for SingTel’s share price. If the MTN acquisition is successful under current terms, it could add S$0.38/share to SingTel’s valuation assuming trailing PE of 25x on proforma 2007 earnings, net of acquisition debt. However, we caution that deal completion risk is high given that MTN has a fairly fragmented shareholder base (free float of just under 75%). We do not rule out the emergence of competitive bids. MTN’s two largest shareholders only have a combined stake of 26%. The next four largest shareholders are institutional investors with combined stake of 28%. Offer price will be the swing factor in winning acceptance from the four institutional investors. SingTel’s share price has not reacted to the news, hence we do not expect SingTel’s share price to be punished if the deal falls through. We see option value for in SingTel shares in light of this transaction and SingTel’s initial share price reaction.