>INDIAN TELECOM SECTOR (ICICI DIRECT)

Mounting subscribers; waning earnings quality

The Indian telecom industry has grown more than 12 times in five years, from just 33 million subscribers in 2004 to 386 million in 2009. Even at its current size, it proved to be fairly immune to the current economic slowdown with 11% of total base being added in the last quarter of FY09. Today, the industry is at a crucial point with over 50% of net adds coming from rural India. With one of the lowest ARPUs globally, volume growth would be the revenue driver for the industry. We are bullish on the growth momentum. However, at current levels valuations look stretched. We advise cherry picking in the telecom space with preference for companies with higher operational efficiency, low leverage and strong balance sheet. We are initiating coverage on Bharti Airtel with HOLD rating and on RCom and Idea Cellular with UNDERPERFORMER rating.

■ Fast-track subscriber growth
Mobile subscribers have grown at a CAGR of 63% from 33 million in 2004 to 386 million in 2009. With newer licenses being granted and a host of new policy initiatives like MNP and MVNO, this figure is set to grow further. We expect rural penetration to fuel the future growth with subscriber base reaching 654 million by 2012, at a CAGR of 19.2%. However, the quality of new additions remains a concern and falling ARPU, MoU & ARPM could dent the margins, going forward.

■ Passive infrastructure – value unlocking
By 2012, we expect the tower base to increase nearly 1.5 times from existing ~2.86 lakh towers with 90% population being covered as compared to ~60% in FY09. Penetrating further into rural areas while maintaining financial viability would require aggressive passive infrastructure sharing. Moreover, we expect new telecom operators to use the infrastructure of existing tower companies. Incumbent operators would benefit by renting out tower services to competitors.

■ Declining margin
With increasing competition, renting of passive infrastructure, 2G network expansion and rollout of 3G, we expect margins across players to decline in the mobile segment. However, with robust
growth coupled with increasing margins in the non-telecom business, integrated players like Bharti and RCom will be able to arrest the decline in overall margins to a certain extent.

Outlook and recommendation
Indian telecom companies are currently trading at 20x FY10E earnings. Although lower than their historical multiples, the valuations looks stretched given that the benchmark index is trading at 17x and telcos in other emerging markets are trading in the range of 12-14x FY10 earnings. We do not believe this premium is justified. While we believe subscriber led volume growth will continue to be
robust in the foreseeable future, it may not translate into a commensurable EPS growth for all companies. We advise cherry picking among telcos with preference for companies with good quality of earnings, higher operational efficiency, low leverage and strong balance sheet. We initiate coverage on Bharti Airtel with HOLD rating and on RCom and Idea Cellular with UNDERPERFORMER rating.


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