>MTNL (HSBC)

Downgrade to UW (V); Why give scarce 3G spectrum to MTNL?

• Q1-FY10e results weak; labour costs drive EBITDA negative; we lower our estimates significantly
• We believe MTNL has no viable 3G business case; government better placed to auction scarce 3G spectrum to private telcos
• Downgrade from N (V) to UW(V); reduce TP to INR52 (INR77) as we factor the likely payout for 3G spectrum auctions.

MTNL reported a lacklustre Q1, posting a net loss of INR468mn with revenues declining by c12% sequentially. ARPUs were down c4% q-o-q while EBITDA margins remained in negative territory on higher labour costs (57% of sales). In our view, most investors are focussed on the merger with sister company BSNL (Bharat Sanchar Nigam Ltd, N/R) rather than on earnings. We note that the merger of MTNL with sister company BSNL is dependent on the listing of BSNL and is at least 12 months away in our view, given the priority for 3G and 2G spectrum policy. We believe the disagreement with labour unions as key obstacle to BSNL’s listing.

The continued poor financial performance of MTNL in our view reflects the absence of a
longer term strategy and execution. As per news reports (Economic Times, 20 July 2009)
MTNL is in the process of inviting bids from global telcos to run its 3G operations in Delhi
and Mumbai on a franchise basis for a 10 year period ; a clear acknowledgment in our view of
its poor execution capabilities. However, we believe the chances of MTNL to benefit from
such a structure will be restricted as the state owned enterprise culture of MTNL get in the way
of foreign telcos, restricting their ability to deliver. We believe 3G services require aggressive
marketing capabilities and product innovation, which in our view cannot be delivered by
MTNL in its present form.

Given the scarcity of 3G spectrum in metros, we believe the Indian regulator should
auction it to private players. In our view, the Indian regulator’s objectives of low tariffs
are best delivered by auctioning spectrum among private players.

Valuation and risks- We continue with our approach of valuing MTNL based on its cash
balance, but now are adjusting for the potential payment for 3G spectrum auctions. We are
reducing our TP to INR 52 (INR77) to adjust for the likely payout for 3G auctions and our
new target price leads us downgrade from N (V) to UW (V). The potential merger with its
sister company and the monetization of tower assets represent upside risks to our view.

To see full report: MTNL