>INDIA WIRELESS (MACQUARIE RESEARCH)

Disruption first, consolidation later

Event
■ Downgrading sector and stock views: We have been caught by surprise by the tariff announcements in the last two days – by the extent of cuts, the timing and the need for such severe cuts at one go without really testing the resultant elasticity. We downgrade our sector outlook to Underweight, as we foresee inevitable competitor responses likely in a matter of days, in different shape and form, from Bharti Airtel, Vodafone Essar and Idea Cellular. While longer-term value may well emerge, the likely barrage of competitor responses and associated negative noise will likely cap any meaningful near-term re-rating. We thus recommend that investors avoid Indian telecoms, as a dynamic game of price positioning plays out over at least the next two to three quarters. We cut earnings and target prices across the board and downgrade Bharti to Underperform. We maintain our Underperform ratings on Idea and MTNL.

■ Within the sector, we see relative value in the most efficient player – Bharti: This rapid rebasing in pricing by an incumbent (as announced on Monday) will seriously affect and threaten smaller, regional and startup operators, perhaps shortening the period before which industry consolidation inevitably takes place. While we would view this as ultimately a structural positive for Bharti, which we believe is the best positioned of all the operators to weather an intense period of irrational price competition, the timing of possible industry consolidation is too uncertain to consider this in our investment recommendation.

Impact
■ Price cuts and promotions are not new in Indian wireless; what is new is that one of the three wireless incumbents has done it: This marks a major shift in industry dynamic and is fundamentally different from a smaller, unprofitable player resorting to price cuts (which we had anticipated earlier).

■ Price plans of all kinds are being tried out, all having a dilutive impact on ARPM and, more important, ARPU as MoU elasticity is not evident: Tata DoCoMo launched a per-second pricing plan on GSM and a fixed price per call on CDMA (unlimited duration per call) in July 2009, and now we have a flat rate per minute tariff offering. The other key tariff positioning is an ‘unlimited bucket plan’ offer that is seen in many other markets but has not been seen in India. However,the large GSM incumbents may be capacity-constrained on 2G. However, that may change if 3G spectrum is awarded. Without 3G, however, the response from incumbents may be focused on on-net calls to prevent the existing subscriber base to move away to the competition. The lack of MoU elasticity is a key driver of our downgrades in the sector.

Outlook
■ We cut Bharti’s EPS by 12.5%, 27.5% and 28.7% for FY10E, FY11E and FY12E, respectively, with a new DCF-based TP of Rs320 (FY3/11E PER 12.8x), down from Rs525. We cut Idea’s EPS by 37%, 86% and 72%, respectively, with a new TP of Rs35, down from Rs70. We build in sharp drops in ARPM (16% for Bharti, 18% for Idea) in the current quarter. If Bharti stock were to go down to around Rs300 (FY11E PER of 12x), then we think longer-term investors should start to accumulate. However, value arguments in near term will hold little weight as the likely rounds of competitive responses play out in the next two to three quarters.

To see full report: INDIA WIRELESS