>BHARTI AIRTEL: Proposed Zain acquisition: Banking on execution (EDELWEISS)

Bharti Airtel (BHARTI) is in exclusive talks with Zain till March 25, 2010, for purchase of Zain’s African assets for an EV of USD 10.7 bn.

■ Zain Africa: Growth opportunity, though some uncertainties
Zain has presence in 15 African countries with an overall subscriber base of ~41.9 mn in September 2009. Stake in Zain will provide BHARTI entry into the highgrowth African market with 8 of 15 countries of operation at sub-35% teledensity, ~50% higher average ARPU than BHARTI’s India ARPU, and lower competitive intensity. While we believe there are long-term strategic benefits for BHARTI-Zain, integration challenges and regulatory risks are a concern.

■ Emulation of domestic ‘minutes factory’ model to drive growth, efficiencies
We believe there is considerable scope for value addition by BHARTI in Zain. Zain’s lower profitability vis-à-vis BHARTI, despite 50% higher ARPUs, indicates scope for opex rationalisation. Management highlighted that current tariff levels in Africa are ~10x BHARTI’s India tariffs, while MoU is less than 1/4th of BHARTI’s India MoU. The strategy is, therefore, to emulate the domestic ‘minutes factory’ model by lowering tariffs to spur usage and improve market share and profitability.

■ Premium valuations but long-term strategic benefits
Based on the deal size of USD 10.7 bn (implied EV/sub of ~USD 255 and EV/EBITDA of 8.9x), BHARTI’s offer for Zain was at ~20% premium to the former’s valuations at the time of deal announcement. If funded through debt, BHARTI would need to raise ~USD 8.3 bn which could hit FY11 earnings by ~20%. We believe the recent ~10% erosion in BHARTI’s market cap likely reflects concerns on the valuation premium for Zain and the near-term dent on earnings. We see material synergies arising via opex/capex efficiencies post integration of Zain.

■ Outlook and valuations: Execution is key; reiterate ‘BUY’
With competitive pressures mounting in the core domestic business, we believe the proposed Zain acquisition is a strategic positive for BHARTI given: (1) scope for higher growth opportunity; (2) material synergies for BHARTI-Zain combine; (3) high FCF generation in domestic operations to aid expansion; and (4) strong management execution capabilities (commendable execution in the Indian market driven by scale and innovations such as outsourcing of network and IT requirements). We do not rule out near-term overhang on the stock owing to integration uncertainties besides a tough domestic industry environment and imminent 3G auction. We maintain ‘BUY’ on the stock and rate it ‘Sector Outperformer’ on relative return basis. Our earnings estimates remain unchanged as the deal is yet not closed.

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