Sunday, October 3, 2010

>TELECOMMUNICATION SECTOR: The next round gets tougher

We maintain our medium-term cautious view on the telecom sector and downgrade Bharti
Airtel (Bharti) to ‘HOLD’ and Reliance Communications (Rcom) to ’REDUCE’. We maintain
‘HOLD’ on Idea Cellular (Idea) and ‘BUY’ on Tulip Telecom (TTSL). We anticipate tariff wars
to re-emerge with the implementation of Mobile Number Portability (MNP) and launch of 3G services. We believe, Bharti’s dominance in revenue market share and margins will be challenged by Idea, Aircel, and Tata Docomo. The entry of MVNOs will further make the market competitive. Over the longer term, we believe, the sector will witness de-leveraging of balance sheets and sustenance of healthy cash flows. But, at current valuations the street is in for a disappointment.

Resurgence of competitive intensity likely
In the past 10 months, headline tariffs have been stable, but revenue per minute (RPM)
has declined 22%. With implementation of MNP and launch of 3G services, we anticipate
re-emergence of tariff wars. In our view, Idea, Aircel and Tata Docomo will utilise the
MNP opportunity to target Bharti’s and Vodafone’s high usage customers. As per media
reports, the government is planning to allow entry of MVNOs, which will make the
market more competitive. Thus, Bharti’s dominance, with 32% revenue market share will
be severely challenged.

Margins to remain under pressure
MNP implementation and launch of 3G services will lead to escalation in costs. We
believe, the entry of MVNOs will lead to further pressure on business for incumbents.
While on one hand tariffs will be under pressure, on the other, we expect network
operating costs and customer acquisition/retention costs to escalate. This, combined with
expensing of interest cost and amortisation of 3G licence fee will lead to lower
profitability. In our estimate, Bharti will have to generate incremental ARPU of INR 622
per month from 3G services in Mumbai to breakeven and INR 800 to defend current

No meaningful consolidation expected
Street is expecting consolidation in the sector. We believe, a shake-out is imminent in
the new operator segment. Post-consolidation we expect the current top 7 operators,
who control 98% of industry revenues to continue. Thus, consolidation will not be

Tower and handset businesses offer attractive alternate options
The tower industry is fairly consolidated with five players mostly fulfilling infrastructure
requirements of telecom operators. We expect the tower industry to generate revenue of
INR 191 bn and EBITDA of INR 112 bn in FY12E. The handset industry, riding on
significant growth in subscribers, is expected to sell 295 mn handsets and report
revenues of INR 286 bn in FY12E.

Valuations and view: Await a better entry point

Bharti and Idea stock price has risen 40% in the past three months due to investor
optimism on stable tariff environment and as the stocks have under performed the broad
indices over the past two years. We don’t believe tariff wars have ended. Bharti is
trading at similar valuations as it did when its stock price peaked in February 2008
despite higher competitive intensity in business and inferior financials. We downgrade
Bharti to ‘HOLD’ and RCOM to ‘REDUCE’. Maintain ‘HOLD’ on Idea and ‘BUY’ on Tulip

To read the full report: TELECOM SECTOR