Bharti Infratel is a cash flow story – Subscribe says Nirmal Bang

Bharti Infratel (BIL) is raising over Rs 4,000 crore from the primary equity market to build new towers, to upgrade existing infrastructure and to set up environmentally friendly energy sources at tower sites. Of the 18.9 crore shares to be offered to the public, 14.6 crore will be fresh equity and the remaining will be offloaded by private equity firms which currently hold a stake in Bharti Infratel. 

The IPO will open for subscription on December 11 and will close on December 14. The company has fixed a price band of Rs 210-240 for the offer

Nirmal Bang, among the top brokerage and research firms in India recommends investors to subscribe to this issue….

Here is summary of the report...

A Cash Flow Story...

BIL is a cash flow story, in our view. We expect rising tenancy to boost profitability going forward and subsequently FCF as well. The likely rise in tenancy ratio (from 1.85x in FY12 to 3.00x in FY22E) will boost EBITDA margin (excluding energy costs) from 58.3% in FY12 to 74.4% in FY22E. As regards capex, we expect a steady decline in capex intensity owing to slowing tower rollout and greater focus on tenancy, with capex as a percentage of revenue likely to decline to 5% in FY22E from 13.1% in FY12. This is likely to lead to strong growth in FCF, from Rs12.7bn in FY12 to nearly Rs80bn in FY22E.

Based on our DCF calculations, fair value of BIL is Rs278, implying a 32% upside from the lower end and a 16% upside from the upper end of the IPO price band.

Blue-chip client base drives confidence on revenue, cash flow predictability: BIL has a blue-chip client base, with Bharti Airtel (directly), Vodafone India and Idea Cellular (indirectly) accounting for a major portion of tenancy and revenue.

For 1HFY13, Bharti Airtel accounted for 62.1% of BIL’s standalone revenue, while for associate company Indus Towers, Bharti, Vodafone and Idea accounted for a lion’s share of revenue. Going forward, given that Bharti is the majority shareholder in BIL and with Bharti, Vodafone and Idea being majority shareholders in Indus, it is more likely that these operators will route their expansion plans through BIL and Indus rather than through rival tower companies. This is a key factor that drives confidence on revenue and cash flow predictability for BIL.

RoE to get a boost from lower interest costs, higher profitability: In FY12, BIL’s RoE stood at a low 5.3%. This was on account of low interest burden ratio (81.2%) and lower EBIT margin (14.7%). Going forward, we expect RoE to inch up, aided by falling interest costs (leading to higher PBT/PBIT ratio) and rising EBIT margin due to higher tenancy ratio.

We expect interest burden ratio (PBT divided by PBIT) to rise from 81.2% in FY12 to 99.1% on FY22E, and EBIT margin to touch 44.3% in FY22E (14.7% in FY12), thereby leading RoE to rise to 19.0% in FY22E.

Outlook and valuation: We have valued BIL via the DCF method. Given good revenue predictability owing to the long-term nature of MSAs, improving margins due to higher tenancy ratio, falling capex intensity and rising FCF, we believe DCF is the best way to value a tower company like BIL. Our WACC is 12.7% owing to low debt-equity ratio of 0.2x, with post-tax cost of debt at 7%. We assume 0.8x  beta, which is the average of the betas of global peers American Tower, SBA Communications and Crown Castle. We take 8% as risk-free rate and 8% as equity risk premium. Thus, cost of equity (CoE) works out to 14.4%. We assume 3%

terminal growth.

Thus, present value (PV) of FCF until FY22E works out to Rs270.7bn, while PV of the terminal value is Rs254.6bn, implying total EV of Rs525.4bn. Adjusted for net debt, total equity value is Rs556.4bn, implying a fair value of Rs278. This implies a 32% upside from the lower end and a 16% upside from the upper end of the IPO price band. Therefore, we recommend investors to subscribe to the IPO.

Company Background

Bharti Infratel is a provider of tower and related infrastructure and on a consolidated basis, it is one of the largest tower infrastructure providers in India, based on the number of towers that Bharti Infratel owns and operates and the number of towers owned or operated by Indus, that are represented by Bharti Infratel’s 42% equity interest in Indus. The business of Bharti Infratel and Indus is to acquire, build, own and operate tower and related infrastructure. Bharti Infratel and Indus currently provide access to their towers primarily to wireless telecommunications service providers on a shared basis, under long-term contracts and we believe that there exists the possibility of providing additional services such as signal transmission and first level maintenance services in relation to customer equipment at towers. Bharti Infratel’s and Indus’ three largest customers are Bharti Airtel (together with Bharti Hexacom), Vodafone India and Idea Cellular, which are the three leading wireless telecommunications service providers in India by wireless revenue. (Source: TRAI)

Bharti Infratel has a nationwide presence with operations in all 22 telecommunications Circles in India, with Bharti Infratel’s and Indus’ operations overlapping in four telecommunications Circles. As of September 30, 2012, Bharti Infratel owned and operated 34,220 towers in 11 telecommunications Circles while Indus operated 1,10,651 towers in 15 telecommunications Circles. With Bharti Infratel’s towers and Bharti Infratel’s 42% interest in Indus, it has an economic interest in the equivalent of 80,656 towers in India as of September 30, 2012.