Bharti Infratel-Indus deal positive but Vodafone-Idea overhang a concern

Valuations a tad in favour of Indus; impact of Voda-Idea merger suggests tenancies to remain under pressure

The merger announcement of Bharti Infratel and Indus Towers had little impact on the former's share price, which fell one per cent, despite the benefits. Why?

Infratel would gain significant scale --- with 1,63,162 telecom towers, including 39,523 already owned, and 367,000 tenancies across all 22 service areas in India, it will be the largest tower company in the world, excluding China. And, with a simple operating structure, the merged entity could see benefits of scale for capex and maintenance, besides, savings on dividend distribution tax (of Rs 5 billion). 

On the flip side, some analysts are a bit surprised with the valuations. An analyst with a domestic brokerage, requesting anonymity, said, "The implied enterprise value-to-Ebitda for Indus is almost similar to Infratel, which was trading at 8.7 times on Tuesday's closing. This is marginally negative for Infratel."

The other reason for the muted reaction was that the deal was already known. It also comes when the telecom space continues to face headwinds. The exit of smaller players due to intense competition following Reliance Jio's launch has impacted demand for towers. Infratel saw its March quarter consolidated revenue rise four per cent over a year (compared to 7-11 per cent increase in each of the previous seven quarters), while operating profit was up 1.3 per cent over a year. Decline in tenancy (number of operators having active infrastructure on a tower) is one key reason. Analysts estimate Infratel's tenancy exits at 6.6 per cent in the past two quarters. This is also reflected in the fall in its share price over recent months.

Going ahead, the merger of Vodafone and Idea will also act as an overhang. "It will hit Bharti Infratel's ebitda by 13-18 per cent but we have not accounted for this in our estimates due to lack of clarity on timeline and mutually agreed long-term tenancy structure," said Emkay Global's analysts on Tuesday. 

Some of this impact will get offset by penalties if operators choose to exit early. Moreover, there is demand from Jio and Bharti Airtel (which will own 37 per cent in the merged entity). Emkay estimates 7,000 and 5,700 tower additions for Infratel for FY19 and FY20, respectively.

Importantly, demand for data continues to surge. This, coupled with new technology roll-outs such as 5G (besides Wi-Fi), Smart City projects, etc, suggest incremental demand for towers, even as if not at a frantic pace. The surprise would be if service providers draw up aggressive capex plans, or if Infratel can curb costs sharply, as in the March quarter.

Kotak Institutional Equities’ analysts made an observation in a recent report: “Tower firms face risk from the continued large losses in the wireless telecom industry, which may force service providers to renegotiate lease rentals with tower companies.” This suggests, unless the financial health of operators improves reasonably, it may reflect on tower players too.