Bharti Infratel: Strong tower base, stronger tenants

With the recent Reliance Jio deal and likely roll-outs by operators set to support data growth, expect Bharti Infratel to improve operational performance

In the past month, the Bharti Infratel stock rose about 20 per cent due to better prospects after the recent telecom spectrum auctions, the implementation of the its agreement with Reliance Jio and a good December quarter performance. The immediate trigger for the surge was the signing of the master services agreement that would enable Reliance Jio to launch its telecom services across India by utilising Bharti Infratel’s tower infrastructure.

Analysts at IDFC Securities estimate the deal to improve tenancies from the current 1.89 times to 2.05 by the end of FY16, and this will contribute to the company’s financials.

Another area of growth will be the uptick in data services resulting from 3G networks. Jaideep Ghosh, partner, KPMG India, says, “With the increasing smartphone penetration, the demand for data and lowering of 3G rates, it is expected 3G will see significant uptake in the next three-five years.” Given the 3G/4G rollouts, he expects the tenancy ratios of tower companies to increase to 2.1-2.2 from the current 1.8.

Given the potential roll-out of the Reliance Jio network and the incremental tower additions to augment 3G/4G capacity by other operators, analysts believe Bharti Infratel, with its own tower assets and a 42 per cent stake in Indus Towers, will be a key beneficiary. Kotak Institutional Equities’ Rohit Chordia and Shyam M say, “With the assets already in place, tenancy-driven growth will improve asset utilisation and drive strong incremental Ebitda (earnings before interest, tax, depreciation and amortisation) growth and free cash flow generation for Bharti Infratel.” For FY16, most analysts have increased their Ebitda margin estimates for the company by 100 basis points and earnings about six per cent.

It is this expected improvement in operational and financial metrics that has helped the only listed player in the telecom tower segment gain ground, even as the rest of the telecom services pack has seen some price correction. Most analysts are positive on the stock. According to Bloomberg, of the 26 analysts tracking the stock, 20 have a ‘buy’ rating, with six have ‘hold’ and ‘no sell’ calls, with consensus target price of Rs 206. While the business case is strong, considering the sharp rise in the stock and the limited upsides, investors are better off picking the stock on corrections.

The Reliance Jio deal
While the two companies have not disclosed any details, Kotak analysts estimate through the next few years, Reliance Jio will have to roll out about 100,000 cell sites for its service offerings. With the pact with Reliance Communications (RCom) accounting for 45,000 towers, Bharti Infratel (along with Indus) is likely to host Reliance Jio in about 50,000 towers which, on a consolidated basis, will mean 25-30,000 towers for Bharti Infratel. The pricing will be arm’s length, based on prevailing market rates.

For Bharti Infratel, the average realization/tower is about Rs 38,000 a month/tenant. IDFC Securities analysts say this is significantly higher than the Rs 15,000-20,000 a tenant/ month implied in the deal between Reliance Jio and RCom. Analysts say the market rate will be about Rs 30,000.

Operational gains
On the operational front, rental revenue growth of two per cent in the December quarter on a sequential basis was good, considering in the previous three quarters, it was below one per cent. Also, the tenancy ratio improved from 1.93 to 1.96 on a sequential basis, the second consecutive quarter of improvement, driving Ebitda margins by 130 basis points quarter-on-quarter to 41.4 per cent.

The company has to ensure higher incremental tower additions which, on a consolidated basis, grew less than a per cent. The company’s consolidated tower base is pegged at 82,000, of which 35,000 are standalone. Given 40 per cent of towers have single tenants, there is scope for improvement in the tenancy ratios, driven by infrastructure sharing and the requirement for data rollout. HSBC analysts say data revenues still account for 10 per cent of the revenues for big players who have not been very aggressive with their data rollout. They believe the rollouts will increase once revenue contribution reaches the critical threshold of 15 per cent. While the 3G customer base for companies such as Bharti Airtel has been increasing 80 per cent year-on-year and data usage 50 per cent, the requirement for towers, especially beyond metros, is likely to increase. So far, given the data requirement has been restricted to large cities where tower infrastructure (2G towers) is already available, higher tenancies have not resulted in new tower roll-outs.

As the impact of higher tenancy and increased tower base kicks in, expect faster growth in the company’s profits. Bharti Infratel, which is generating positive free cash flows (post capex), has very low debt (debt-equity of 0.38 times, as of September 2013) and a good amount of cash and bank balance on its books, is comfortably placed to tap the coming opportunities. Effective use of cash will also ease investor concerns over the surplus cash.