The Bharti Tele-ventures initial offer may well be the biggest public issue in recent times, but it definitely doesn't promise big gains
Notwithstanding the gloomy primary market scenario, the Delhi-based Bharti Tele-Ventures Ltd.(Bharti) is all set to tap the capital market with a mega public offering of 18.53 crore equity shares. The sheer magnitude of the issue has created ripples in the market. More so, as a positive response to the issue could set the undertone for the much-awaited revival of the primary market.
The enthusiasm also stems from the fact that the Bharti group is one of the few fully integrated and reputed players in the Indian telecommunications landscape.
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Although its approach has been mainly focused on developing a seamless nationwide footprint in cellular services, it has a strategic interest in fixed-line, national long distance (NLD) and broadband services. It also is a serious contender for the international long distance (ILD) telephony services. Except for Reliance Group, Bharti is the only private sector player addressing the entire gamut of telecom services in India.
Bharti Tele-Ventures was incorporated in 1995 as a special purpose vehicle to hold Bharti's equity interest in diversified telecom services projects. The group has unified its businesses under four companies -- Bharti Cellular, Bharti Telenet, Bharti Telesonic and Bharti Broadband Network -- all of which are 100 per cent subsidiaries of Bharti Tele-Ventures.
Issue objective
The proceeds from the proposed public offer will be utilised to part-finance the Rs 3,450 crore expansion plans of the company. As part of its ambitious expansion plan, the group has acquired licences for nine new cellular circles, including restoration of the Punjab circle.
This will give the company a foothold in 15 of the most sort-after circles out of a total 22 circles, apart from being the distinction of being the only operator to hold cellular licences for all the four metro circles. Bharti has also acquired licences for four fixed-line circles and is working overtime to complete the network expansion of its Rs 873 crore NLD project.
The issue, made through a 100 per cent book building route, has reserved 25 per cent of the total inital offering for retail investors while 75 per cent will be allocated to instituational buyers.
According to the draft document, the company has already incurred expenditure of Rs 1,537 crore (funded by a combination of equity -- Rs 1,111 crore, internal accruals - Rs 144 crore and borrowings - Rs 282 crore), largely towards the entry fee for the recently acquired cellular, fixedline and NLD licences. The company has rolled-out 12,000 kilometres of optic fibre backbone for its NLD services.
A strong signal
From a modest begining in 1995, the company has expanded its operations rapidly from offering services in two cellular circles (Delhi region and Himachal Pradesh) and one fixed-line circle (Madhya Pradesh) to six cellular circles and two fixed-line circles. Apart from this, the company is the first private sector player to offer NLD services in the country.
With a subscriber base of over 1.3 million customers, including over one million cellular subscribers, Bharti, with its Airtel brand of mobile services, has emerged as the market leader in four out of the six cellular circles. It achieved operational profits within two years in the Delhi cellular circle and the Madhya Pradesh fixed line circle. In fact, all of Bharti's circles have turned cash-positive at the operational level.
The consolidated revenues has grown rapidly from Rs 250 crore in 1999 to Rs 848 crore in 2001. However, this is not an indicative of the future growth as initially prices were quite high and competition was limited. But, on the other hand, the company definitely has the first-mover advantage in some of the most lucrative cellular circles.
The group has been a front-runner in the ongoing consolidation process in the industry. It has acquired the Kolkata cellular circle from Modi Group, Andhra Pradesh and Karnataka cellular circles from JT Mobile and bought back British Telecom's (BT) stake in Bharti Cellular.
For instance, Bharti paid Rs 803 crore for BT's 44 per cent stake in Bharti Cellular in September 2001, which actually works out to valuation of around $800 (Rs 38,000) per subscriber. "This is far below the international standards of about $900 per subscriber valued for markets with much lower growth rates," explains Sunil Mittal, chairman and managing director, Bharti Tele-Ventures.
So far, the management has been able to secure more than one billion dollars in private equity investment. Currently, foreign investors hold 46.3 per cent of Bharti's equity, with Singtel (17.7 per cent) and Warburg Pincus (20.6 per cent) being the two largest investors. Bharti is Singtel's second largest investment anywhere in the world outside Singapore.
Alarm bells
Although the company appears to be well positioned to exploit the opportunities offered by the fast-growing telecommunication sector, there are both external and internal factors that can have a strong bearing on the company's future growth. The associated risk can be broadly classified as price, technology and regulatory risk.
Price risk: The steep decline in tariff resulting out of rising competition is often cited as a most obvious risk for any private sector telecom service provider anywhere in the world. And India is no exception.
In fact, the sharp decline of 40 per cent in cellular tariffs after the introduction of third operator in February 2001 and the more recent price war in NLD rates substantiates the argument even though this is not the end of the declining trend in tariffs. Analysts expect a further competition led tariff war in both cellular and NLD services.
In cellular services, the next phase of price reduction will be triggered by the introduction of fourth operator. Until now, Bharti has been more or less been able to maintain its average revenue per unit (ARPU) at Rs 1,200 per month. Going forward, analysts estimate the ARPU to decline significantly (could be in the range of 40 to 60 per cent) over the next four years.
But, the extent of reduction will depend on the collective strategy of the operators. Apart from the pricing pressure, the ARPU are expected to decline gradually with the addition of customers from lower end of the market segment.
However, lower prices are bound to bring in more volumes. After the average reduction of 40 per cent in cellular tariffs, net additions per month of cellular subscribers vaulted by over 30 per cent over the last six months.
International experience shows that after a certain threshold price level, there is an exponential increase in subscriber base. Even on the conservative basis, analysts estimate the subscriber base to increase to over 55 mln users by 2010, up from around 5 mln now. In China, the subscriber base jumped to 120 million from about 10 million in the past five years alone.
The recent cut in NLD rates (average of about 60 per cent) is expected to bring in a 20 to 25 per cent increase in traffic in the next six months. Going by the experience in other countries, the NLD market has grown threefold in about ten years after the introduction of private players. For India, growth rates are expected to be faster because NLD rates, pre-deregulation were inflated and are expected to fall dramatically with the entry of private players.
Private operator like Bharti will gain from this expected growth in volumes. Says Akhil Gupta, joint managing director, Bharti Tele-Ventures, "In addition to growth in volumes, the growth from the new circles will more than balance out any adverse impact of falling tariffs on the company's growth." The company will be rolling out their services in nine new cellular and four new fixed-line circles.
Even so, Bharti could be under pressure. When tariffs were high and competition limited, it took Bharti a minimum of two years to break even in a lucrative circle like Delhi. Now, the 60 per cent cut in NLD rates, which state-owned Bharat Sanchar Nigam Ltd (BSNL) has also announced in addition to Bharti is likely to impinge on overall revenues.
And for BSNL, price cuts may not hurt as much because as it would mean only fall in earnings and not running into losses as is the case with the new players. The possibility of another entrant in NLD services -- possibly the Reliance or Tata group -- could put Bharti under even more pressure.
Where Bharti could gain is at the expense of financially weaker players with fragmented footprints such as Escotel, Spice, Hexacom & Aircel. But, the real test for the company will be in Mumbai where the two incumbents -- Hutchison and Batata-BPL -- are well-established and are strong players.
Bharti seems to have acquired an edge because it has offered a much higher share of revenue to cellular operators as collection charges at 40 per cent for outgoing calls and 20 per cent for incoming calls. BSNL only offers a 5 per cent collection charge. This has encouraged cellular operators to shift to Bharti's IndianOne brand of NLD services.
This apart, the arrival of customer access code (CAC) regime, where the choice of NLD operator will be left to the customer, could drastically change the whole dynamics of the NLD market. "We are eagerly waiting for the CAC regime where the quality of service and other value-added features like caller card, reward programmes etc will also have a strong influence on the customer's decision," explains Mittal. He may be partially right.
But in a CAC regime, the customer would choose to go with the NLD service provider who offers the lowest price. So the strategy that Bharti has adopted now to retain cellular operators to use Bharti's NLD services by offering higher collection charges will not work then.
Also, since telecom services is still a price-sensitive market, offering the right price will also be critical for gaining market share -- and cash-rich private competitors or established BSNL could hold the edge here.
With a huge equity base, and high leverage this could be a possible cause of future pressure in that it could limit the company's flexibility on the price front.
Technology risk: The introduction of code division digital multiplexing (CDMA) based wireless in local loop(WLL) or "limited mobility" services is often touted as a serious threat to cellular operators, especially for a country like India with extremely price sensitive customers.
In fact, the recently launched CDMA-based services 'Garuda' by Mahanagar Telephone Nigam (MTNL) has been a success in Delhi. It is actively promoted as a relatively cheap alternative technology for mass consumers.
Although the regulator has packed the monthly fixed rental in the range of Rs 450 to Rs 550, the cost of a three minute call on WLL connection is only Rs 1.2 compared to Rs 1.49 to Rs 4 per minute on cellular phones.
Moreover, since this wireless technology gives the fixedline operators a backdoor entry into the country's lucrative cellular market and they don't have to pay any entry fee as cellular operator. WLL operators could afford to offer substantial subsidy on handset to overcome the disadvantge of relatively higher prices for WLL handsets.
Though industry experts agree that the initally there could be a spike in demand for WLL services, it is overestimated as a threat to cellular services. To begin with, the stringent roll-out obligations (as compared to cellular services) to cover compulsory rollout in semi-urban and rural areas corresponding to every urban SDCA (short distance charging area) brought under coverage makes it relatively uneconomical for the WLL operator to subsidise the services.
Moreover, the floor price of Rs 450 on rentals prescribed by the Telecom Regulatory Authority of India (TRAI), compared to Rs 350 to Rs 395 for cellular services, has reduced the cost edge over the GSM services, to some extent.
The WLL service would therefore be cost-effective only for high usage consumers, a segment that will typically require roaming. Roaming from one SDCA (generally of 25 km radius) to another is not allowed in WLL. In future, the expected competition-led reduction in cellular tariffs will substantially narrow down the price differential between cellular and WLL services.
The prohibition of mobile switching centres (MSC) in all WLL networks is another hurdle. This could further restrict the mobility to one base station. While this may not be a concern in smaller SDCAs, it could become a stumbling block in high-density metros where the capacity of the base station could get exhausted fairly rapidly.
Regulatory risk: While the government has opened up all the sectors (except ILD services which will be thrown open to private competition after April this year) of the telecom spectrum, there are several grey areas that could impede the growth of private operators.
For instance, there is still ambiguity about the interconnection charges.There has been no clear decision on calling party pays (CPP) - where the incoming calls for mobile users will become free. The WLL services issue is also lingering with the appealling authority -- TDSAT.
Financials and Valuations
For the first half of the fiscal ended Spetember 2001, Bharti showed a notable improvement in operational performance in existing circles such as Andhra Pradesh and Karnataka. It reported revenues of Rs 625 crore for the first half, as against Rs 848 crore in the full year ended March 2001. With H1 operational profits of Rs 193 crore, the company's operating margins have also jumped significantly to over 30 per cent, up from about 22 per cent in 2001.
The management expects a further improvement in the operating margins in future. "Despite the expected decline in ARPUs, the company's operating margins will improve and stabilise in the range of 35 to 40 per cent as fixed costs get allocated over a higher subscriber base," claims Gupta.
In future, Bharti's financial performance is expected to mirror the rollout plan in the new circles. These circles are not expected to break-even before 2005. Moreover, a large portion of cash generated (around Rs 250 crore in this year) will be used to expand the existing network while a portion of it will be used to part finance the losses in new circles.
Assuming the company is able roll-out its services in the new circles over the next one year, analysts estimate the topline to grow at least by over 70 per cent in next three years.
Notwithstanding the phenomenal growth in the recent past, it is advisable to view the company as an infrastructure providers rather than a high-growth tech stock. The managment has clearly stated in the draft offer document that Bharti has over Rs 204 crore of accumalated losses and certain subsidiaries will continue making losses in the foreseeable future.
Apart from this, the repayment obligations of a huge debt of about Rs 1,365 crore as on September 2001, will restrict the company's ability to pay any dividend or bonus for years to come.
The company is also facing litigation with respect to its ownership of Bharti Mobile (formerly known as JT Mobile and operates cellular services in Andhra and Karnataka) from Parasrampuria Credit and Investment and with Crompton Greaves for acquiring 40.5 per cent of the reamining equity for the Chennai circle.
The company is yet to announce the floor price for the issue. However, media reports are buzzing with the benchmark figure of about Rs 55 per share which happens to be the acquisition cost of recent investment $280 million by private equity investors such as Warburg Pincus and Singtel.
With huge floating stock (one of the largest on the bourses), it is unlikely that the scrip will witness any significant upside after listing. In fact, if the issue manages to go through, it would be only with the help of large institutional investors. For any risk-averse investors the Bharti issue is avoidable.
Only investors who are willing to take an extremely long-term view should opt for this. But, it is quite likely that the stock will be available at a discount to offer price on listing and it will be cheaper to pick it up from the secondary market, if at all.