Strong Signals

On March 28, 2017, American private equity heavyweight KKR and Canada Pension Plan Investment Board bought a 10.3% stake in Bharti Airtel’s tower arm, Bharti Infratel for a consideration of Rs.6,193 crore. It is the second time that KKR has placed its bet on Bharti Infratel. It had made an investment of $250 million for a 2.5% stake in the company in 2008, which it finally exited with a more than 70% gain in 2015.  The stock is currently at Rs. 353 (as on 21st April) trading almost 9% higher than the private equity firms’ acquisition price.

Bharti Airtel plans to use the money from the stake sale to reduce the debt on its books and counter the increasing competitive pressures thanks to the price war unleased by Reliance Jio. In fact the entire telecom industry is undergoing a consolidation and change of business model after the disruptive 4G launch of Reliance Jio. This is also expected to drive consolidation in the tower business as telcos involved in a merger will cut down on tower locations where both companies are tenants in a bid to rationalise costs driving weaker tower companies out of business. Tower companies help mobile operators increase their network coverage by providing cell sites that  connect two callers.

 In fact, the news of an impending merger between Vodafone and Idea had initially sparked off concerns that the combined entity cutting down on common tower locations would have an adverse impact on Bharti Infratel. But analysts believe that the exits may not be as sudden and sharp as the Street fears and telco-owned companies like Bharti Infratel will be least affected. According to them, the Idea-Vodafone merger may at the most result in just 30,000 exits for Bharti Infratel over FY18-FY23, moderating the tenancy growth to an average of 7% each year against an earlier estimate of 9%. The fear might also have been overdone as Bharti Infratel has stringent exit conditions where in a 10-year contract telecos have to pay 100% of the residual contract if they exit before five years and 35% of the residual contract value if they leave after five years. 

Bharti Infratel presently owns 38,997 towers on a standalone basis. After factoring in its 42% stake in Indus’ tower business, Bharti Infratel’s consolidated tower network stands at about 90,255 tower network, accounting for one-fourth of the market. Telco-owned tower companies like Bharti Infratel, Indus Towers have a 53% market share while US based tower companies like American Tower Company, Brookfield have 27% share of the market and BSNL which has around 11%. Weaker players in the tower business like GTL Infra, Tower Vision and Ascend Towers that together account for 41,533 towers (10% market share).  Given the fact that they are reeling under debt with their average tenancy ratio of 1.5x being among the lowest in the industry makes them the most vulnerable as the industry moves towards consolidation. Tenancy ratio indicates the average number of tenants (operators) who occupy each tower.

In fact, the merger throws Bharti Infratel a chance to consolidate its position as both Idea and Vodafone are looking to monetise their assets in the tower business. Himanshu Kapania, managing director at Idea Cellular has already said that his company would be open to monetise its stake in Indus Towers or its standalone tower assets. Analysts reckon that Vodafone could also follow suit, as the combined entity would be looking to bring down their debt levels. At the end of H1FY17, Idea’s net debt stood at Rs.36,401 crore, while Vodafone India’s net debt stood at Rs.35,400 crore. Media reports suggest that Bharti Infratel is in talks for Idea’s 16% stake in Indus Towers, which would give it ownership to additional 19,527 towers. Bharti Infratel has the first right of refusal for a stake sale in Indus Towers and news reports indicate that Bharti Infratel is keen on picking up Idea’s stake in Indus or getting in a financial investor like KKR whose interests are aligned with them to pick up the stake. American Tower Company which is keen on increasing its footprint in India is said to be the frontrunner to snap up Idea’s standalone towers (9,784 towers).  If Bharti Infratel picks up Idea’s Indus stake, it would take its total tower network to 1,09,782 towers from current 90,255 towers.  In terms of tenancies, the deal would shore up Infratel’s market share from 26% to 32%.

Apart from gains from industry consolidation, Bharti Infratel is also likely to gain from the impending 2.3/2.5GHz 4G network rollouts as telcos move from voice to data. So far, the rollouts have been mainly through loading of existing 2G sites. The intensifying competition and 4G network rollouts would require substantial enhancement of cell site density and the company is expected to benefit the most from the data explosion. It is already seen in their numbers. Consider this: in the December 2016 quarter, Bharti Infratel saw an addition of over 3,000 tenancies, the highest seen in the past five years.  Devender Singh Rawat, CEO, Bharti Infratel, said during the company’s earnings call that while the likes of Bharti Airtel, Vodafone and Idea added new tenancies, Jio’s contribution was more material to Bharti Infratel’s new additions.

Further, analysts reckon that it is the annuity-like revenue model of the tower company that is drawing investors’ interest. Due to the long-term (8-12 years) contracts with operators, the present revenue stream forms the base, and every new tenancy or cell site loading adds to this base.

Moreover, Bharti Infratel introduced a uniform rate card in the June 2016 quarter for new tenancy or old renewals, adding to the predictable nature of its revenue model. This rate card also introduced yearly escalation of 2.5% on the rental rates.  Dharmesh Kant, Head-retail research, Motilal Oswal Financial Services, believes the company is an attractive play on yield. “At a time when the telecom industry is under pressure, Bharti Infratel is generating cash flow yield of 5%,” he says.

Apart from a stable revenue model, its fixed cost structure is the other main attraction in the stock. As every new tenant comes on board, the rental income multiplies, whereas costs don’t see a linear increase. Loading revenues (upgrading existing tenancy to 3G or 4G networks) are also highly margin accretive. Operating expenses of a tower, which include site rentals, security and maintenance, are largely fixed. The average cost to build a ground-based tower and a roof-top based tower is Rs. 25 lakh and Rs.17-18 lakh, respectively. “Bharti Infratel is a steady story with strong cash flow generation, steady top-line, fixed contracts, no capex and zero debt on a net debt level,” says Bhavesh Gandhi, AVP-research, IIFL.

Over the last five years, the company’s revenues have grown at an average of 7.6% every year, while its bottom line has grown at a much quicker pace at an average of 34%. The company’s operating margins have improved from 38% in FY11 to 49% in FY16 as tenancy ratio has improved from 1.7x to 2.16x during the same period. Bharti Infratel’s high tenancy ratio shows operators’ preference for its tower network over other players. Analysts say that operators prefer Bharti Infratel due to its wide presence across 22 circles, quality assets and the good placement of its towers.

Unlike these smaller players, Bharti Infratel has an edge, having strong players – Vodafone, Idea and Airtel – as its anchor tenants (first tenants in any new tower), which lend stability to its earnings. The presence of anchor tenants helps a tower company absorb the initial costs of new towers as they provide a ready revenue stream to the tower players.

Bharti Infratel is currently sitting on free cash reserves of Rs.2,589 crore which can be used to fund its inorganic growth.  Apart from consolidating its position, the company is already looking for additional revenue streams by providing newer services such as in-building installations and providing B2B Wi-Fi spots to all operators. The company is also working with the government to explore opportunities for infrastructure deployment in smart cities. As part of a consortium with Swedish telecom gear maker Ericsson, Bharti Infratel recently bagged a smart city project from Bhopal Smart City Development Corporation (BSCDCL) to deploy smart poles in Bhopal at an investment of Rs.690 crore. These poles will be equipped with environment sensors, electronic vehicle charging points, surveillance cameras, digital signage systems and wi-fi access points. The poles will be backed by a 200 kilometre long optical fibre network deployed by Bharti Infratel that will connect government buildings and schools. BSCDCL also plans to execute the smart school project using this network.

Bharti Infratel is currently trading at EV/Ebitda of 9.3x its one-year forward estimates.  US-based tower companies like ATC, Crown Castle and SBAC trade at multiples of 16x-17x. Analysts expect the consolidation in the tower industry to narrow down this discount.The exit of weaker tower companies would create an oligopolistic market and lead to healthier margins for stronger players like Bharti Infratel as they would have better bargaining power with the telecos. As telecom operators push their users towards more data consumption, they are unlikely to compromise on their infrastructure. Once the dust settles on the consolidation in the telecom industry, companies will look to ramp their 4G network rollouts making more efficient and robust. And when they do, there’s little doubt that Bharti Infratel would be their partner of choice.