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Bharti Airtel: Can Bharti’s FCF surprise positively? ICICI Securities

The biggest disappointment for Bharti we have heard from investors is lack of FCF generation in the past, which has capped shareholder value creation. In this note, we highlight the reasons for Bharti’s lack of FCF generation, which includes competitive intensity, costs of building spectrum portfolio, leapfrogging in technology adoption, regulatory payouts and Africa acquisition. The heavy-lifting on most investments is behind except for 5G network rollout. Thus, we have come a long way, and are close to crossing the line from where Bharti can possibly generate cashflow equivalent to 10% of its current market capitalisation, and this, we believe, is just two years away. We maintain our BUY rating on Bharti with an unchanged SoTP-based target price of Rs960.

Bharti’s FCF generation has been disappointing for long. The single-biggest disappointment for Bharti since FY10 has been its inability to generate healthy FCF. It has barely registered any FCF after interest payments, which has capped value creation for shareholders through dividends, buybacks or simple net-debt-reduction, which boost equity value. We analyse the data from FY10 to reckon what went wrong for Bharti. Below are a few major factors that adversely impacted FCF generation:

  • Rise in competitive intensity – India’s telecom industry had seen unreasonable competitive intensity, which is the prime factor for low cashflow from operations. The number of players in the industry went up to 14-15 per circle leading to massive price erosion. Reliance Jio (RJio) foray completely shook up the industry forcing it to restructure, though it also helped consolidate. Nonetheless, despite investment across technologies, ARPUs have remained lower than anticipated. Notably, Bharti’s ARPU in FY10 was Rs240 (including contribution from IUC) compared to FY23 ARPU estimated at Rs190, which implies hardly any growth.
  • Investment to augment spectrum portfolio – Indian government allocated spectrum through the administrative process till CY08 for small licence fees. Therefore, spectrum cost was negligible for telcos in the 2G era. While cost was negligible, spectrum availability was unpredictable and use cases were restricted. Administratively allocated spectrum had defined technology attached to it, thus restricting spectrum use. India moved to spectrum allocation via auctions, but the spectrum prices were most expensive globally, and legacy telcos also ended up paying huge spectrum payments to renew administratively-allocated spectrum. Bharti has invested ~Rs1,600bn for spectrum purchases since FY10.
  • AGR dues and penalties – Telcos lost their AGR definition case against the government in Oct’19. This resulted in creation of huge AGR dues and penalties. Bharti has amassed payment of ~Rs420bn towards AGR dues.
  • Technology transition – India has leapfrogged in technology-adoption from being a laggard to being an early adopter. India’s 3G spectrum auction was conducted in CY10 while globally 3G rollout started in CY02/CY03. First 4G-LTE was launched in CY10, but it became popular in CY13 with launch of services by China Mobile (TD-LTE). India launched commercial 4G services in CY16. First 5G was launched in CY19, but India is among the countries that are rolling out 5G fastest (5G spectrum auctions took place in CY22). Refer to article (link) – ‘India ahead of world in 5G rollout, growing ‘extremely fast’, say Ericsson, Nokia’.
  • Leveraged buyout of Zain Africa didn’t work out as anticipated – Bharti bought Zain’s Africa operation in CY10 for an enterprise value of US$10.7bn. It was a leveraged buyout. Two aspects impacted Bharti from the Africa acquisition: 1) significant under-performance (the asset was under-invested, and Bharti misread the market and implemented India-based learning in Africa which didn’t work), and 2) significant depreciation of African currencies, and the INR. The debt was largely USD-denominated.

Where are we in each of these aspects? The situation has undergone massive / rapid repair in each of the five aspects discussed above, which provides huge comfort.

  • Consolidation and acceleration in revenue growth – India’s telecom industry has now consolidated into three private players, wherein one player faces a risk to its ‘going concern’ status. Further, new player(s) entry has largely been during technology transition, and Bharti / RJio have rapidly progressed on 5G deployment. The risk of new entrant is now pushed to 6G. India has also started taking large tariff interventions supporting revenue growth. Bharti’s ARPU (adjusted for IUC) has seen a CAGR of 15% over FY20-FY23E. We expect an ARPU CAGR of 9-10% at least over the next two years as well.
  • Spectrum investments to be very limited – Bharti has built a very large spectrum portfolio across technologies. These spectrums should take care of 5G rollout and, in worst case, the company may be forced to buy some sub-GHz spectrum (we assign low probability to it). The next big spectrum payout may only be in CY30 when its 2100MHz and 2300MHz band spectrum comes for renewal.
  • Regulatory payouts – The only large dispute pending with the government is about one-time-spectrum-charges.
  • Technology transition – India has become an early adopter on the technology front, which means technology transition will coincide with industry hereon. In fact, India is ahead in SA-5G (standalone 5G) while a developed market such as UK is planning for ubiquitous rollout only by 2030 (link). We estimate 4G and 5G to coexist for next 8-10 years before we adopt 6G as the mainstream technology. Globally, 5G investments are not justified by mobile services; therefore, telcos are targeting to develop new enterprise use cases. It would require an ecosystem to evolve for telcos to realise the benefit of 5G investments.
  • Africa contributing to FCF – Airtel Africa has smartly turned around in past few years. Its EBITDA grown >2.5x to US$2.5bn in FY23E since FY18. Despite significantly increasing dividend payout, its net debt stands at only US$1.6bn.

We remain optimistic on Bharti’s FCF generation. Our confidence in FCF generation emanates from the following factors: 1) India, at worst, will remain a 3-private-player market for the foreseeable future limiting competitive intensity; 2) telcos will keep playing with tariffs, but we expect ARPUs to grow at least 10% p.a. for the next few years as operators focus on FCF generation vs market share in prepaid 4G / 5G segments. Bharti has taken unprecedented tariff hikes in its base voice plans in the past two years moving from Rs75 to Rs155 (for 28 days); 3) network capex likely to peak in FY24, and progressively reduce as 5G coverage layer reaches ~75% of the population; and 4) spectrum investment to be limited; large spectrum renewal expected only in CY30.

  • Bharti’s cashflow will also benefit from steady growth in non-mobile services including FTTH and enterprise. Dividends from Airtel Africa and Indus will add to India FCF generation. Spectrum moratorium is due to end in FY26 and this will increase cash outflow towards government payment from FY27.
  • Our estimates suggest FCF generation (after interest cost) of >Rs400bn for Bharti in FY25E, which is 10% of its current market capitalisation. Bharti has set a good precedent of paying dividends in its two related companies – Indus Towers (erstwhile Bharti Infratel), and Airtel Africa. We remain hopeful of Bharti generously rewarding shareholders from FY25.

For report,

CT Bureau

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