I was reading Damodaran’s excellent book ‘Narratives and Numbers’ in which he advises poets(those who love stories and narratives) and quants(those who love numbers), to unite the approaches during a valuation exercise. Perchance, I got a chance today when the largest listed telecom tower operator of India (Bharti Infratel) corrected corrected 20% in 2 sessions, as the market tried to absorb the risk of tenancies loss due to the proposed merger between 2 leading telecom players Idea and Vodafone India. This poses an interesting valuation exercise because
· 85% of Bharti Infratel’s tenancies are from the Big 3 operators-Bharti Airtel, Idea and Vodafone, and therefore any consolidation would give those customers pricing power
· However, Bharti Infratel also owns 42% in an affiliate towerCo Indus, which is jointly owned by it along with Idea & Vodafone.
· Indus & Bharti Infratel have geographically delineated areas of operations, and non compete agreements in place which deter entry
· ~50% of Bharti Infratel’s valuation is from its minority holding in Indus
· Average lease period of Infratel sites are ~5.5years implying that operators cannot exit the sites without considerable penalty.
· A new player Reliance Jio has been doing a ‘test launch’ for a long time-it is speculated that the proposed merger talks were sparked off by this impending commercial launch of Reliance Jio.
Two possible scenarios appear evident to me which the market is pricing in, for a valuation range of 246-296, ASSUMING THAT THE MERGER TALKS FRUCTIFY, AND THAT THE MERGER IS APPROVED, both of which are very optimistic assumptions presently. But let us try and put some numbers to it.
In the first scenario, going by published estimates of consolidation impact, Infratel will lose 4000 colocations and Indus will lose 14000(which is around 5% of present operations). I have further layered on a 5% price drop assumption, for an overall 10% revenue decline. While EBITDA remains constant on the lowered price, the valuation multiple of EV/EBITDA compresses to 10x, giving a value/share of 246. Here, EV approximates market cap as cash and net debt are margina.
In the 2nd scenario, we consider that the towerCos honour the existing contracts for 5 years with the 2.5% escalation, after which 10% of sites are exited(hence the dip after 2022). The lack of pricing power therefore ensures merely a 6% revenue growth, versus a cost of capital of 13.1%, to arrive at an overall value/share of 263. This scenario is what I would consider optimistic.
Scenario 3 would be where the proposed merger is approved, with safeguards to remove undue market concentration. If this accrues to the benefit of Infratel(eg a scenario where shareholding in IndusTowers is reduced below 50% etc), then the share price should move back to present levels of 350. This might also happen if due to Reliance Jio entry by the time of transaction closure, Vodafone-Idea do not have bargaining power vis-à-vis Infratel.
Scenario 4 is if the rumoured merger talks fail due to Idea valuation avoiding swap ratio etc. In this case, the bull case for Infratel will return. This scenario is possible given that negotiations are still underway and that swap ratio is not yet concluded. In that case, the share price could touch 400-500
At an overall level therefore, considering all 4 scenarios, a rational valuation could be
With the CMP at 294, there does not seem much upside at present levels. While such an exercise is difficult, it is often in the zone of darkness that rewards are maximum