Is Bharti Infratel a buying opportunity after recent 20% correction due to Vodafone-Idea merger

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 2^nd 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

Aanjaneya Lifecare FCCB conversion price reset-backdoor M&A?

With USA, UK, Japan, Chinese and other equity markets in a turmoil, it is unsurprising to see Indian markets in even more turmoil, with external volatility magnifying its inherent volatility. To avoid missing some interesting snippets among all the financial news 'noise', I read corporate announcements on a weekly basis. During one such read, I found that Aanjaneya Lifecare has proposed to reset the conversion price of its 5.44% USD40Mn bonds due 2018, from Rs 260 per share to Rs 55 per share(!). This works out to hardly a 10% premium over the existing share price of Rs 49.5. With a present market cap of Rs 68.81 Crores, the company's present capital structure is 13.9Mn shares. If the conversion option is fully exercised at Rs 55 per share and fixed exchange rate of 54.29, there would be an additional issue of 40Mn shares, or nearly 3x the existing share capital! The postal ballot notice can be read below
http://www.bseindia.com/xml-data/corpfiling/AttachHis/Aanjaneya_Lifecare_Ltd_280613.pdf

While trying to figure out the reason, I read the  Offering Circular FCCB which envisages the only adjustment contemplated to the conversion price was as per Clause 5.3 of the FCCB which stated that The Conversion Price of the Bonds will be reset downwards only if, on the Reset  Dates, the average of the Volume Weighted Average Price (VWAP) of 21 consecutive  Trading Days on BSE prior to and including any of the Reset Dates is lower than the  Conversion Price prevailing on that Reset Date. Maybe this was to safeguard against price manipulation on that date. However, even this came with the caveat that The Conversion Price will not be reset  below 90% of the Conversion Price prevailing on the relevant Reset Date. However, such Conversion Price will not be  reset below the floor price which is in turn defined as The minimum conversion price of  a convertible bond as calculated under the provisions of Press Note dated 21 November 2008 issued by Ministry of Finance,  Govt. of India

The promoter holding has steadily dipped from 60% to 40%, so maybe this was a way to use friendly FCCB bondholders to acquire control at bargain basement prices. After all, the company trades at P/BV of hardly 0.2 and with net debt of hardly 300 odd crores{Gross debt Liabilities around Rs 735 Crores less Cash Rs 212 Crores minus 50%*443 Crores of inventory+receivables=>approx 300Crs http://www.bseindia.com/xml-data/corpfiling/AttachHis/Aanjaneya_Lifecare_Ltd1_300513_Rst.pdf}, control could be got at Rs 600crs or so, for which you get a 500MTPA quinine plant at Mahad, a plant at AP and brand. Plus the management has won quality awards including one for its annual report. The name change to 'Dr Datson's Labs' seems reflective of management's R&D focus.  The auditors and merchant bankers are lesser known brands, nothing against that but does nothing to enhance investor confidence in price discovery of FCCB/fairness of FCCB allotment process.

The questions I have are

1. Even if share price dropped to hardly 20% of earlier highs, is that a reason to say that price discovery done hardly 3 months ago, was improper? Does management not expect the stock price to recover to its old highs, even in 5years from now i.e 2018? Or did a bull cartel drive down the share price to force the company to reset conversion price, and hence acquire control? After all, unlike direct share purchase, FCCB holders identity is not disclosed.The auditors and merchant bankers are lesser known brands, nothing against that but does nothing to enhance investor confidence in price discovery of FCCB/fairness of FCCB allotment process.
2. Institutional shareholders hold a majority voting stake with Religare Finvest 13.43%, Apex Drugs 9.44% and some brokerage firms 10.7%. Their collective vote of 33% odd percent will be crucial, given the management's vote at just 41%. Shareholding Mar13 Will institutional shareholders abstain/back management as always, or go ahead considering this is allotment at the existing market price only(almost)? This is an interesting question since if they decide to be activist, there can be plenty of trouble.
3. In such cases where potential equity shares are 3x of existing capital, should repricing be
   allowed in the first place, without an open offer to the remaining shareholders? Will the SEBI ruling in case of IFCI apply where open offer is exempted http://www.moneycontrol.com/news/market-news/sebis-exemptionifcis-open-offer-what-is-it-about_763393.html
   
   Even if the share looks cheap, management does not think so, nor does the street otherwise an equity white knight should have come by now. Anyways, this is worthy of a case study in itself, and if successful/unchallenged, may write a new takeover strategy.