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

Time to buy Videocon now at present valuations.

Videocon is perceived largely as a consumer goods company. But often, it has been in the news for its GDR issues, new new petroleum/natural gas findings of its JVs etc. Given the company’s low price to book of 0.6, possible natural resources upside, and very good technology and its grabbing market share in the digital TV market; I just had to analyze this as a potential multibagger given the possible upsides. But finding data was so difficult that I had to often remind myself of the old warning ‘If you gaze into the abyss long enough, the abyss becomes part of you’ i.e the psychological danger of getting attached/anchored to something where analysis/research has taken a lot of time. That said, lets plunge into the company itself.

The latest annual report for year ended Dec-11 can be downloaded from the BSE website (http://www.bseindia.com/bseplus/AnnualReport/511389/5113891211.PDF) while the Luxemburg May-12 GDR prospectus can be obtained from this link after free registration-tellingly neither this nor the annual report are uploaded on the company website but that is an indictment of the IR team actually ( https://www.bourse.lu/application?&_flowId=SignEmetDocumentsFlow&numEmet=228665#SignEmetDocsInstr_showMoreDetails). The data I use is sourced from these hard to find documents, and summarized below

Hence, even stripping out the capital invested in other businesses(telecom, energy, power), the question is given the strong underlying performance of the consumer appliances division, is the market penalizing Videocon too much by assigning an equity valuation of just Rs 5355odd crores?  But then, remember the huge debt of around Rs 27000 crores(consolidated FY11 figure). Lets go business by business

1.    Consumer Electronics:- This is the mainstay of the company. Unfortunately we do not have segment profit figures to value the company. Still, even taking a profit of standalone figures to value the company of Rs 3600crores,  that needs just a P/E ratio of 9x to achieve the combined valuation, which does not seem such a challenge. Even the standalone EBITDA is around Rs 2200crores, which would entail EV/EBITDA multiple of 15x(seems much steeper challenge here).

2.     Crude Oil:-  On the energy assets of the company(details available in the annual report and press release), I’m not an energy buff, so really do not know how to value them.  I welcome comments from energy investors on this front on what multiples to assign proven reserves! Presently, the Ravva Oil & Gas Field is currently the only source of revenue in our Oil & Gas Business, so valuing this is a challenge. Still, given the May-12 board announcement of a possible spinoff to unlock value, we can get clarity about what the management has done with the funds and how the assets are  working! This segment contributed around 500crores to the company’s bottomline, as evident from standalone P&L(before interest expense). Still, given the capital commitments in the next year, spinoff would improve cash flows

3.    Telecom-Post the license cancellation, the temptation would be to assign zero value to this business, given that the mobility business is not very strong. However, a silver lining exists in telecom. As per Dish TV’s investor relations presentation(http://www.dishtv.in/Library/Images/DishTV-Investor-Presentation-Apr'12.pdf), Videocon had 12% of the market share for digital TV. While we do not know the active base/ARPU for this business, anecdotal evidence praises both the quality and the distribution efficacy of the business. With 29% market share, Dish TV had a enterprise value of around Rs 9400 crores(equity 7200crores, debt 1200crores). Given that metric, and assuming the superior technology/subscriber adds of Videocon DTH allows the same multiples(a very big assumption but then we do not have comparable metrics for DTH), the DTH business itself should be valued around Rs 4000 crores, much more than the negative book value assigned to it as a part of telecom. Of course, as I blogged earlier, DTH is a loss leader but investors assign it a valuation for some weird reason. Even Edelweiss praises the DTH operations in this research report (http://www.edelweiss.in/IEReport/common/content/reports/current/sector_&_company/media/2011/11/15/15112011142151/Videocon_d2h_-_visit_note-Nov-11-EDEL.pdf)  

4.    Power-With land acquisitions, coal linkages and PPAs pending for the project, it is a Herculean task to value the two power projects which Videocon has entered into. Still, book value is fair.

What works against the company is the qualitative factors like

1.    this nugget on pg6 of GDR prospectus In the past, we have made loans and advances to, and given guarantees for, and have received loans and advances from and benefited from guarantees given by certain Promoter Group entities. Some of these loans and advances are undocumented and may therefore be more difficult to enforce than if they were documented

2.     Also, we do not know much about the contract manufacturing operations revenue(presumably sale of components which makes up 11% of revenue). As described in the risk factor, We rely on the income generated by manufacturing and sales under licensed international brand names for a significant proportion of our income. If the marketability of the licensed brand names diminishes, this could have an adverse effect on our sales and results of operations. We also manufacture finished goods on an OEM basis and components for third parties. We also produce products under the brands “Electrolux”, “Philips” and “Kenstar”, which are marketed by the members of the Promoter Group. One would need more clarity on this, before giving the generous 9x P/E multiple!

3.    Promoter owns the brand, and perpetual license terminates if control changes. Also, the promoter holding is 60%+, which does not permit easy change of control(not that India business families sell out that often)

Upside triggers for the stock seems

1.    Sale of DTH business-if rumours like this one come true(http://www.dealcurry.com/2012076-Videocon-To-Exit-DTH-Biz.htm)

2.    Spinoff of oil and gas assets-no more expensive capex. Also, it may reduce the complexity discount/conglomerate discount attached to the stock. 

3.    Resolution of telecom 2G auction issues and possible compensation

With all 3 looking possible, this is certainly a good speculative bet. INVEST

SP Tulsian's buy on GTL Infrastructure-justified but for the wrong reasons

Whatever the grand old king of Indian stock markets(SP Tulsian) says makes news, so his comments on GTL Infrastructure was no different. You can read them below but the basic rationale was that the asset value of the towers would be more than enough to cover the debt and leave 60% odd upside for shareholders. 
http://www.moneycontrol.com/news/market-outlook/sp-tulsianpowerinfra-stocksgtlaptech_637010.html

This company triggered quite a few red flags from my side namely

1. Since the promoter(Manoj Tirodkar) was caught up in the Ketan Parekh stocks(K10) earlier and the other stocks involved like Satyam/Cybermedia etc have gone nowhere/crashed. So call it poetic justice or whatever, maybe this was come back time
2. the company has been in CDR since Aug-11. The results are yet to be announced formally.
3. Income Tax authorities raided the company(search) in Oct10 but the company claiming it subjudice did not make any provision in its accounts, which were finalized In Nov11. But on Dec20(2011), the Minister of State of Finance gave a written reply on the floor of the Lower House, that GTL Infra had admitted concealing taxable income of Rs 500.65 crores. Now, they have deferred tax of Rs 67 crores(standalone basis) or Rs 167crores(on consolidated basis). But India not having group taxation, even setting of Rs 67 crore deferred tax asset against that loss, it would still amount to a tax liability of atleast 20% of Rs 400 odd crores=>Rs 80 crores, to say nothing of a penalty which can extend to 3x taxable income. This episode raises issues of WHY did the company not provide for this in accounts despite offering that income for tax. Either GTL or the company is lying If the latter is true, it does not reflect well on the governance.
4. Hard to access investor relations site: When I clicked on the links to download latest annual report/IR ppts, there was an error in both chrome and mozilla. Plus they have this weird norm of having the user enter his details for every download! Not good
5. Delayed annual report/finalization of accounts:-The annual report was finalized only in November last week, and can be downloaded here(http://www.bseindia.com/bseplus/AnnualReport/532775/5327750311.pdf). Makes interesting reading especially the consolidated accounts, which remove the complicated group structure that lead to off balance sheet debt
6. As the table below shows, even at these low valuations, GTL Infrastructure commands an EV/EBITDA multiple comparable to the best in the industry-mature USA operators. It is doubtful whether the industry economics justify an higher multiple for GTL. So even on a deal related valuation, one should check chance of upside

The above points would show that on an asset play basis, the company would face tax, and paying the old tax arrears. Plus lured by the sale proceeds, the taxman may increase the penalty to the maximum permitted by discretion.

However, the positives for the stock are, on a going concern basis

1. Some towers(company does NOT disclose how many) are under construction, and will add to the EBITDA when operational. The figure of 32,650 towers includes work in progress too.
2. When they had purchased towers from Aircel at EV of Rs 43 lakh/tower, Aircel had promised GTL 20,000 tenancies @ Rs 3.5lakh(approx) per tower for 3 years viz=>Rs 700 crores/year for 3yrs=>Rs 2100 crores tenancy. Of that, Aircel has fulfilled only 10% of that commitment. As the gross margins are very high in the industry, the more Aircel fulfills that commitment, it will be pure gravy to the bottomline. For example, even 200 Cr/yr from Aircel EBITDA would give a huge valuation boost to the company! But this depends on how effectively GTL can enforce the deal. Expect Aircel to try wriggling out. Some legal battles would be interesting here.
3. Banks own nearly 20% of the company after invoking promoter's pledge. Hence, the CDR will hopefully not squeeze the shareholders too much

Bottomline:-The stock appears interesting but unless the governance cloud is settled, very risky. At the Dec27th AGM, I intend asking some directed questions to decide what to do next.

Why profitable mobile VAS leader Onmobile Global trades just below book value?

That was the question which perplexed me because the company did not trigger any red flags during my initial scrutiny. Indeed, it has positive cash flows, net debt<0, strong customer loyalty, IP driven, white label B2B player thus insulated from retail customer vagaries  etc. And the company Investor relations materials are quite transparent and frank-in fact the Mar11 edition of the IR ppt even showed that the company had materially underperformed both Nifty and its peers/customers. For that type of chart to appear anywhere, needs gumption and I credit the company for that. Also, they have about 20% revenues on content spending, and they are trying to get themselves to a net revenue model(so that the telecom operator directly pays the content owner) with higher reported margins. For a company to intentionally lower net reported revenues in this dotcom age, is commendable.

But when I noticed the postal ballot results, alarm bell rungs. Nearly 10% shareholders opposed the option repricing, which went through due to the promoters support. Granted but unexercised options(which benefit from the repricing) amount to nearly 5% of the company's outstanding shares, which is not a small number. And the proposed 2011 Options scheme, is almost a similar percentage. Once management has got the disease of repricing options, then one never knows when it will end. However,  this has saving graces that

1. Indian promoters own only around 14%, balance 34% is with foreign VC fund which went along with the option repricing-so if they found it kosher, why not us
2. In Dec-11, the company separated posts of Chairman and CEO. 
3. The lockin period of the foreign VC recently ended, so the VC would certainly be looking for an exit. It would not dilute its holdings via options repricing, unless it is the the interest of the company. VCs are not known for being sentimental. 
4. Independent directors of the repute of Prof JR Varma would not pass such a resolution routinely.

 But the measure came in for severe criticism on forums like The Equity Desk, and also among some institutional investors as seen by the fact that otherwise postal ballot results read like election results in a banana republic-management wins by 99% or so! Given that, a 6 to 1 margin is quite low and reflects that institutional investors are asserting themselves.

Governance issues apart, the company is still an Indian player(75% revenues from India, though it aims at 50% foreign revenues by FY13-14) and the TRAI regulations on commercial communications/VAS confirmations etc have hit it. Also add the fact that telecom is in a relative slumber, and you see why investors are not very enthused about the company. That is a pity because

1. its ability to breakeven(cash flow basis no less!) in its Latin American operations within the first year itself, points to its execution ability. 
2. And despite the EU crisis, the extent of debtors(via dues from telecom operators) greater than 6 months, is quite less. 
3. The company has showcased its innovative nature quite well with innovations like zero balance missed call(!)-a truly Indian phenomenon-and is ahead of the curve so far.   

So I guess the stock is due for rerating, and I'll revisit it later if it still seems attractive.