India ― Telecom

Infrastructure sharing: Credit squeeze, tower freeze 29 October 2008

The sharp rise in cost of capital has brought telecom infrastructure sharing—particularly of towers, which Valuation matrix
constitute nearly 50% of the sector’s total capex—into renewed focus. The imperative to maximise ROE will Company Bharti Idea RCOM
not only drive accelerated sharing among telcos, but will also prevent over-investment in new towers. We CMP (Rs) 615 41 229
reckon that Indus Towers, owned by the Bharti-Vodafone-Idea trio, will alone result in capex savings of TP (Rs) 877 72 360
US$7bn and be ROE-accretive for its owner-carriers. We estimate the value of these three companies’ Recommendation BUY BUY ADD
investments in the tower business at 17-30% of their value. Bharti is our preferred play in the sector.
FY10ii EV/Ebitda 7.1 7.5 5.6
(x)
Worsening credit conditions: a blessing in disguise? Tower sharing started as a cost reduction measure but began FY10ii P/E (x) 10.9 16.6 8.3
transforming into an industry by itself, with most carriers making lofty plans of tower investments. This was worrisome, FY08-11ii EPS 24.00% 17.80% 8.60%
because towers on a standalone basis, break even at 1.5x tenancy, and need 2x tenancy and significant leverage to CAGR
generate 15% ROE. With the recent surge in cost of capital, we believe that the market’s behaviour will be more rational. Source: IIFL Research
With carriers in an intense capex mode, and with 3G auctions looking imminent, carriers are likely to step up sharing to
better prioritise capital allocation. Regulation around sharing is much more permissive now than just a few months ago.
Carriers are likely to resort to intra-circle roaming in rural areas to tap these markets cost-effectively; and active sharing,
especially in 3G, in urban areas.

Strong growth outlook, higher tenancy rates: Over the next three years, we estimate Indus and Reliance Infratel
(RITL) will increase their tower count by 55% and 64% respectively. By FY12, when the business has attained steady
state, we expect average tenancy rates to rise to 2.6 for Indus and 2.4 for RITL. Range disparities due to spectrum and
technology differences will limit their ability to raise tenancy beyond these levels, especially in rural areas. Apart from
owner-carriers, we expect the three other large incumbents—BSNL, Aircel and Tata Tele—to use the infrastructure of the
major tower companies to accelerate rollout or improve ROEs.

A value-accretive business: We value Bharti’s ownership in tower assets at Rs150/share, that of Reliance
Communications (RCOM) at Rs107/share and that of Idea at Rs20/share. Our valuation model assumes 16% cost of
equity, 12% cost of debt and 4% terminal growth rate. Our valuations are 16-24% lower than the levels at which PE funds
have invested in tower subsidiaries, and we believe this is fair, considering the higher cost of capital now. Tower sharing
will drive cost-competitiveness, and will be one of the determinants of who wins and who loses in the long run.

Tower assets worth Rs150/share of Bharti and Rs107/share of RCOM

Tower company BIL* (ex Indus) Indus RITL** GTLI#
Enterprise value (US$ bn) 3.1 12 5.6 1.1
Equity value (US$ bn) 2.5 10.5 5 0.8
Contribution of tower assets
Per share of Bharti Idea RCOM GTLI G.V. Giri
Rs/share 150 20 107 40 gvgiri@iiflcap.com
(91 22) 6620 6649
Contribution to target price 16.7% 27.8% 29.8% 100.0%
Recommendation BUY BUY ADD ADD Rahul Seth
rahul.seth@iiflcap.com
Source: IIFL Research
(91 22) 6620 6667
 Unhitch Ltd - BUY.
India ― Telecom

Those who can, share… others, beware Figure 2: Bharti Infratel and RITL are already profitable at 1.2x tenancy
Leasing towers instead of owning them can be significantly more (Rs m) Revenue (LHS) EBITDA (LHS) PAT (LHS) Tenancy (RHS)
profitable for carriers. This is because standalone towers are likely to be 16,000 14,574 1.3
profitable only at 1.5x tenancy, and for a 15% ROE may require tenancy 14,000
above 2x, plus significant leverage. Overinvestment in towers by 12,000 1.2
carriers and subsequent search for 2x+ tenancy could have put 10,000
pressure on tower rentals and limited ROEs—a 100bps drop in rental 8,000 7,050 6,750
1.1
yield of a tower can depress its ROE by 7%.
6,000
3,206 1.0
4,000 2,497
However, the current credit squeeze is likely to preclude such over- 1,246
2,000 632
investment, and by the time credit conditions ease, rollout plans of 419 0.9
carriers would have progressed considerably. We assume that carriers 0

will prioritise network rollout over tower investment and use cash (2,000) -595 0.8
BIL RITL GTLI
judiciously—and risk of over-investment would then be minimal. We
also find that despite the 1.5x break-even tenancy, Reliance Infratel GTLI does not include pass-through costs in revenues, hence EBITDA margin is higher than it is
(RITL) and Bharti Infratel (BIL) are profitable at a tenancy ratio of just for the two other companies. BIL’s numbers correspond to less than one quarter’s active
operations, RITL’s for full year FY08. Source: Annual reports of BIL, RCOM and GTLI; IIFL
1.2x. This, however, is because both companies charge lower-than- Research.
steady-state depreciation rates; RITL also charges rentals that are 20%
higher than market rates. 3x tenancy tough; 3G to drive active sharing
Current expectations seem to be that 3x tenancy is achievable, but a
Figure 1: Sharing in India still in infancy – tenancy ratios are still quite low
breakdown of demand into captive and external suggests otherwise. We
Tow ers (LHS) Tenancy (RHS) reckon that RITL’s tenancy for GBTs from RCOM is unlikely to exceed
70 1.8
('000) 1.33x, given the range disparity between CDMA and GSM. For Indus
1.6 1.6
60 Towers, range differences between 1800MHz and 900MHz in GSM imply
1.4
50 1.3 1.3 1.4 1.4 1.3 a maximum captive tenancy of 2.25. External tenancy should mainly
1.2 1.2 1.2 1.2
40
come from BSNL, Aircel and Tata, with RCOM capable of creating
1.0
1.0 upsides, as it emphasises network rollout over towers.
0.8
30
While incremental rural potential for carriers should limit GBT capacity
0.6
20 increase to 80%, intra-circle roaming and lower frequencies such as
0.4
10 700MHz would be downside risks for rural tower count. Our steady-state
0.2
projections—186,700 towers with tenancy ratio of 2.8x on GBTs for
0 0.0
Bharti BSNL Vodafone RITL WTTIL Idea GTLI ESSAR Quippo Others* Indus+BIL and 70,500 with a ratio of 2.61x on GBTs for RITL—are
Infratel Cellular significantly lower than consensus. Urban demand growth for towers will
double over time, thanks to 3G data usage (3G auctions look certain in
Tower counts for these companies are as on different dates, from 31 March 2008 till August
2008; average tenancy would not be materially affected by taking exact tower counts for today. FY09) and mainstream GSM players will attempt savings through active
*MTNL, TT(M)L, XL Telecom, IMIL, ATC, TVS Interconnect, Tower Vision, Aster, etc. sharing, which is already in vogue internationally. We assume urban
Source: Companies, IIFL Research (rooftop) tenancy of 2.0.

gvgiri@iiflcap.com 2
 Unhitch Ltd - BUY.
India ― Telecom

Figure 3: RCOM’s pan-India GSM coverage requirements (BTS count)

Capacity Coverage Total How will the rentals, opex and capex pan out eventually?
Urban 10,000 20,000 30,000 At present, GTLI and BIL are charging rentals at similar levels, while
Rural 0 40,000 40,000 RCOM charges a “fixed pass-through” that remains constant on a per-
Total 10,000 60,000 70,000 tower basis, regardless of tenancy. Over time, we expect parity to
Source: IIFL Research emerge in all tower companies’ rentals. We also assume escalation of
rentals at 2.5% pa (RITL stipulates escalation at 3.0% pa, but this must
BSNL, Tata and Aircel will be key external tenants: On a net basis,
converge to market levels if RITL is to remain competitive).
demand for towers generated by established carriers would come
primarily from BSNL, TTL and Aircel. None of these three companies Figure 7: Rentals will eventually converge
seems keen on setting up large tower companies to cater to demand FY08 FY18ii
beyond their own needs. (Rs m) GBT RTT (Rs m) GBT RTT
Figure 4: 192,500 BTSs will be added by BSNL, Tata & Aircel
22,550 28,162
Demand Required Outsourced Demand GTLI GTLI
35,875 44,803
Net demand from BSNL 70,000 70.00% 49,000
Net demand from Aircel 55,000 70.00% 38,500 28,162
22,550
Net demand from Tata GSM 70,000 50.00% 35,000 BIL BIL
35,875 44,803
Net demand of 1 Start-up 70,000 100.00% 70,000
Total net demand 265,000 192,500 30,887 28,162
RITL RITL
Source: Industry sources, IIFL Research 50,784 44,803

Based on the above demand projections and including demand from 28,162
22,550
Bharti Airtel, Vodafone & Idea Cellular, we reach the final steady state Indus Indus
44,803
tower count and occupancy ratio as mentioned below: 35,875

Figure 5: The final steady state Ground base towers (GBTs) projections Source: Company data, IIFL Research
Company FY18 count Tenancy
Indus 104,500 2.8 We expect opex to converge for RITL and the Indus/Infratel combine
BIL 27,500 2.8 eventually, as the scale of their operations would be significantly above
RITL 49,500 2.61 that of GTLI.
GTLI 14,300 2.25
Source: IIFL Research
Figure 6: Roof top towers (RTTs) ― Projections for FY18
Company RTT count Tenancy
Indus 42,000 2.0
BIL 12,800 2.0
RITL 21,000 2.0
GTLI 4,500 2.0
Source: IIFL Research

gvgiri@iiflcap.com 3
 Unhitch Ltd - BUY.
India ― Telecom

Figure 8: The big guns will have lower opex and higher capex / tower of preference for telecom stocks. Competitive pressure may see RITL
FY09 FY18 Capex per GBT (Rs m) become the fulcrum for a counterweight to Indus. Our valuation
18,000 3.1 framework is based on number of factors, among them: 1) convergence
Opex (Rs / month / tow er)
16,000 3.0 of rentals (RITL’s rentals are currently about 20% higher than the
14,000 2.9 market’s going rates); 2) scale advantage in opex; and 3) trimming of
12,000 2.8 capex in line with anticipated utilisation and 4) steady-state
10,000 2.7
replacement capex of 10-15% of replacement cost of towers. Since PE
deals in BIL and RITL, the market has corrected by 35-50%, but our
8,000 2.6
valuations are at discounts of 16% to 24% to those implied by PE deals.
6,000 2.5
We value Indus at US$10.5bn, BIL at Rs170/share of Bharti (share of
4,000 2.4 Bharti being Rs150/share) and RCOM’s tower ownership at
2,000 2.3 Rs107/share. We rate Bharti and Idea as BUYs and RCOM as ADD.
0 2.2
Indus RITL BIL GTLI Indus RITL BIL GTLI Figure 10: Tower value worth Rs150/share for Bharti; Rs107/share for RCOM
Valuation Summary Indus RITL BIL GTLI
Source: Company data, IIFL Research
WACC 12.80% 12.80% 13.00% 11.80%
Replacement capex is assumed at 10% pa for GBT and 15% for RTT. Terminal growth rate of CF 4.00% 4.00% 4.00% 4.00%
We gradually raise the replacement capex to these peak percentages, EV (US$ bn) 12 5.6 3.1 1.1
and specifically for RITL and GTLI, since the tower count has more than
Equity value (US$ bn) 10.5 5 2.5 0.8
doubled in the last year, begin including replacement capex only from
EV / EBITDA FY10 (x) 9.7 6.1 7.2 13.2
FY13
Exit EV/EBITDA FY18 (x) 5.4 4.9 5.4 6
Figure 9: Replacement capex significant in tower business
Exit EV/FCF FY18 (x) 11.6 11.4 10.2 9.8
(Rs m) Replacement Capex FY18 (LHS) Replacement Capex as % of total capex (RHS)
Terminal value as % of EV 49% 43% 50% 73%
48,000 96% Per share of RCOM Bharti GTLI
42,000 40,600 93.8% 94% Ownership 95.0% 88.1% 100.0%
36,000 92% No. of shares (m) 2,064 1,898 997
30,000 90% Equity value (Rs/share) 107 150* 40
24,000 20,520 88% Source: IIFL Research; *including Indus stake of 42% held by BIL
86.5%
18,000 86%
85.2% 11,128 85.2% Figure 11: Our valuations are lower discounts to recent deals than index fall
12,000 84%
US$ bn PE Deal Implied Our Difference Correction
4,741
6,000 82% Valuation valuation in Sensex
0 80% RITL Equity value July 07 by PE investors 5.9 5 -16.40% 34.60%
Indus RITL BIL GTLI Bharti Infratel EV March 08 by PE investors 9.5 7.5 -21.00% 50.50%
Source: IIFL Research Indus equity value May 08 by PE fund 13.7 10.5 -23.70% 39.90%
All towers are equal, but some taller than others: The Source: IIFL Research. In BIL deal, US$/Rs assumed at Rs39.5, and value re-computed at
US$/Rs of Rs47 at the low end of the valuation range post-money. In the Idea deal, US$/Rs
effectiveness of tower companies as cost-savers—we estimate Indus assumed at 42.9 and the valuation recomputed at US$/Rs of Rs47.
can save more than US$7bn for its owner-carriers—influences our order

gvgiri@iiflcap.com 4