Sector update | 7 January 2013

Telecom
Consolidation, pricing improvement inevitable; increased focus on profitability
Raising target prices; upgrading Bharti to Buy

We are upgrading Bharti from Neutral to Buy, and increasing our target prices for the Telecom stocks under our coverage. The target price increases reflect the rollover to FY15 estimates as well as higher EV/EBITDA multiple for Bharti/Idea, as we believe sector earnings have bottomed, and consolidation / pricing improvement are inevitable. Our recent industry interactions suggest increased focus on profitability across challengers, likely led by non-availability of further "loss funding". Apart from taking extreme measures like discontinuing operations altogether from several circles, many challengers also seem to be aggressively pursuing time-bound breakeven targets within the current span of operations. Industry measures like decline in channel commissions and promotions indicate shift from reliance on "volume/subscriber growth" to "pricing/margin improvement". Five consecutive months of decline in the industry subscriber base is probably the best measure reflecting this. While most challengers continue to face financial distress, significant spectrum liabilities for GSM incumbents also seem to be crystallizing, given the unaccommodative government stance. With high leverage levels across operators, continued decline in traffic growth, and low contribution from data revenue, voice pricing improvement appears to be the only major lever available incrementally for the industry.

Valuation and view

Bharti: Upgrade from Neutral to Buy, with a target price of INR390. Our target price is based on 8x FY15E EV/EBITDA for India & South Asia ex-tower business (v/s 7x FY14E EV/EBITDA including tower business, earlier), 6x FY15E EV/EBITDA for Africa business (v/s 5x FY14E EV/EBITDA earlier), market value of stake in Bharti Infratel (valued along with India & South Asia earlier), and INR188b (INR49/share) for potential spectrum liability (v/s INR142b earlier). Our spectrum liability estimate is based on 25% discount to the liability due over the next four years at reserve price/auction discovered price. We expect 10% EBITDA CAGR and 39% earnings CAGR over FY13-15. Idea: Maintain Buy, with a revised target price of INR140. Our target price is based on 8x FY15E EV/

EBITDA ex-Indus (v/s 6.75x FY14E EV/EBITDA earlier), INR5m/tower for stake in Indus Tower (unchanged), and INR109b (INR33/share) for potential spectrum liability (v/s INR121b earlier; spectrum payment of INR20b for new circles now incorporated in estimates). Spectrum liability is based on 25% discount to liability due over next 4-years at reserve price/auction discovered price. We expect 18% EBITDA CAGR and 52% earnings CAGR over FY13-15. RCom: Maintain Neutral, with a target price of INR79 based on 6x FY15E EV/EBITDA. We expect 7% EBITDA CAGR and 45% earnings CAGR over FY13-15. While RCom has high sensitivity to pricing improvement, we remain Neutral, given concerns on high leverage (net debt/EBITDA of >5x).

Summary of recommendation and TP changes

Company Bharti Idea RCom Earlier Neutral Buy Neutral Rating Now Buy Buy Neutral Target Price (INR) Earlier Now 265 390 90 140 52 79 Source: MOSL EV/ EV/ RoE EBITDA (x) Sales (x) (%) 7.0 2.2 7.3 6.8 2.0 10.4 7.0 2.3 3.9 RoIC (%) 6.5 7.8 5.0

Comparative Valuations (FY14)

CMP Target (INR) (INR) Bharti * Buy 327 390 Idea Buy 110 140 RCom Neutral 81 79 * Proportionate EV/EBITDA and EV/sales Company Reco Upside (%) 19 28 NA Mcap (USDb) 22.6 6.6 3.0 EV (USDb) 34.4 9.0 9.5 EPS (INR) 10.6 4.7 6.2 P/E (x) 30.8 23.6 12.9

Shobhit Khare (Shobhit.Khare@MotilalOswal.com); +91 22 3982 5428

Investors are advised to refer through disclosures made at the end of the Research Report.

Telecom

Increased focus on profitability across challengers; footprint reduction in several circles

Our recent industry interactions indicate renewed focus on profitability and timebound breakeven targets. Formidable challengers like Aircel and Uninor have taken extreme steps like reducing their span of operations in order to restrict cash burn. While Uninor re-bid for only 6/22 circles in the 1,800MHz, Aircel has ramped-down operations in five circles - Madhya Pradesh and Chattisgarh, Gujarat, Haryana, Rajasthan and Punjab. Operating cash flow breakeven in India was termed as the primary focus area for 2013 by Telenor management during its recent analyst presentation. Operators like Sistema Shyam face licence cancellation effective 18 January 2013 as per the Supreme Court's February 2012 order cancelling 122 licences. We believe further pricing pressure is unlikely, given ongoing consolidation at operating level on a pan-India/pan-operator basis.

Circle-wise market share map: Footprint reduction across the board (%)
Bharti Delhi Maharashtra A.P. T.N. (incl. Chennai) Karnataka Mumbai U.P.(E) Gujarat Rajasthan Bihar Kerala U.P.(W) Punjab M.P. W.B. & A&N Kolkata Haryana Orissa Assam N.E. Jammu & Kashmir H.P. Aggregate 37 21 41 37 47 21 28 19 40 47 17 19 35 29 29 29 19 42 32 40 40 42 32 Vodafone 28 24 10 19 14 32 28 38 22 13 23 23 18 9 36 32 29 16 16 12 9 10 22 Idea 11 26 18 3 9 8 12 18 11 11 33 26 21 37 5 5 23 4 2 3 3 9 15 Tata Group 8 10 11 7 12 13 5 7 7 7 6 8 10 10 4 13 14 10 2 2 3 4 9 BSNL/ MTNL 3 6 9 6 6 3 9 5 6 5 14 8 7 8 8 4 8 15 9 12 16 15 7 RCOM 9 6 6 6 7 11 7 7 4 5 4 7 4 6 3 6 5 2 16 8 6 13 6 Aircel 3 1 2 19 2 2 4 1 5 5 2 3 2 1 5 5 2 8 22 23 24 7 5 Telenor 0 5 3 1 1 3 7 5 0 4 0 6 0 0 6 4 0 2 0 0 0 0 2 Sistema Revenue Mix 1 0 9 1 0 8 1 0 8 1 0 8 2 0 8 1 6 7 1 0 6 0 0 6 4 0 5 2 0 5 1 0 4 1 0 4 0 3 4 0 0 4 5 0 3 3 0 2 1 0 2 0 0 2 0 0 2 0 0 1 0 0 1 0 0 1 1 1 100 Source: Company, MOSL Others

7 January 2013

Telecom

Five consecutive months of subscriber base decline: Focus shifting to margins?

November 2012 was likely the fifth consecutive month of decline in the Indian wireless industry subscriber base. While overall November addition numbers are yet to be announced by TRAI, the GSM industry lost ~9m subscribers during November as per the data released by COAI and dual technology/CDMA operators lost another ~4.5m. While November 2012 subscriber additions were also impacted by implementation of stringent subscriber verification norms, reduced channel commissions and promotions have significantly impacted gross additions across operators in 2HCY12. We believe that reduction in channel commissions and promotions is an important milestone towards margin and RPM improvement, as it will arrest "rotational churn" as well as free minutes in the system.

Monthly wireless subscriber net additions: November 2012 to be fifth consecutive month of decline in subscriber base (m)

Source: Company, MOSL

Blended monthly churn has been at multi-year highs (%)

Source: Company, MOSL

7 January 2013

Telecom

Unaccommodative government stance: Significant liabilities crystallizing for GSM incumbents

The government stance towards the industry remains unaccomodative given (1) the decision to levy "one-time spectrum charges" in 4QFY13 (current quarter), (2) only 30% reduction in reserve price for the four circles (where auction had failed due to high reserve price), (3) no change in spectrum price for balance 18 circles despite muted bidding, (4) spectrum re-farming, and (5) policy gravitating towards "renewal at market price". After factoring in the reduced reserve price in four circles, we compute total spectrum liability of ~INR360b for Bharti (~INR250b due in next four years) and ~INR225b for Idea (~INR165b due in next four years). While we expect operators to take legal recourse, we believe these government decisions imply crystallization of the liabilities for GSM incumbents to a large extent.

Bharti: Spectrum liability of ~INR360b crystallizing; ~70% due in four years (INR b)

Idea: Spectrum liability of ~INR203b crystallizing; ~70% due in four years (INR b)

Source: Company, MOSL

Pricing increases inevitable given stressed balance sheets; voice traffic growth tapering; listed universe (including Vodafone) wireless revenue growth to decelerate to ~7% YoY in 3QFY13
While the industry has witnessed stable RPM post two consecutive quarters of decline in 4QFY12/1QFY13, we believe RPM improvement is inevitable. Balance sheets remain stretched across operators. GSM incumbents have been better placed but now face significant spectrum liabilities.
7 January 2013 4

Telecom

Wireless traffic growth continues to taper down, with YoY growth for our listed universe (including Vodafone India) declining to ~10% YoY in 2QFY13 and wireless revenue growth expected to decline to a low of 7% YoY in 3QFY13. We believe increase in effective tariffs is the only major lever available for the industry apart from reduction in channel commissions, which is underway already. There could be upside risk to our estimate of 3% CAGR in RPM over FY13-15, as bulk of the increase in our projections is attributable to growth in data revenue contribution.

FY12 Net Debt/EBITDA (x)

Aggregate wireless traffic growth and RPM trend for wireless majors

Aggregate India wireless revenue growth for wireless majors (YoY, %)

Source: Company, MOSL

7 January 2013

Telecom

Bharti: SOTP valuation

FY15 EBITDA (INR b) India business (excl. towers) 181 Tower business (Bharti Infratel) Africa business 81 Less FY15 net debt Less 75% of potential spectrum liability within 4 yrs Total Value Shares o/s (b) 3.79 CMP Upside (%) OwnerProporship tionate EV/EBITDA (%) EBITDA (INR b) 100 181 8.0 79 90 73 6.0 Fair value (INR b) 1,449 306 436 524 188 1,479 Value/ Share (INR) 382 81 115 138 49 390

327 19 Source: MOSL Driver Fair Value (INR b) 8.0 595 INR5m/tower 69* 97 109 460 3,303 Multiple Value/sh (INR) 181 21 29 33 140 110 28 Source: MOSL

Idea: SOTP valuation

Methodology

Core Business (ex-Indus) FY15 EV/EBITDA 74 Stake in Indus Tower base 108,500 Less Net debt (FY15E) Less 75% of potential spectrum related payments within 4 yrs Total Value Shares o/s (m) CMP (INR) Upside (%) * 80% stake in ABTL which owns 16% stake in Indus towers

RCom: SOTP valuation

Methodology Consolidated Less Net debt (FY15E) Total Value Shares o/s (m) Value per share (INR) CMP (INR) Upside (%) FY15 EV/EBITDA Driver 77 Multiple 6.0 Fair Value (INR b) 462 303 158 2,063 79 81 -2 Value/sh (INR) 224 147 79

Source: MOSL

7 January 2013

Telecom

Comparative valuations
CMP Rating Mcap EV (INR) (USDb) (USDb) Bharti* 327 Buy 22.6 34.4 Idea 110 Buy 6.6 9.0 RCom 81 Neutral 3.0 9.5 * Proportionate EV/EBITDA and EV/sales FY13E 41.9 35.8 17.4 P/E (x) FY14E 30.8 23.6 12.9 FY15E 21.8 15.4 8.3 EV/EBITDA (x) FY13E FY14E FY15E 8.0 7.0 6.0 8.6 6.8 5.6 7.7 7.0 6.1 FY13E 2.5 2.3 2.5 EV/Sales (x) FY14E FY15E 2.2 2.0 2.0 1.6 2.3 2.0

RoIC (%) RoE (%) EBITDA Margin (%) Net Debt/EBITDA (x) Net Debt/Equity (x) FY13E FY14E FY15E FY13E FY14E FY15E FY13E FY14E FY15E FY13E FY14E FY15E FY13E FY14E FY15E Bharti Idea RCom 4.6 5.9 4.6 6.5 7.8 5.0 7.6 10.3 5.9 5.6 7.5 3.0 7.3 10.4 3.9 9.5 14.0 5.8 31.0 27.0 32.1 31.1 29.0 32.0 31.7 29.1 32.6 2.8 2.5 5.3 2.3 1.7 4.7 1.7 1.2 3.9 1.3 1.1 1.1 1.1 0.8 1.0 0.8 0.5 0.9

Capex/Sales (%) Sales Gr. (%) EBITDA Gr. (%) EPS (INR) EPS Gr. (%) FY13E FY14E FY15E FY13E FY14E FY15E FY13E FY14E FY15E FY13E FY14E FY15E FY13E FY14E FY15E Bharti Idea RCom 19.4 23.3 7.1 13.8 10.6 9.8 15.0 9.0 9.9 12.9 12.5 3.6 9.3 12.8 5.1 8.8 13.6 6.6 5.3 16.5 4.7 9.8 21.4 5.1 11.0 14.0 8.4 7.8 3.1 4.6 10.6 4.7 6.2 15.0 7.1 9.7 -30.5 40.2 -3.1 36.3 51.9 41.3 52.6

34.2 55.2 Source: MOSL

7 January 2013

Telecom

Bharti: Key assumptions and value drivers

Mobile segment Mobile - India Subs (m) YoY (%) Average subs (m) YoY (%) Netadds per month (m) YoY (%) Total mobile traffic (b min) YoY (%) ARPU (INR/month) YoY (%) MOU YoY (%) Mobile RPM (INR) YoY (%) Mobile EBITDA margin (%) Mobile Capex (INR b) Mobile Capex/sales (%) Mobile - Africa Subs (m) YoY (%) Netadds per month (m) ARPU (USD/month) YoY (%) Capex (USD b) Capex/Sales (%) EBITDA margin (%) Passive Infrastructure Indus Towers Towers (000s) Cellsites (000s) Tenancy ratio (x) Sharing revenue per operator per month (INR 000s) EBITDA margin (%) Bharti Infratel Towers (000s) Cellsites (000s) Tenancy ratio (x) Sharing revenue per operator per month (INR 000s) EBITDA margin (%) FY10 128 36 111 42 2.8 6 610 28 243 -25 459 -10 0.53 -17 38.7 34 10 FY11 162 27 145 31 2.9 3 792 30 201 -17 455 -1 0.44 -17 34.7 59 16 44 5 0.2 7.3 0.9 24 25 FY10 103 176 1.7 FY11 109 201 1.9 29.5 26.6 FY12 181 12 172 19 1.6 -45 889 12 188 -6 431 -5 0.44 -1 33.9 32 8 53 20 0.7 7.1 -2 1.5 37 27 FY12 109 214 2.0 31.3 28.5 FY13E 186 2 183 7 0.4 -77 958 8 187 0 435 1 0.43 -1 30.5 75 17 64 21 0.9 6.3 -11 0.8 19 27 FY13E 112 229 2.1 30.7 27.6 FY14E 198 6 192 4 1.0 176 1,031 8 199 6 448 3 0.44 3 30.9 40 8 78 20 1.1 5.8 -8 1.0 20 27 FY14E 113 242 2.2 29.8 26.9 FY15E 209 6 204 6 1.0 -1 1,091 6 205 3 447 0 0.46 4 31.4 58 11 91 17 1.1 5.3 -8 1.0 18 28 FY15E 114 256 2.3 29.2 26.3

31 50 1.6 37.2 46.2

33 58 1.8 37.0 48.1

33 60 1.8 37.3 47.8

35 66 1.9 38.3 48.0

37 73 2.0

39 81 2.1

36.9 36.0 47.8 48.0 Source: Company, MOSL

7 January 2013

Telecom

Bharti: Business Mix

Revenue (INR b) Mobile Telemedia Enterprise Passive Infrastructure Others Africa Total revenue Eliminations and others Consolidated revenue YoY (%) EBITDA (INR b) Mobile Telemedia Enterprise Passive Infrastructure Others Total India & SA Africa Total EBITDA Eliminations and others Consolidated EBITDA YoY (%) Capex (INR b) Mobile Telemedia Enterprise Others Passive infrastructure Africa Consolidated capex YoY (%) Capex/Sales (%) FY10 331 34 45 71 6 0 487 -68 418 13 FY10 128 15 13 25 -10 168 0 170 -2 168 11 FY10 34 10 12 16 12 0 83 -41 20 FY11 363 36 41 86 10 131 667 -72 595 42 FY11 126 16 10 32 -10 171 29 202 -3 200 19 FY11 59 8 4 14 23 36 143 71 24 FY12 403 37 45 95 16 198 794 -80 715 20 FY12 137 16 8 36 -9 184 53 240 -3 237 19 FY12 32 8 2 9 14 76 140 -2 20 FY13E 439 38 54 102 19 242 894 -87 807 13 FY13E 134 15 9 39 -9 184 66 253 -3 250 5 FY13E 75 6 1 15 14 45 156 11 19 FY14E 480 38 65 107 22 263 975 -94 882 9 FY14E 148 14 11 40 -8 202 72 278 -4 274 10 FY14E 526 38 72 113 25 286 1061 -102 959 9 FY14E 165 15 12 42 -7 223 81 308 -4 304 11

FY14E FY14E 40 58 5 5 1 1 15 21 7 6 53 52 122 144 -22 18 14 15 Source: Company, MOSL

7 January 2013

Telecom

Bharti: Financials and Valuation

7 January 2013

10

Telecom

Idea: Key assumptions and value drivers

Y/E March FY10 Subs (m) 64 YoY (%) 48 Average subs (m) 53 YoY (%) 70 Net adds/mon ex acquisition (m) 1.7 YoY (%) 40 Total mobile traffic (b min) 225 YoY (%) 46 Average Rev Per User (INR/month) 207 YoY (%) -21 Minutes of Use/Sub/Month 388 YoY (%) -5 Mobile RPM (INR) 0.53 YoY (%) -18 Mobile EBITDA/min. (INR) 0.15 YoY (%) -19 Capex (INR b) 33 Capex / Sales (%) 27 Y/E March FY10 Consolidated revenue break-up (INR b) 13 established service areas 118 9 new service areas 8 Idea standalone (ex-3G) 126 Proportionate revenue - Indus 8 Incremental 3G revenue Eliminations -11 Consolidated revenue 124 YoY growth (%) 22 Consolidated EBITDA break-up (INR b) 13 established service areas 35 9 new service areas -4 Idea standalone (ex-3G) 31 Proportionate EBITDA - Indus 3 Incremental 3G EBITDA Consolidated EBITDA 34 Cons. EBITDA margin (%) 27 YoY growth (%) 20 FY11 90 40 77 44 2.1 23 363 45 165 -20 394 2 0.42 -21 0.10 -30 88 57 FY11 142 15 156 11 0 -12 155 25 39 -5 33 5 0 38 24 11 FY12 113 26 101 32 1.9 -10 453 25 158 -5 372 -6 0.42 1 0.11 8 39 20 FY12 174 21 195 13 1 -14 195 26 51 -6 45 6 0 51 26 34 FY13E 117 4 115 14 0.3 -82 528 17 156 -1 383 3 0.41 -4 0.11 -1 51 23 FY13E 191 26 217 21 4 -23 220 13 58 -7 51 6 2 59 27 17 FY14E 130 11 123 7 1.1 210 585 11 164 5 395 3 0.42 2 0.12 10 26 11 FY14E 211 32 243 23 6 -25 248 13 FY15E 142 10 136 10 1.0 -5 645 10 169 3 395 0 0.43 3 0.12 3 25 9 FY15E 234 40 273 26 10 -27 282 14

68 75 -6 -5 63 70 7 8 3 4 72 82 29 29 21 14 Source: Company, MOSL

7 January 2013

11

Telecom

Idea: Financials and Valuation

7 January 2013

12

Telecom

RCom: Key assumptions and value drivers

Y/E March FY10 Wireless Subs (m) 102 YoY (%) 41 Average subs (m) 88 YoY (%) 48 Netadds per month (m) 2.48 YoY (%) 11 Total mobile traffic (b min) 351 YoY (%) 27 Average Rev Per User (INR/month) 161 YoY (%) -34 Minutes of Use/Sub/Month 334 YoY (%) -14 Wireless RPM (INR) 0.48 YoY (%) -23 Wireless EBITDA/min (INR) 0.16 YoY (%) -34 Wireless capex (INR b) 31 Wireless Capex/Sales (%) 19 Y/E March Global Minutes carried NLD minutes (b) YoY (%) ILD minutes (m) YoY (%) Broadband Access lines (000s) YoY (%) Average access lines (000s) YoY (%) Netadds per month (000s) YoY (%) Revenue (INR b) Wireless GEBU Total revenue Eliminations and others Consolidated revenue YoY (%) EBITDA (INR b) Wireless GEBU Total EBITDA Eliminations and others Consolidated EBITDA YoY (%) EBITDA margin (%) 7 January 2013 FY10 56 29 85 6 79 -15 35.5 FY11 47 24 71 6 66 -17 31.9 FY12 47 23 70 6 65 -2 31.7 FY13E 49 23 72 5 68 5 32.1 FY14E 52 24 75 4 71 5 32.0 FY15E 57 24 81 4 77 8 32.6 13 FY10 169 110 279 57 222 -3 FY11 166 102 267 62 206 -8 FY12 177 94 271 68 203 -1 FY13E 182 98 280 69 211 4 FY14E 193 101 293 72 221 5 FY15E 209 103 312 76 236 7 FY10 FY11 136 33 119 36 2.77 12 375 7 116 -28 262 -21 0.44 -8 0.13 -21 116 70 FY11 FY12 153 13 144 21 1.4 -48 399 7 102 -12 231 -12 0.44 0 0.12 -6 8 5 FY12 FY13E 135 -12 144 0 -1.5 -205 417 4 105 3 241 5 0.44 -2 0.12 0 8 4 FY13E FY14E 144 7 140 -3 0.8 -153 431 3 115 9 257 6 0.45 3 0.12 2 14 7 FY14E FY15E 153 6 149 7 0.7 -10 454 5 117 2 254 -1 0.46 3 0.13 5 17 8 FY15E

51 59 10 30 1,469 6.1 1,427 18.1 18 -42.7

65 26 15 57 1,514 3.1 1,492 4.5 5 -70.5

65 0 20 28 1,515 0.1 1,515 1.5 2 -64.3

61 -5 22 11 1,502 -0.9 1,509 -0.4 -1 -126.1

64 4 23 5 1,507 0.3 1,505 -0.3 0 -33.3

66 4 24 5 1,512 0.3 1,510 0.3 0 -225.0

Telecom

RCom: Business mix

FY10 Revenue mix (%) Wireless Global Broadband EBITDA mix (%) Wireless Global Broadband Capex mix (%) Wireless Global Broadband Capex mix (%) Wireless Global Broadband 61 29 10 66 21 14 79 18 3 79 18 3 FY11 62 28 10 66 20 13 92 6 1 92 6 1 FY12 65 25 10 67 19 13 62 29 10 62 29 10 FY13E 65 26 9 68 21 11 57 26 17 57 26 17 FY14E 66 26 9 69 21 10 68 26 6 FY15E 67 25 8 70 20 9 75 19 6

68 75 26 19 6 6 Source: Company, MOSL

7 January 2013

14

Telecom

RCom: Financials and Valuation

7 January 2013

15

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