Bharti Airtel Ltd has placed a bid of $10.7 billion for acquiring the African assets of Zain Group, which the board of the latter has approved. In our opinion, the deal does not appear highly expensive and earnings dilutive for Bharti. Moreover, even if the entire deal were to be funded through debt, Bharti’s net debt would rise from nil currently to a comfortable $10-12 billion.
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However, a turnaround in Zain’s deteriorating operating and financial metrics remains pertinent to our hypothesis. This apart, though Zain’s acquisition would be a strategic fit for Bharti in Africa’s high growth market, Bharti’s move seems to be a desperate attempt to avert a decline in its growth trajectory as the domestic market gets increasingly competitive.
Bharti has valued Zain Africa on 7.7 times and 9.2 times 2008 and estimated 2009 earnings before interest, tax, depreciation and amortization (Ebitda) of the company (full value) against seven times for its own domestic operations.
This valuation, we believe, is fair, taking into consideration the premium attached to the controlling stake as well as the high growth profile of the African territory.
However, adjusted for the minority interest in Zain Africa, the deal becomes expensive at 9.8 times and 11.6 times.
Zain’s African operations, after reporting strong growth in 2007 and 2008, deteriorated in 2009.
Turning around Zain’s Africa operations, thus, assumes critical importance for Bharti to make this acquisition value accretive. This turnaround, we believe, is at least two years ahead.
The Bharti management has been accredited for its execution capabilities in the Indian territory. However, it has little experience in managing cross-border operations.
It, therefore, remains to be seen whether Bharti is able to replicate its domestic growth story in Africa.
We find the deal to be earnings per share neutral for Bharti as Zain’s Ebitda ($1.4 billion) would be sufficient to offset the increase in depreciation and interest cost for Bharti after acquisition ($1.2-1.4 billion). Lower-than-estimated interest costs, higher tax shields and operating synergies would thus be positive for Bharti. In contrast, the investment banking fees and merger/rebranding cost would have a one-time negative effect.
Even at the elevated debt level, Bharti’s debt-equity would stand at 1 times and debt/Ebitda at 2-2.4 times (including that of Zain Africa)—a comfortable zone. The initial public offering of Infratel/Indus tower would further help make Bharti’s balance sheet debt-free, mostly in FY11.
Bharti will hold exclusive talks with Zain till 25 March.
Deal closure remains subject to due diligence and regulatory approvals. In the past, Bharti made two failed attempts to close the deal with MTN Group Ltd. We maintain our estimates and buy rating on Bharti with a target price of Rs380.
Graphic by Yogesh Kumar / Mint