Is Bharti Infratel’s correction an overreaction?
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Tower firms such as Bharti Infratel Ltd were expected to be the only beneficiaries of Reliance Jio Infocomm Ltd’s aggressive network expansion. Now, they’re likely to become victims of collateral damage. Last week, after Vodafone India Ltd and Idea Cellular Ltd announced they are in merger talks, Infratel’s shares fell over 15%.
If the merger goes through, the combined entity will no longer need as many towers and related infrastructure as they did when they ran separate operations. And what is rationalization of costs for the Vodafone-Idea combine will be value destruction for Bharti Infratel.
Analysts at JM Financial Institutional Securities Ltd have estimated the damage could range between Rs40 and Rs53 per share for Infratel. The tower firm’s shares have fallen by Rs54 in the past week. Prima facie, investors seem to be assuming both a 100% probability for the merger to go through and a worst-case scenario in terms of tenancy losses and recovery losses. While there’s no doubt a merger will be bad news for the firm, the combined entity may well choose to retain a fair share of tenancies for better coverage and capacity. Besides, its exit clause may include penalties, which could compensate losses to some extent.
“The master service agreement (MSA) specifies a recovery of 35% of the balance-period rental, subject to certain exceptions (which are not disclosed by the firm). If Infratel is able to collect these exit-penalties, the net impact on its equity value comes down to Rs40 per share (vis-a-vis Rs53 per share if no penalties are collected),” JM Financial’s analysts said in a note to clients.
To be sure, some analysts see things differently. Apart from the one-off impact due to the expected loss in tenancies, they also factor in lower valuation multiples due to an expected drop in growth rates in future.
But note that growth hasn’t been really spectacular to start with. In the December quarter, year-on-year growth in the average tenancies stood at 6.1%, marginally higher than the 5.7% growth in the September quarter, and lower than the 6.5% growth in the June quarter. Revenue growth slowed from 9.9% and 7.7% in the first two quarters of the year to 7% in the December quarter, and similarly growth in core operating profit fell to 7.1%, from an average of over 9% in the first two quarters.
Besides, free cash flow is estimated to have fallen, compared with the first two quarters of the year. While it’s true that the response to the merger news may be an overreaction, it’s worthwhile to also note that Infratel used to enjoy fairly high valuations in the past. And profit growth rates, which are already sluggish, may come under further pressure, thanks to the consolidation in the sector. Having said that, considering that the company still generates large amounts of cash, some investors are likely to find the stock attractive on a free cash flow yield basis. As such, downside may well be limited.