Graphic: Mint

A reality check for tower company valuations

There have been a large number of exits in the past three quarters, because of which overall tenancy numbers have been on a decline

Is consolidation among telcos a good or bad thing for tower companies? The answer to this should have been obvious. But for some reason, investors were highly excited about the growth prospects of tower companies till about a year ago (bit.ly/2O32gUV).

In mid-October last year, Bharti Infratel Ltd’s market capitalization rose to 88,633 crore, or 35 times trailing 12 months’ net profit. This was after the company said in its 2016-17 annual report that “the consolidation leading to a few, but strong participants, is good for the tower industry in the medium- to long-term... (as these) financially stronger operators (would have) the ability and inclination for enhanced data networks".

It turns out that all hope of a pickup in growth was a mirage. Gross tenancy additions peaked at 8,843 in the June 2017 quarter, around the time the above statement was written. Tenancy addition fell to 4,398, 1,950, 1,933 and 839 in the following four quarters, respectively. Note that these are gross numbers, before accounting for exits from the likes of Aircel Ltd, which has shut operations. There have been a large number of exits in the past three quarters, because of which overall tenancy numbers have been on a decline. There will be far more exits in the September quarter, with Vodafone India Ltd and Idea Cellular Ltd completing their merger, and now getting rid of overlaps.

It’s little wonder Bharti Infratel’s market capitalization has since dropped by 44% to 49,940 crore. The tower infrastructure company now trades at a more palatable 20 times trailing earnings.

So, what happened to the expectations of rapid expansion by the few remaining large telcos? The sanguine view is that infrastructure spends are lumpy in nature, and that the drop in tenancy additions is only a temporary phenomenon.

But according to an analyst at a domestic institutional brokerage firm, Reliance Jio Infocomm Ltd is increasingly relying on other tower companies and on in-house infrastructure for its recent roll-outs. That leaves Bharti Airtel Ltd, whose network growth plans would need to make a generous contribution to Bharti Infratel, for the impact of exits to be offset. At this stage, growth clearly looks like a challenge.

What about the hope that exit penalties will make up for the loss in business from telcos? There isn’t much hope of recovery from companies such as Aircel that have filed for bankruptcy. Even with Vodafone Idea Ltd, reports suggest that exit penalties may be adjusted against future revenue commitments. The above-mentioned analyst says that roughly 25% of the business that was lost may be recovered through exit penalties.

In this backdrop, there may well be further downside for Bharti Infratel shares. For now, the plan to sell a large stake to private equity investors is off the table. Telcos could possibly choose to extract savings on tower rentals, rather than continue to bleed. While no one is betting on this, it is clearly foolhardy to expect tower companies to continue making rich margins and return ratios, while telco losses expand.