Bharti – Is Zain a good match?
On 15th Feb, 2010 Bharti announced the acceptance of its bid for Zain’s Africa business by Zain’s board. The deal value is $ 10.7 billion which Bharti plans to fund by loans arranged by Standard Chartered Bank and a couple of other Banks. This is the third attempt by Bharti to enter Africa after two failed attempts with MTN of South Africa. The share price of Bharti took a serious beating after this announcement as most of the analyst felt that Bharti is overpaying for Zain’s assets by around $ 2 billion. My analysis shows that it is a good deal for Bharti and its stock price would rise in the long run. In fact, just after the announcement of the deal, I brought Bharti shares and my optimism is based on the following facts:
1. Low Financial Leverage
Bharti has a very low “Net Debt to Equity Ratio” of 0.05 at the end of Dec., 2009 which means that it is virtually a debt free company. It is good to have low debt but zero debt is not a desirable situation as debt can increase the shareholders’ return on their investment due to tax advantages associated with borrowing. The figure along side illustrates how financial leverage can help companies optimize their cost of capital. As it can be seen from the figure, the total cost of capital is high if there is no or low debt and there is a level of financial leverage where the total cost of capital is the lowest. Most of the companies try to maintain leverage at the level where the total cost of capital is lowest.
Bharti is a profitable company with over 40% EBIDTA margins which is higher than the cost of debt. This means that it is better for the company to pay interest than paying dividends to a large number of shareholders and hence it should either reduce the shareholding (through share buyback) or increase debt and deploy debt in a profitable way. Bharti has selected the second option and is taking debt to buy Zain that would return higher profits in the long term. It is like investing for the future. Even if Bharti were to pickup $ 7 billion for the Zain acquisition as debt, then also the leverage is unlikely to exceed 1 which would still be lower than many listed companies. To put the case in perspective, Verizon has a debt to equity ratio of 1:45 while the similar ratio for Sprint Nextel is at 1.19 and for Telefonica, it is as high as 2.78 (source: Forbes financial application).
2. Free Cash
Bharti is one of the few carriers across the world that has free cash flow and it does not make sense for the company to keep sitting on the pile of cash when it can deploy it in productive assets. The capex in the Indian operations have started to decline and hence the free cash flow is likely to increase even further in future. If Bharti decides to fund the Zain acquisition through debt, it would not find much problem in servicing this debt due to generation of free cash flow in the years to come.
3. Attractiveness of African Market
Africa is the next frontier as far as mobility is concerned. As markets saturate, the carriers start to look at opportunities outside of their domestic markets. Vodafone invested in India around three years back to increase the growth potential of its revenues. Now that the tariffs have declined significantly in India and that the penetration levels have crossed 45% in India, there is little opportunity left in the domestic market for Bharti. The penetration levels in Africa are around 33% and the ARPU levels are high varying from $8 – 12 (apart from Kenya and Ghana where it is closer to India ARPU levels of $4). Bharti can replicate its low cost model in the African market which would not only bring the cost down but would also result in significantly higher subscriber addition. The level of competition in Africa is not as intense as India as most of the countries have no more than 4-5 operators. The countries where Zain has operations in Africa have a population of close to 500 million which is an indicator of the opportunity that lies in Africa.
Summary
I believe that with this deal, Bharti would be able to increase the valuation of the company in the longer term. The Zain deal would turn out to be better than MTN as it would be an outright purchase rather than co-ownership as in case of MTN deal. Most of the joint ventures or mergers fail due to cultural issues and ego issues between partners and the ego issues are more likely in co-ownership model. Moreover, in case of Zain, the regulators are unlikely to hold the deal on account of nation pride as Zain does not belong to any of African country and hence there would not be any insistence on dual listing or any similar binding as it was in the case of MTN.
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The deal for Bharti will be really one of the best deal ever made over seas as its cleary indicated that the current pop of 500mn which is almost 50% of the Indian pop and the penetration levels of the telecom is just at 33% which itself indicates wide opporutnity for Bharti to carve in its market share with best full acquisitions inline with its low cost entry strategies which itself is its major advantage in Indian market today. As you already said that the blended ARPU($8 to $12) of this Market are much higher than Indian ARPU($4) so its one of the wide opportunity to work on the revenues and inturn also will enhance the market share as already Bharti has mastering tactics and experience with its Big Pie amidst the intensive competition market with current existing Operators in Indian soil and will certainly leverage its best policies of Cellular WAR in the current operation scenrio of Africa.
As its already indicated that sole ownership is much better than co-ownership so this deal of Bharti for Zain is almost much better that MTN one as there will be one single ownership deciding policies, attempt to explore better strategies, ego free environment to demonstrate its way forward plans and Bharti is well capable of such take over as already at many such deals in within Indian market itself it has proved to over come the recessive market to dominant and leadership market share.No matter may it be small markets or large markets, the one and only required attribute to “Leadership” dominance and “Break Free” position is the strategies and policies of an Operator which play a major role in contribution to develop the internal and external customer satisfaction resulting into major share in both RMS & CMS, and that’s what Bharti possess in its leadership market in India.
Over all its a good deal and will certainly is one of the best deals for Bharti.
Hi,
What I see happening with this acquisition is Bharti taking a lead in changing the complete dynamics of telecom business in the world as it did in India. Having honed the outsourced managed services model to perfection Bharti will replicate the experience and ensure returns on its investment as well as bring down costs for the international subscriber.
When that happens the deal has to be good since all stake holders win. Lets wait & watch.