Telecom Sector

May 24, 2009

KSL – Sector Update

A New Beginning

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Khandwala Securities Limited

Falling ARPU, EBIDTA margins, increased capex Bharti, RCom and Idea combined market
and customer acquisition costs and other such capitalization corrected much more than drop in
concerns have brought down the combined market combined EBIDTA
capitalization of the three large players - RCom,
Mkt Cap EBIDTA (RHS)
Bharti and Idea – by 60% over the last two-hand-
4,500 (INR Bn) (INR Bn) 80
half years. In reality, the combined EBIDTA of these
three players does not show much deterioration.
3,625 60
We upgrade our view on the Indian telecom
industry to positive considering following reasons:
2,750 40
1. Valuation – Stock prices corrected far more than
drop in EBIDTA
1,875 20
2. Consolidation would be the next trigger for
re-rating of the sector
1,000 0
3. Regulatory environment is now more certain Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
than uncertain
4. Tariffs appear to have bottomed out Consolidation next trigger for re-rating
5. Minutes of usage (MOU) likely to increase as We believe consolidation in the sector in around the
subscribers growth stabilizes corner considering intense competition, which led to
6. Besides being a communication device, mobile fall in tariffs and margins, CAPEX requirements,
phone is now a fashion accessory and life-style spectrum scarcity, rising subscriber acquisition costs
symbol. and tapering off growth in subscriber net addition.
At present, there are 8-10 players per circle, which
we expect to reduce to 5-6 players per circle in the
next 3-5 years. Just concluded, 3G auction shows
that no player won pan-India 3G spectrum which
Valuation
would lead to sharing. Telecom sector registered
We believe concerns are already factored-in stock remarkable growth and now contributes ~6% of
prices and stocks would react to any positive GDP from less than 1% in 1995 and now nearing
surprises. Concerns over heightened competition, maturity which would drive consolidation in our
regulatory uncertainties, aggressive bidding for 3G view.
and falling revenues and margins resulted in stocks’
underperformance over the last two-and-half years. Telecom revenue contribution to GDP
Bidding for 3G spectrum is over and players
6.3 (%)
restrained from aggressive bidding to win their
preferred circles.
5.0
We believe tariffs have bottomed out and 3G launch
is likely to have positive impact on realizations. We
expect regulatory environment to become more 3.8
certain than uncertain going forward as industry
has matured. The stocks prices corrected far more
2.5
than drop in EBIDTA and Bloomberg consensus
estimate absolute EBIDTA to grow in coming years.
1.3

Preferred stocks: Bharti Airtel, Reliance

Communications, MTNL and Spice Mobile 0.0
FY95 FY97 FY99 FY01 FY03 FY05 FY07

KSL – Telecom Sector Update 2

May 24, 2010
Khandwala Securities Limited
Regulatory environment is now more certain than
uncertain
Telecom sector has shown tremendous growth over
past few years and regulatory environment evolved
over a time. As the sector is becoming mature, we
expect regulatory environment to become more
certain than uncertain going forward. We expect
uncertainties over MNP, TRAI recommendation
over 2G spectrum charges, spectrum sharing, M&A
norms etc. will be addressed in near future.
Players displayed disciplined aggression while
bidding for 3G
Just concluded 3G spectrum auction shows
discipline observed by players while bidding as no
player won pan-India 3G spectrum. Players’
restraint themselves from bidding aggressively for
pan-India spectrum and judiciously selected their
preferred circles considering business potential,
overall cash outgo and auction price for circle. Net
debt/EBIDTA for Bharti, Idea and Rcom is likely to
increase to 0.7, 3.6 and 3.6 respectively.
Fastest growing wireless market in the world
Indian telecom sector is the fastest growing market
in the world, adding nearly 20 mn subscribers a
month. In the FY10, the industry added ~192 mn
subscribers taking overall subscriber base to ~584
mn. Rural tele-density remains ~20% leave enough
scope for growth. Multi-SIM usage drives reported
subscribers addition numbers; adjusted numbers
suggests actual users of cellular services are
relatively lower.
Net Additions All India Wireless (RHS)
22 (Mn)
16
10
4 200
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
KSL – Telecom Sector Update
Demographic dividend; encouraging demand
driver
India’s demographic composition augurs favorably;
with nearly half of population below the age of 25
years. Robust macro economic indicators clubbed
with socio-economic drivers are likely to help the
country sustain its growth trajectory. The size of the
working age population exceeds the size of the
dependent population and it is estimated that it will
remain so until the year 2025 and perhaps, even
beyond.
Growth of disposable income combined with
changes in lifestyle
The high economic growth in the past few years has
resulted in a rising number of Indians with a greater
propensity to spend. This rise in income levels
across urban, semi-urban and rural households has
led to changing consumption patterns. Necessities
such as food and apparel are expected to decline in
relative importance to categories such as
communications, education & recreation and
healthcare. With rising disposable income and
prosperity, Customers are moving up the ladder
and shift is clearly visible from their buying
behavior – from less premium/cost products to
better/relatively expensive products in their
subsequent purchases. Almost 2/3rd of population
falls under working group age (15-64 years) and
better education and technology adoption would
augur well for the telecom sector.
3G launch to boost growth momentum and
average realizations
(Mn) 650
The expected launch of 3G services in the near
future, offers opportunities to increase data usage
and revenues from customers. 3G will enable
companies to offer high-speed data and voice to
500 customers. 3G supports higher data speeds and data
services, an operator will grow its share in the value
added services segment specifically the data market.
350 With launch of 3G services, data services
contribution has seen rapid growth globally.
Currently, the value added services contribute 8-
10% of revenue and post 3G it is expected to
increase to grow up significantly. Favorable
demographic, rising disposable income, strong
economic growth and technology savvy youth
3
May 24, 2010
Khandwala Securities Limited

population would likely to result into faster Gross revenues show improvement in March
migration to 3G services. Revenues from data quarter after 3 quarters of subdued performance
services traditionally enjoy a higher margins as
Subscribers Gross Revenue
there is no interconnect expenses that need to be 600 (Mn) (INR Bn) 390
paid as is case of voice segment and thus, increase in
data revenues would support margins.
475 330

3G launch would augur well for mobile

350 270
manufacturers, VAS providers
The expected launch of 3G services in the near
future, offers significant growth opportunities for 225 210
the company, as customers would replace existing
handsets to 3G-enbled handsets to use these
100 150
services. 3G launch is likely to improve average
Mar-08 Sep-08 Mar-09 Sep-09 Mar-10
realization and gross margins per handset. 3G will
enable video calling, live news and movies, M-
commerce, content development for Mobile TV,
Games etc and high data transfer spawning a new Mobile phone is now a fashion accessory and life-
ecosystem and creating a new revenue stream for style symbol
VAS providers. After market penetration has reached over 50% and
mobile phone becomes people’s choice for internet
connectivity, a perpetual market for handsets
Tariff war appears to be behind us manufacturers and service stations has opened up.
Since the launch of “per-second billing” by Tata and With rising aspirations and consumers’ tendency to
“Simply Reliance”, there are no further reductions opt for high-end handset when they buy their next
in tariffs. Most of the players now offer similar tariff phone augurs well for hardware vendors who now
packages in a circle gives little scope for a consumer have perpetual market for replacement demand. In
to choose operator on pricing keeping aside this space, we prefer Spice Mobiles, which provides
advantage of nationwide footprint, network opportunity to participate across the spectrum of
coverage and service quality. value creation in mobility - presence across mobile
handset, retail distribution, value added services,
Players are unlikely to cut tariff further considering and application development
rock bottom tariffs, network roll-out costs,
increasing subscriber acquisition costs and rising
operating expenses. Players are likely to remain
price discipline while launching 3G services
considering spectrum prices and less intensive
competition.

KSL – Telecom Sector Update 4

May 24, 2010
Khandwala Securities Limited

Company Section

KSL – Telecom Sector Update 5

May 24, 2010
Khandwala Securities Limited

Bharti Airtel Limited

Ratings Attractive Valuation: Bharti Airtel stock corrected ~40% in
LTP 266 Recommendation ADD
last one year and underperformed broader markets by
Target 380 Risk LOW
(18-Months)
whopping ~60%. The stock currently trades at ~11x TTM
earnings. We believe much of the fears has already priced-in
Bloomberg Consensus the stock.
(BUY/HOLD/SELL) 20 / 15 / 12
Market leadership to continue: Bharti, a leader in the
Sensex Nifty BSE Teck
domestic telecom market (and now becoming global leader
16,446 4,931 3,073 with Zain and Warid), will be primary beneficiary of
Codes anticipated robust growth momentum. Bharti enjoys almost
BSE NSE Bloomberg Reuters 1/3 of revenue market share and ~22% subscribers’ market
532454 BHARTIARTL BHARTI IB BRTI.BO share. We believe strong management, expanding national
footprint, innovative products, wide distribution and strong
Sensex Bharti Airtel
brand name will enable it to manage its market share.
52 Wk: Hi/Lo 18,048/13,220 467/229
Life High 21,207-Jan 08 575-Oct 07 Well placed to capture rural demand: Bharti is well
P/E 19.52 10.71 positioned to capture rural growth by leveraging its wider
P/BV 3.43 2.75
coverage and favorable frequency allocation (900 MHz) - a
Dividend Yield (%) 1.18 0.38
Mkt Cap (INR Mn) 59,278,820 1,009,570
significant competitive advantage in low density regions.
Equity (INR Mn) - 18,988 Bharti’s network is present in 5,091 census towns and
438,933 non-census towns and villages, covering ~84% of
population.
Share Holding Pattern % Dec-09 Mar-10
Foreign 17.90 18.44 Focus on revenues and margins: Bharti enjoys almost 1/3
Institutions 7.96 7.93 of mobile revenue market share, more than 10% higher than
Corporate 4.07 3.49 nearest competitors. Management suggested their
Promoters 67.84 67.83 preference to maintain focus on revenue market share over
Public & Others 2.24 2.32 subscriber market share. The management is focused
similarly on margins and expects to maintain margin
Returns % Abs Relative to
Perf Sensex BSE Teck
leadership.
1 Month -12.65 -6.84 -4.76 Strong balance-sheet: Bharti has very strong balance-sheet
3 Months -4.46 -6.03 -2.25
and ended FY10 with net cash. Unlocking value in the tower
1 Year -37.97 -54.93 -62.26
business would further strengthen company’s financial
Relative Price Performance muscle.
150 Bharti Airtel Sensex

125 Financial Summary

(INR Bn) FY07 FY08 FY09 FY10 FY11E FY12E
Revenue 185.2 270.2 369.6 396.2 425.4 475.2
100
EBIDTA 74.5 113.7 151.7 160.3 166.4 184.7
EBIDTAM (%) 40.2 42.1 41.0 40.5 39.1 38.9
75 EBIT 49.3 76.5 104.1 99.8 96.9 107.3
PBT 48.9 76.5 93.1 107.0 98.8 111.5
Net Profit 42.6 67.0 84.7 91.0 81.0 91.8
50
May-09 Nov-09
EPS (INR) 11.2 17.7 22.3 24.0 20.9 23.6
Note: Estimates based on Bloomberg Consensus

KSL – Telecom Sector Update 6

May 24, 2010
Khandwala Securities Limited

Mahanagar Telecom Nigam Limited

Ratings
Divestment/Consolidation candidate considering rich
LTP 56 Recommendation BUY
assets: MTNL has presence in only two metros, namely
Target 80 Risk MEDIUM
(24 Months)
Delhi and Mumbai, and penetration saturation and tariff
war resulted into deteriorating operating performance of
Bloomberg Consensus the company. The stock is currently trades at ~1/3 of its
(BUY/HOLD/SELL) 00 / 02 / 14 book value. We believe Government is keen on
consolidation in the sector and recent recommendation by
Sensex Nifty BSE Teck TRAI will encourage consolidation and we believe
16,446 4,931 3,073
government will implement favorable M& A regulations. In
Codes
BSE NSE Bloomberg Reuters
our view, MTNL is potential candidate for consolidation
500108 MTNL MTNL IB MTNL.BO exercise which will be unearth its intrinsic value and gives
broader addressable market. MTNL holds 12.4 MHz
Sensex MTNL spectrum (including 6.2 MHz in 900 MHZ band) for GSM
52 Wk: Hi/Lo 18,048/13,220 124/54 and 2.5 MHz spectrum for CDMA.
Life High 21,207-Jan 08 390-Feb 00
P/E 19.52 - Broadband business doing well: MTNL, despite the fact
P/BV 3.43 0.37 that it provides Broadband services only in Delhi &
Dividend Yield (%) 1.18 1.78 Mumbai, with ~0.8 mn subscribers on its roll, has become
Mkt Cap (INR Mn) 59,278,820 35,469 the 2nd largest broadband service provider only after BSNL.
Equity (INR Mn) - 6,300
Government might give some leeway: Government might
give some relief to BSNL/MTNL on 3G spectrum and/or
Share Holding Pattern % Dec-09 Mar-10 “excess” spectrum charges (if TRAI recommendation gets a
Foreign 11.96 11.18
nod) payment by way of either deferment or discount
Institutions 22.31 22.62
Government 56.25 56.25
which could act as positive trigger for the stock.
Corporate 2.93 2.99 Government might agree to MTNL’s request to take onus of
Public & Others 6.56 6.98 pension payment for employees which would improve
financials considerably.
Returns % Abs Relative to
Perf Sensex BSE Teck Monetization of Real estate and tax refund: The Company
1 Month -22.82 -17.01 -14.94 has sizable quantum of land and monetization of these
3 Months -25.48 -27.05 -23.27 assets would strengthen balance-sheet and cash-flows. The
1 Year -35.66 -52.63 -59.96 company has received Rs 11 bn in Q4 and recently got
Relative Price Performance further entitlement for ~4 bn tax refunds in May and
management expects further tax refunds.
150 MTNL Sensex

125 Financial Summary

(INR Bn) FY07 FY08 FY09 FY10 FY11E FY12E
100 Revenue 49.2 47.3 45.8 37.7 37.6 37.2
EBIDTA 8.8 8.3 3.1 -34.8 -1.0 -0.4
EBIDTAM (%) 17.9 17.5 6.7 -92.2 -2.7 -1.1
75
EBIT 2.0 1.2 -4.1 -42.1 -7.3 -7.5
PBT 8.1 7.9 3.1 -30.7 -2.3 -5.4
50 Net Profit 5.3 5.1 2.2 -24.8 -5.0 -7.7
May-09 Nov-09 May-10 EPS (INR) 10.2 8.1 3.4 -39.9 -7.1 -12.1
Note: Estimates based on Bloomberg Consensus

KSL – Telecom Sector Update 7

May 24, 2010
Khandwala Securities Limited

Reliance Communications Limited

Ratings Attractive Valuation: Reliance communication stock
LTP 133 Recommendation BUY
corrected sharply due to tariff war, increasing competitive
Target 225 Risk HIGH
(18-Months)
intensity, issues over irregularities of accounts, and
leveraged balance-sheet. The stock currently trades at below
Bloomberg Consensus book value and ~6x P/E based on TTM earnings. We
(BUY/HOLD/SELL) 09 / 07 / 27 believe much of the fears has already priced-in.

Sensex Nifty BSE Teck

Integrated player: Rcom is uniquely positioned across the
16,446 4,931 3,073 voice and data spectrum. Launch of 3G will enable Rcom to
Codes leverage its unique advantage further by offering faster
BSE NSE Bloomberg Reuters connectivity and data transfer. It currently derives ~40% of
532712 RCOM RCOM IB RLCM.BO revenues from global, broadband and other businesses,
while these segments contribute ~30% of EBIDTA. We
Sensex RCom
expect income from global and broadband business to grow
52 Wk: Hi/Lo 18,048/13,220 359/132
Life High 21,207-Jan 08 844-Jan 08
faster in the coming years which would help company to
P/E 19.52 55.82 diversify revenue and profit base further.
P/BV 3.43 0.53
MNP to likely to benefit: Introduction of MNP is expected
Dividend Yield (%) 1.18 0.60
to be positive for company’s GSM operations, while CDMA
Mkt Cap (INR Mn) 59,278,820 275,340
Equity (INR Mn) - 10,320 operations likely to maintain its market share. MNP is likely
to be introduced from June 30, 2010. We expect R Com to
thrive tariff war & gain market share in terms of subscribers
Share Holding Pattern % Dec-09 Mar-10 and revenues both eventually.
Foreign 8.82 9.01
Institutions 9.61 9.71 Value unlocking from Reliance Infratel (RITL) and other
Government 0.05 0.05 assets: One of the key concern in the minds of investors
Corporate 2.76 2.41 remain leveraged balance-sheet which is likely to de-
Promoters 67.51 67.58 leverage significantly going forward (net debt of Rs ~285 bn
Public & Others 11.25 11.24 after considering 86 bn outgo for 3G spectrum, 3.6x
debt/TTM EBIDTA) as capex intensity in the business
Returns % Abs Relative to
moderates, value unlocking from Reliance Infratel and other
Perf Sensex BSE Teck
1 Month -20.38 -14.57 -12.49
assets and cash flows from GSM business start contributing.
3 Months -17.55 -19.12 -15.34
1 Year -56.62 -73.58 -80.91

Relative Price Performance

150 RCom Sensex
Financial Summary
125 (INR Bn) FY07 FY08 FY09 FY10 FY11E FY12E
Revenue 144.7 190.7 229.4 222.5 240.8 267.1
100 EBIDTA 57.2 82.0 92.9 78.9 80.4 89.6
EBIDTAM (%) 39.5 43.0 40.5 35.4 33.4 33.5
75 EBIT 32.6 53.9 53.5 41.0 39.0 46.4
PBT 32.6 57.9 61.4 52.9 32.4 40.3
50 Net Profit 31.6 65.9 59.1 47.0 27.0 31.3
EPS (INR) 15.5 31.9 28.6 22.8 13.4 15.4
25 Note: Estimates based on Bloomberg Consensus
May-09 Nov-09 May-10

KSL – Telecom Sector Update 8

May 24, 2010
Khandwala Securities Limited

Spice Mobiles Limited

Ratings Well placed to ride upcoming wave of convergence: The
LTP 81 Recommendation ADD proposed structure will establish Spice Mobility presence
Target 100 Risk LOW
across the mobility value chain and gives cross sales and
24-Months
bundling opportunities. It will enable company to capture
Bloomberg Consensus customer’s imagination and staying at top when more and
(BUY/HOLD/SELL) 00 / 00 / 00 more offerings transcending the boundaries between
devices, services and customer ownerships. Mobile internet
Sensex Nifty BSE Teck is growing rapidly across the globe and expected to grow
16,446 4,931 3,073 even faster which gives unique edge to companies having
Codes presence across in identifying changing trends and
BSE NSE Bloomberg Reuters
addressing them effectively. The new entity will drive
517214 SPICEMOBIL SPCEM IB SPCL.BO
synergies between different businesses and also strengthen
Sensex Spice Mob brand “Spice”. The company provides opportunity to
52 Wk: Hi/Lo 18,048/13,220 82.20/10.81 participate across the spectrum of value creation in mobility
Life High 21,207-Jan 08 82.20-May 10 space - Presence across Mobile Handset, Retail distribution,
P/E 19.52 8.30 Value added services, and Application development. The
P/BV 3.43 4.36 company leverages its knowledge of Indian customer’s
Dividend Yield (%) 1.18 0.35
preferences by offering products with features that suits
Mkt Cap (INR Mn) 59,278,820 5,851
Equity (INR Mn) - 224
Indian market.
Wider distribution and after sales service reach
The company has presence across the country through 62
Share Holding Pattern % Dec-09 Mar-10
Foreign 4.46 2.73
regional distributors, ~500 micro distributors and ~40,000
Corporate 19.22 17.07 retail outlets. The company plans to expand reach further to
Promoters 63.25 63.25 ~100,000 outlets by end of the next year. The company has
Public & Others 13.08 16.96 strong presence in North and expanding reach in other
areas through organic and inorganic route. It has ~300 after
sales centers spread over to cater customers’ needs.
Returns % Abs Relative to
Perf Sensex BSE Teck 3G launch to boost growth momentum and average
1 Month 43.20 49.01 51.09 realizations: The expected launch of 3G services in the near
3 Months 92.39 90.82 94.60 future, offers significant growth opportunities for the
1 Year 623.92 606.95 599.62 company as customers would replace existing handsets to
Relative Price Performance 3G-enbled handsets to use these services. 3G launch is likely
to improve average realization per handset. Number of
800 Spice Mobiles Sensex
wireless subscribers has already reached 584 mn which
700 would result into strong replacement demand for the
company.
600

500
Financial Summary (Mobile Business)
400 (INR Bn) FY07 FY08 FY09 FY10 FY11E FY12E
300 Revenue 1.9 4.1 5.5 10.4 14.0 17.6
EBIDTA -0.1 0.2 0.0 1.0 1.4 1.7
200
EBIDTAM (%) -3.3 4.6 -0.3 9.9 9.7 9.9
100 EBIT -0.1 0.2 0.0 1.0 1.3 1.7
PBT 0.0 0.3 0.0 1.1 1.4 1.7
0
May-09 Nov-09 May-10 Net Profit 0.0 0.2 0.0 0.7 0.9 1.1
EPS (INR) 0.3 2.5 0.1 9.5 12.2 15.4
KSL – Telecom Sector Update 9
May 24, 2010
Khandwala Securities Limited

Analyst Certification
Each of the analyst(s) named certify, with respect to the companies or securities they analyse that:
(1) all the views expressed in this report accurately reflect his/her/their personal views about
any and all of the subject companies and securities; and (2) no part of his/her/their
compensation was, is, or will be, directly or indirectly, related to the specific recommendations or
views expressed in this report.

KSL Ratings
Target Price refers to one year unless specified; LTP: Last Trading Price
BUY: Expected return >15%
ADD: Expected return 0-15%
REDUCE: Expected decline 0-15%
SELL: Expected decline >15%

Company Risk is based on the systematic risk of the stock. (1-year Beta)
HIGH: >1.2
MEDIUM: 0.8-1.2
LOW: < 0.8

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KSL – Telecom Sector Update 10

May 24, 2010
Khandwala Securities Limited

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KSL – Telecom Sector Update 11

May 24, 2010