Corus

The Bharatiya Bharti : India’s Atlas in the Making

Sanjeev

Sanjeev

I am not prone to making stock calls very often. The last time I did so, was when Tata Steel fell 14% the day they announced the acquisition of Corus, and I pointed out that things weren’t really so bad. The stock rallied 250% after that, before joining others in the basement in end-2008. I still think the co will pull through, for the same reasons: its core operations will eventually deleverage the Corus acquisition, and value will flow from the fact that the cost of equity in Corus will be replaced by the cost of (repaid) debt.

Declaimer: This article written was originally in February 2010, and some of the data points may be outdated.

 

There is an identical, even better story happening just now

There is an identical, even better story happening just now. Let’s see: things have never been worse in the fast-growing Indian Telecom sector. While sector fundamentals have never been better, industry players have never had it worse. With hyper-competition driving down unit prices to impossible lows, the survivor would have won the toughest competitive battle in the Telecom world to win market share in the lowest tariff regime in the world. The winner will control the second-largest subscriber base in the world and will learn to live with the lowest Average Revenue Per User (ARPU) in the world.

The survivor will learn more about communication than about mobile phones. It will learn to spread its network to low-density areas and extract revenue from the poorest of the poor through culturally sensitive communication programs (e.g. music downloads, edutainment, even weather forecasts, cyclone warnings, and grain price alerts). It will learn to integrate backward and forwards, out of reach of Govt regulators and tariff pricing regimes for basic voice services. It will locate ‘investment famines’, especially in the core infrastructure that supports the entire Telecom industry.

As underwater competitors run around like headless chickens, selling the very Telecom infrastructure that is going to be the key limiting factor in the future, they will have picked up useless, price-sensitive customers through a bruising price war in saturated markets. The cash they will lose to acquire such customers would have been better utilized to acquire Telecom infrastructure, which seems to be the only physical entry barrier left in the industry. A greedy Govt will sell licenses to anyone who will buy them, as long as they can extract a few pennies from them.

Remember: the ability to invest incremental cash (from Operating earnings) into the industry is reducing. Further, the industry is very unattractive to any new entrant now, because the breakeven point (in terms of the of subscribers, areas covered, and range of products) has shifted far upwards. The only source of cash now is Debt capacity, which nobody has, except 3 players.

Behavioural Investing Rule

Behavioural Investing Rule No.1: if cash cannot come in through the Balance Sheet, matters will so compose themselves that the cash needed for industry growth will start to come through the P & L Account, i.e. through pricing power.

Assuming the industry continues to grow >30%, money will be needed for growth. This money can no longer come from markets if the industry is no longer attractive. SOMETHING WILL HAPPEN to ensure that the cash for growth is generated, usually in the hands of the last man standing. Either new products will turn extra-ordinary profitable, or the cost of (new) customer acquisition will drop, or competition will fall off, ending the price war….something will happen!!

Behavioural Investing Rule No.2: investments done under conditions of fear and with a shortage of prosperity, are well evaluated with a high cost of capital. If done by intelligent people, there is a high probability that they will create value and that every potential for downside has been weighed against the opportunity. This is not a ‘macho’/arrogant investment.

We know from previous experience that Bharti has the smartest management in the business. The probability that they know something which the market does not know is high. For example, Zain is a No.1 or 2 player in every one of the 15 African markets it operates in. Bharti’s management can get to work on increasing market share to dominant shares, from being a first among equals. This is something they would have learned in similarly profiled markets (India, Sri Lanka, Bangladesh). The populous countries (Nigeria, Tanzania, Kenya, Uganda) are all at low levels of penetration, with Zain within the springing range of market leadership. Most important, GDP per capita in all these countries, is all >$1000, the level at which consumption patterns move towards discretionary spending favoring telecom. The cost of the acquisition per EXISTING subscriber is not very relevant, because subscriber growth has not been factored in, not just in absolute numbers of subscribers, but also the average spend per subscriber. The potential for new (augmented) products around the core offering (which Bharti is very good at) has not been fully understood by a myopic stock market.

Behavioural Investing Rule No.3: go where no man has gone before, do what no man has done before. Preferably, do it from firm ground, i.e. with the ability to pay for your forays from existing resources.       

So which other Telecom co from India can you imagine doing this? Who else has shown the original thinking and innovation leadership, to be able to scale up (and now sideways) like this? What all this will achieve, is that Bharti now has the added possibility that if they get one battle right, the other one is won by default. When we buy Bharti stock now, we buy 2 possibilities: either the Indian Telecom market will get consolidated in favor of Bharti, or they will outperform in Africa. If one happens, the probability of the other increases automatically.       

Behavioural Investing Rule No.4: don’t operate outside your circle of competence. Don’t plan to turn around acquisitions with skills and competencies that you don’t have.

The African markets are not very different from India, where Bharti has shown remarkable cultural sensitivity to tap into a young Indian population (e.g. the music download business). It has already learned rural marketing, bottom-of-the-pyramid (BOTP) marketing, and learned to be profitable in low revenue environments. The only thing it needs to learn is cross-cultural management; the rest of the story is a repeat of competencies that have already outperformed in India.

Compare this with the typical global Telco, which needs to learn much more to get into Africa. And we get to ride on the only pan-EM telco that understands low-revenue markets. Once these markets are tied up, inroads can be made into basic services in developed markets. Quite simply, this will be the most competitive telco in the world, the L.N. Mittal of Telecom.

As Bharti goes into Telecom PLUS services, like edutainment, farm-related communications, etc, those products will be launched across a range of similar countries. Learnings from one country will be used in another, outflanking local competition in the respective countries.

Behavioural Investing Rule No.5: buy at the market bottom, and be fully invested when the market turns. Importantly, maximise Operating and Financial Leverage, with a put option on Equity if there is a need to deleverage.

 Except for Vodaphone, nobody else could have done this. We don’t know whether the timing is in the midst of a global bottoming out. But things look like they can’t get worse in the domestic Telecom market, and Africa could rebound in relative terms to the rest of the world. What looks like bad (geopolitical) countries can get better, simply because they can’t get worse. The other Mittal (LN) also did this, with spectacular results.

Behavioural Investing Rule No.6: Learn to look stupid, esp when nobody gives you a snowball’s chance in hell of coming out unscathed.

 This is not for Bharti. It is for you, dear reader. Bharti is in the value range. It might fall more from here; that does not mean you should sell. If it looks good at 280, it should look better at 240…!!!

P.S. Notice that I have quoted no numbers. Most analysts are bearish, which is a good sign. Telecom is under-owned by the ‘smart’ institutions where you usually keep your money.

If an FII suddenly gets excited about India and decides to bid up the Sensex P-E, this is surely the first stock it will pick on. The beta is low, the P-E downside is limited and the stock has size and depth. If carry trading into India starts (after the Euro fiasco, where do they go?), this is one of the first targets. You could get a 30% upside with no change in fundamentals.    

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