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VIL ceding share to the government; Bharti, RJio to benefit?

The last few days have seen heightened investor interest in VIL’s equity conversion of the regulatory obligation for the next four years. How will this change the sector dynamics?

EVENT – VIL has agreed to convert the AGR and spectrum differed interest into equity as a part of government aid to the sector. The government had offered the option to convert the interest component accrued during the moratorium period into equity – the Net Present Value (NPV), as per VIL, is expected to be ~INR160b. This implies that the government’s stake in VIL would be closer to 35%. It is important to highlight that Bharti did not opt for a similar arrangement a couple of days ago.

So what will be the future repercussions?

For Vodafone Idea

a) This would still increase the EMI to INR353b from the earlier EMI of INR236b annually. Moreover, the overall liability would increase to INR1656b from INR1554b. Its annualized EBITDA (pre-Ind AS) stands at just INR81b as of 4QFY22 (post the tariff hike benefit).

b) The future outlook would depend on multiple factors. i) Large-scale capital support is needed to meet the liabilities of INR1,945b (2QFY22). It would also need to invest in the network to arrest the ongoing market share churn. ii) The numbers are startling; therefore, VIL would need to take a tariff hike – leading to an ARPU increase of ~1.9x – to reach a self-sustainable level over the next four years. Alternatively, it may need to grow its revenue ~3x from current levels. iii) Containing the rate of churn should be a priority – even 3QFY22 is expected to see a nearly 4– 5m subscriber churn. Until VIL has sufficient funds to invest in the network and compete in the market, the subscriber churn may continue to dilute earnings.

c) Despite the government owning a sizeable stake – more than the other two promoters, Vodafone and Aditya Birla Group – the management has communicated that the government would not take a board seat, nor undertake operation or management of the company. Hence, the government would be a passive shareholder for now.

For other peers – Bharti and RJio

We see the situation turning increasingly positive for Bharti and RJio.

a) As a VIL shareholder, the government would realize that there is no option but to increase the ARPU (which augurs well for both Bharti AND RJio) if the entity is to survive beyond four years. Thus, there could be repeated tariff increases.

b) Vodafone Idea continues to lose market share, and the promoter ceding large-scale shareholding to the government does not bode well for the company. Over the last four quarters, Bharti/RJio has captured 4%/1% market share from VIL. The latter’s eight weak circles (comprising an average 7–8% market share) have 150bp market share available. The remaining stronger circles need to drive market aggression and network investments. This could continue to provide 4%/3% incremental revenue growth for Bharti/RJio.

Steady earnings growth for Bharti and RJio

We expect a 22% EBITDA CAGR for Bharti over FY21–24E. Furthermore, with market share gains as an additional option value, Bharti has the capability to achieve 17% revenue growth in India Mobile (from an 8% mix-led ARPU improvement over FY23– 24E) – assuming a ~3m monthly 4G subscriber add run-rate and 2–3m subscriber growth. RJio is expected to drive a 12% revenue CAGR on the back of 6% subscriber growth over FY21–24E. We see additional EBITDA potential of INR100b if VIL is unable to infuse large-scale capital and improve its ARPU/revenues to sustainable levels. Incremental EBITDA growth may far outpace the capex intensity over the next 2–3 years, driving RoCE and FCF for Bharti and RJio.

Valuation and view

Bharti: We see a potential re-rating upside in both the India and Africa businesses on the back of steady earnings growth in each of the regions. We maintain TP of INR920. Strong earnings growth from the tariff hike, improvement in the ARPU mix, and market share should drive double-digit EBITDA growth, with optional value in case there is sector consolidation (given VIL’s financial stress).

RJio: The incremental EBITDA opportunity from the consolidation could provide an impetus to the valuation. We revise our TP to INR855/share, factoring in a 34% stake sale. RJio’s rich valuation factors in a) its dominant position in the market and b) its foray into Digital, along with the cross-sell opportunity.

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