IMT GHAZIABAD

MACR Project

Bharti Airtel – Zain Deal Analysis

Prepared by Deepali Rai 09FN-064 Parvesh Bansal 09FN-074 Rohit Sharda 09FN-093 Sahil Pabby 09FN-096

31/12/2010

Submitted to Prof. Alok Kumar as part of the MACR project undertaken in Term V of the PGDM course in Finance

Contents Introduction .................................................................................................................................................. 3

Transaction details ........................................................................................................................................ 4

Parties involved in the Transaction ............................................................................................................... 5

What attracted Bharti Airtel to takeover Zain Africa? .................................................................................. 6

Reaction to the deal ...................................................................................................................................... 7

Cost savings in Zain ....................................................................................................................................... 8

Valuations ..................................................................................................................................................... 8

Annexure 1 : Airtel Valuation (RS MILLION) ................................................................................................. 9

Annexure 2 : Synergy valuation .................................................................................................................. 11

Introduction On February 15, 2010, Bharti Airtel announced that it had entered into exclusive discussions with Mobile

Telecommunications Company KSC (“Zain”) for the acquisition of Zain Africa International BV (“Zain

Africa”) and thereby the entire African operations of Zain, excluding the operations in Sudan and

Morocco. With bitter experience to haunt, Bharti Airtel strategically played it safe this time and made an

offer to Zain which it just could not refuse. For a commercially ailing Zain, Bharti Airtel's offer of USD

10.7 billion was a jackpot.

On March 30, 2010, Mr. Sunil Bharti Mittal, Chairman and Managing Director of Bharti Airtel and Mr.

Asaad Al, Banwan, Chairman, Zain Group executed the definitive agreements at Netherlands marking

the transformation of Bharti Airtel into an emerging-market multinational. The acquisition is the largest

by an Indian company, second only to the USD 12 billion takeover of Corus by Tata Steel in 2007. In the

Indian telecom space, the deal is the second largest after the USD 11.2 billion (approximately) Vodafone

Hutchison transaction in 2007.

Transaction details Acquirer Bharti Airtel Limited

Seller Mobile Telecommunications Company KSC

Target Zain Africa International BV

Acquisition Bharti Airtel Limited indirectly acquired 100% of Zain Africa International BV and its

business operations in Africa from Zain under a privately negotiated agreement.

Mode of

acquisition

Security (Share) Sale

Consideration USD 10.7 billion

Mode of

Payment

All cash deal Bharti Airtel to pay:

a) USD 8.3 billion within three months from the date of closing;

b) USD 700 million after one year from the date of closing; and

c) USD 1.7 billion assumed as debt on the books of Zain.

Funding Leveraged Buy-out

a) Bharti Airtel to borrow USD 7.5 billion from a consortium of banks led by

Standard Chartered Bank and Barclays Bank.

b) Bharti Airtel to avail of a rupee loan of USD 1 billion equivalent from SBI Group.

Parties involved in the Transaction Bharti Airtel

India’s first private telecom services provider with a footprint in all the 23 telecom circles. Widely

regarded as India’s largest telecom service provider in terms of annual revenues, Bharti Airtel provides

mobile & fixed wireless services using GSM technology across all the telecom circles along with

broadband & telephone services in 94 cities. All these services are provided under the “Airtel” brand.

Bharti Airtel, as we understand, also has licenses to operate telecom operations in Sri Lanka and

Seychelles. In January 2010, it acquired Warid Telecom, a 3-million-subscriber company based in Dhaka,

Bangladesh for USD 300 million.

Zain

Zain was established in 1983 in Kuwait as the region's first mobile operator. It is a public company

engaged, together with its subsidiaries, in the provision of mobile telecommunication and data services,

including operation, purchase, delivery, installation, management and maintenance of mobile

telephones and paging systems in Kuwait and 21 other countries in the Middle East and North Africa. Its

wholly owned subsidiaries include; Mobile Telecommunications Company Lebanon (MTC) SARL,

Lebanon, and Sudanese Mobile Telephone (Zain) Company Limited, Sudan.

Zain Africa

Wholly owned subsidiary of Zain, incorporated in Netherlands and held the African operations of Zain.

The company was originally named Celtel which was acquired by Zain in 2005 and renamed as Zain

International BV. The same has been acquired by Bharti Airtel now through Bharti Airtel Netherlands BV.

What attracted Bharti Airtel to takeover Zain Africa?

Expansion was necessary :

Bharti Airtel left the world gasping in horror with its “out of the box” decision to hand over every core

function from IT to networks, to IBM in 2004. The idea was to remain and grow as a core telecom

company which it did and did with elegance. In the telecom space, Bharti Airtel notched up its 100

millionth customer last May and also overtook BSNL to become India’s largest telecom company by

revenues that year but there was continuous drop in the margin of profit over the years. The visionaries

who led the company could easily notice the mounting competition in the Indian telecom market with

13 service providers battling out for a chunk of the revenue. Bharti Airtel identified various speed

breakers to its growth in India. The Indian telecom market has almost reached its saturation point with

scope of expansion left only in the inner part of rural India. Being a core telecom company it could not

diversify its portfolio into other business and geographic expansion into new markets was the only

strategic alternative to escape slowing profit growth in India.

Also, it was indispensable for Bharti Airtel to reduce its dependence on the fast-saturating Indian

wireless market. This realization is what compelled Bharti Airtel to establish its presence in Africa.

Hence, this investment, despite being on the costlier side was a business necessity for Bharti Airtel.

Long-term benefits are alluring :

Even with all the financial drawbacks, Zain Africa is a strategic investment for Bharti Airtel from a long-

term perspective. Post acquisition, Bharti Airtel will become fifth largest service provider in terms of the

number of subscribers.

Acquisition of so many assets and access to so many markets through one single transaction happen

very rarely. The size of Zain Africa's business diversifies Bharti Airtel's risk portfolio away from its

concentration in South Asia. The combined businesses will be able to withstand global business shocks

much better and will give it additional leverage in capital investments and with key vendors.

Africa is where the next round of telecom growth is due. With the aim to enter into the continent and to

widen their risk portfolio from India, it made sense for Bharti Airtel to invest into Africa. Zain's African

business was considered a natural target for Bharti Airtel, which has thrived in an Indian market with

low incomes and tariffs and a heavily rural population – characteristics shared by African nations. The

multi-geography strategy will be a blessing in the long run. For Bharti Airtel, this is the start of being a

truly global player.

The African market has high growth potential for Bharti Airtel as the region is currently under-

penetrated. The average revenue per user of Zain Africa is quite high and that justifies its current

valuation by Bharti Airtel. If Bharti Airtel can attain operational synergies with Zain Africa, it can go for

more such acquisitions in the coming days as the Indian market is gradually getting saturated.

Financing is strategically managed

Bharti Airtel has structured this acquisition as a leveraged buyout and the loan for financing the

transaction has been availed by the two SPVs created in Netherlands and Singapore for the purposes of

this acquisition. The SPVs will take the borrowings, aggregating to USD 8.3 billion, on its balance sheet.

Bharti Airtel Netherlands BV will avail loan to the tune of USD 5.5 billion and the Singapore SPV will

borrow the rest of the amount. Once Bharti Airtel is able to transplant its Indian model to Africa, the

negative earnings per share of the African assets on Bharti Airtel’s financials would diminish.

Bharti Airtel’s decision to opt for the SPV route makes a lot of sense since it will not impact the parent’s

balance sheet in the near term. At the end of the quarter to December 2009, Bharti Airtel’s debt-equity

ratio was 0.4 and this would have shot up to 1.2, had Bharti Airtel taken the loan on its books. That

would have limited Bharti Airtel’s ability to raise funds in the future for expansion into new third

generation technologies through participation in the 3G spectrum allocation. Hence, Bharti Airtel has

structured the acquisition strategically and routed it through the SPVs keeping Bharti Airtel’s standalone

financials intact. However, that does not absolve Bharti Airtel from overall responsibility of a borrower

since it has provided a guarantee to bankers for the loan that will be in the SPV‟s books.

Reaction to the deal Despite Bharti Airtel’s optimism, 8.2 million shares of the company changed hands within first two

months. The value of the shares fell to 16-month low of Rs 272. Investors were apprehensive of the deal

being largely debt-funded. Though, Bharti Airtel has the history of keeping its debts low (it is just 0.4

times the 2010 EBITDA), the deal could stretch its balance sheet a tad too much. The subsequent 3G

auction added to the worry. Investors considered Bharti Airtel’s present valuation of USD 2 billion debt

ridden company at ten times its EBITDA is not worthwhile.

Credit rating agencies Crisil and S&P placed Bharti Airtel’s long-term banking facilities and debt

programmes on “rating watch with negative implications”. Also, investors were wary as to how Bharti

Airtel would fare in African market, with 15 different regulatory bodies.

Cost savings in Zain Airtel will achieve two types of cost savings :

1. Cost of operation : As of now, the EBITDA margin of Zain is 32%. It is anticipated that Airtel will

be able to copy the low cost model to Zain also and EBITDA margin of Zain will rise to 40%

(current Ebitda margin of Airtel) till 2014.

2. Fixed asset cost : One major capital expenditure of any telecom company is in setting up the

Base Transmitter Station. It forms around 80% of the capital expenditure of any telecom

company. Right now, capital investment of Zain is 40% of the increase in sales while that of

Airtel is 30% of the increase in sales. It is anticipated that Airtel will be able to lower the capital

expenditure to 30% of the sales till 2014.

Valuations Airtel

Airtel’s valuation is done using Discounted Free Cash flow model using which the value of the form is

coming out to be Rs. 2353520mn (refer to annexure 1). In this valuation, the increase in ARPU is also

considered due to 3G introduction. It is assumed that around 5% of the 2G users will switch from 2G to

3G for year 2012 and 2013 while 7.5% will switch to 3G for year 2014. The intrinsic value of the share

price is coming out to be Rs 593 (approx.).

Zain

Free cash flows for Zain are negative considering the existing cost conditions. Using EV/EBITDA approach

value of Zain is coming out to be around USD 7bn (considering EBITDA of USD 1bn).

Annexure 1 : Airtel Valuation (RS MILLION) INCOME STATEMENT

2009 2010 2011 2012 2013 2014

Revenues 369615 418472 451949.8 583242 609833.5 670757.2

Change (%) 36.8 13.2 1.08 1.290502 1.045593 1.099902

Total Expenses 217937 250839 270906.1 306123.9 336736.3 370409.9

EBITDA 151678 167633 181043.6 277118.1 273097.2 300347.3

% of Gross Sales 41 40.1 0.400584 0.475134 0.447823 0.447773

Depn. & Amortization 47581 62832 67052.5 70006.57 70604.88 71975.67

EBIT 104097 104800 113991.1 207111.5 202492.4 228371.6

Net finance cost 11613 178 13910.88 10910.88 7910.88 4910.88

Other Income 589 468 0 0 0 0

PBT 93073 105090 100080.3 196200.6 194581.5 223460.7

Tax 6615 13453 15012.04 29430.09 29187.22 33519.11

PAT 86458 91637 85068.22 166770.5 165394.3 189941.6

Rate (%) 7.1 12.8

Minority Interest 1759 1870 1735.954 3403.22 3375.135 3876.064

Minority Interest % 0.0203 0.020407 0.020407 0.020407 0.020407 0.020407

Adjusted PAT 84699 89767 83332.27 163367.3 162019.1 186065.6

Revenue breakup

2009 2010 2011 2012 2013 2014

Total Revenues 369615 418472

2G 247642.1 280376.2 302806.3 422167.1 435872.7 482879.5

Others 121973 138095.8 149143.4 161074.9 173960.9 187877.8

Total Expected Revenues 369615 418472 451949.8 583242 609833.5 670757.2

Revenue Calculation

2011 2012 2013 2014

3 G tarrif 3 2.5 2

2G 0.44 0.44 0.44

Weighted Average ARPU 0.568 0.543 0.557

Growth in MOU/Subscribers 1.08 1.08 1.08

Num for growth in revenues 0.61344 0.58644 0.60156

Free Cash Flow valuation

2011 2012 2013 2014

FCF

EBIT 113991.1 207111.5 202492.4 228371.6

EBIT(1-.15) 96892.47 176044.8 172118.5 194115.9

NCC 67052.5 70006.57 70604.88 71975.67

FCInv 132993.3 39387.67 7977.467 18277.11

WCInv 6695.552 26258.45 5318.311 12184.74

FCF 24256.09 180405.2 229427.6 235629.7

Terminal Value 2879475

Total 24256.09 180405.2 229427.6 3115105

Present Value Factor 0.897436 0.805391 0.722787 0.648655

21768.28 145296.8 165827.3 2020628

Value of firm 2353520 Market Value of Debt 101898 Value of Equity 2251622 Total Number of Shares 3793.9 Share Price 593.4849 EPS 23.66088 P/E 25.08296

Annexure 2 : Synergy valuation As already discussed, cast savings for Zain would be in two ways :

1. EBITDA margin increase to 40% till 2014 (in steps) with around 1.5% increase each year.

2. Capital investment reduction to 30% (in steps) till 2014.

Differences between the free cash flows generated for pre-deal and post-deal scenarios are calculated

for each year till 2014. The present value of those cash flows is considered to be the actual cost savings.

Cost Saving Calculation (Rs. Crore)

Ebitda Margin Improvement

2009 2010 2011 2012 2013 2014

Revenues 15288 16816.8 18498.48 20348.33 22383.16 24621.4769

Ebitda margin (Pre acquisition) 0.32 0.32 0.32 0.32 0.32 0.32

Ebitda 4892.16 5381.376 5919.514 6511.465 7162.611 7878.8726

Ebitda margin (Post Acquisition) 0.34 0.36 0.38 0.4

CapEx improvement

2009 2010 2011 2012 2013 2014

CapEx (Pre acquisition) 6115.2 6726.72 7399.392 8139.331 8953.264 9848.59075

CapEx (Post Acquisition) 6881.435 6714.948 6714.948 7386.44306

Free cash Flow Calculation-Pre Deal

Pre Deal

2011 2012 2013 2014

Ebitda 5919.514 6511.465 7162.611 7878.873

Ebitda - Dep 5364.559 5901.015 6491.117 7140.228

(Ebitda - Dep)(1-t) 4559.875 5015.863 5517.449 6069.194

Plus : Dep 554.9544 610.4498 671.4948 738.6443

minus : CAPEX 7399.392 8139.331 8953.264 9848.591

Rough FCF -2284.56 -2513.02 -2764.32 -3040.75

Free cash Flow Calculation-Post Deal

Post deal

2011 2012 2013 2014

Ebitda 6289.483 7325.398 8505.601 9848.591

Ebitda - Dep 5773.376 6821.777 8001.98 9294.608

(Ebitda - Dep)(1-t) 4907.369 5798.51 6801.683 7900.416

Plus : Dep 516.1076 503.6211 503.6211 553.9832

minus : CAPEX 6881.435 6714.948 6714.948 7386.443

Rough FCF -1457.96 -412.817 590.3559 1067.957

Free Cash Flow Improvement :

FCF improvement 826.6046 2100.202 3354.676 4108.709

PV factors 0.894454 0.800049 0.715607 0.640078

Present Values 739.3601 1680.264 2400.63 2629.894

Total of PV 7450.147

Therefore, the present value of the cost savings is Rs. 7450.147 Cr.