Monday, May 17, 2010

Update on Bharti and Mr. Market

Lately, the telecom industry and Bharti have frequently been in the news. Given my previous blog recommending Bharti as a long term investment I thought I would spend some time to analyse the impact of the recent TRAI recommendations on our investment.

Recent TRAI recommendations: TRAI has made a slew of recommendations last week on the telecom industry. Some of these are good for us and some are not. Mr. Market seems to have focused on one bad one with particular severity. TRAI has recommended that any player holding spectrum above 6.2 MHz would have to pay a one-time fee per MHz for the excess spectrum based on the current 3G prices. Bharti has spectrum >6.2MHz in 13 circles, the most amongst all players. If you remember, this was one of the competitive advantages we had said was in our favour giving us a “moat” from competitors. There is now a cost to protect this moat. As per current prices for each sector Bharti has to pay the following as per Thursday’s Mint:

a. Delhi – Rs. 945 cr
b. Mumbai – Rs 833 cr
c. Karnataka – Rs. 265 cr
d. Tamilnadu – Rs. 264 cr
e. AP – Rs. 211 cr
f. Bihar – Rs. 40 cr
g. Maharashtra – Rs. 235 cr
h. Kolkata – Rs. 73 cr
i. UP – Rs. 58 cr
j. MP – Rs. 54 cr
k. Rajasthan – Rs. 52 cr
l. Punjab – Rs. 32 cr
m. Orissa – Rs 15 cr
TOTAL – Rs. 3,078 cr

Lets take a re-look at the small model we had created earlier for analyzing the right price to buy Bharti:

At my recommended price of Rs. 275 the market cap was Rs. 104,413 cr. At the current price of Rs. 260 the market cap is 98,718 cr, a difference of 5,700 cr or 185% higher than the cost of excess spectrum. The future cash flows have not changed because this is a one-time fee that does not impact cash flows going forward. Thus, Mr. Market seems to be mispricing the impact of the bad news on the stock. If we were to buy the stock at the current price and assume the recommendations will be fully accepted and therefore pay the new fee we would still be better off (98,718 cr + 3,078 cr = 101,796cr which is < 104,413 cr). What I am trying to say is that its like buying the company at 101,796 cr compared to 104,413 cr.

The same Mint article also says that analysts at ICICI Securities estimate the impact to be Rs. 8.8 and Rs. 4.1 on the EPS for the next 2 years. As long term investors, this is precisely what we like about Mr. Market. He makes decisions with a short term horizon. We have analyzed the company’s long term strengths and are in it for the long haul and not for the next 2 years. Also, Mr Market has ignored other recommendations of TRAI which facilitate consolidation, give discounts on spectrum fees and cracks the whip on only “urban centric” players who have not helped (unlike Bharti) the rural Indian. Finally, this is just a recommendation and has not been accepted yet.

What makes me drool right now is the fact that Bharti is available at a 42 month low, that’s lower than what it was available at during the recession. I feel that Mr. Market has over reacted to the recommendations as he frequently does. Let me re-quote Ben Graham here from my earlier blog:

“It is customary to refer with great respect to the 'bloodless verdict of the market place', as though it represented invariably the composite judgment of countless shrewd, informed and calculating minds. Very frequently, however, these appraisals are based on mob psychology, on faulty reasoning, and on the most superficial examination of inadequate information

I plan to buy more at the current prices.