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Merger may be a short-term on Bharti
May, 27th 2009

Bharti Airtels long-distance call to South Africas MTN is likely to be a costly affair in the short-term, as the current structure of the deal will lead to net outflow of cash from the Indian telcos coffers, making it necessary to raise fresh debt.

As per the scheme of arrangement, Bharti may have to raise $4 billion to close the deal and is likely to turn to debt. Bhartis balance sheet today shows little net debt, but the MTN deal would increase the companys long-term debt to around $5 billion, raising the debt-equity ratio to slightly over 1 from 0.2 now.

For Bharti, the days of credit crisis seem to be over, as it would not have planned such a deal where it has to raise so much debt.

As part of the deal, Bharti will get $2.9 billion cash from MTN whereas it will pay around $7 billion to acquire stake in the South African company. The net result would be cash outflows of around $4.1 billion from the deal.
In addition, the company has to spend $3.2 billion in committed capital expenditure, which would almost offset the annual cash flow from operations for 2009-10. In 2008-09, the company generated $2.5 billion cash from its operations.

For a long time now, Bharti Airtel, unlike many telecom companies in the country, has enjoyed a premium in valuation due to its ability to generate positive free cash flows.

Free cash flow is the cash generated through normal course of business operations net of capital expenditure for the year. However, Bharti is unlikely to command such a premium, at least in the short term.

While such strategies are part of a big companys long-term growth plans, Tata Steel-Corus and Tata Motors-Jaguar deals, among others, serve a note of caution for dealmakers.

However, if both Bharti and MTN continue to generate huge operating cash flows in the long term, they wont face problems in servicing the debt. Last year, MTN generated an operating cash flow of $4 billion, and if Bharti gets a controlling stake in the company, such cash flows would reward Bharti handsomely.

Bharti Airtel seems to be better placed in terms of total transaction value, but the exact value would depend on a number of factors, such as stock price recent price, or one-month/three-month average price and exchange rates. A quick calculation based on recent stock prices seems to benefit Bharti, while a three-month average price consideration puts the company in a neutral position.

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