Description
The documentation about telecom comapny Airtel in terms of Earnings growth, Tax rate, Capital Expenditure, Depreciation, Working capital, Market risk premium, Risk free Interest rate (Rf), Beta, Discounting rate, Terminal value, Intrinsic share value
Bharti Airtel Valuation
Assumptions for Bharti Airtel Valuation project 1. Earnings growth: The earnings growth has been computed by using the formula Growth = Reinvestment rate (b) * Return on capital. The growth for the period 2005 to 2009 has been computed and averaged out. The growth rate of telecom industry in India is around 26.6% (See References 1). Bharti Airtel has been consistently doing well till the second quarter of 2009. However with the launch of Tata-Docomo, the cellular tariff rates have been slashed to match the rates provided by Tata-Docomo. This will have a negative impact on the revenues of Bharti Airtel. We first calculated the historic growth rates from 2005 to 2009 and taken the average value. Incidentally this average value comes to around 26.65%. Hence our group has assumed this average historic growth rate (from 2005 to 2009) of 26.65% for the two years 2009-10 and 2010-11. (Thus we assume that in the prevailing competition Bharti Airtel will grow at the same rate as the Telecom Industry). We also assumed that the competitor intensity would increase after 2011 and thus the earnings have been gradually reduced to 18%, 15% and 14% in the subsequent years till 2014. After 2014 we assume that Bharti Airtel will attain the maturity phase and will then show a constant growth of 7% (which is also the rate of growth of Indian economy). 2. Tax rate: We have assumed a marginal corporate tax rate of 30% for all our calculations. 3. Capital Expenditure: The capital expenditure basically consists of two parts Increase in gross block Work in progress Our group has assumed that all work in progress will complete in 1 year time and be added to the gross block the next year. Hence while computing the capital expenditure we have considered the year on year increment in gross block less the work in progress of the first year (since its expenditure is accounted for in the previous year). We then add the work in progress for the current year. The grand total is assumed to be the capital expenditure for the current year. The average Y-O-Y growth rate of the gross block and work in progress is computed for the period 2005 to 2009. We assume that the gross block and capital work in progress would grow at these average rates for the first year ie. 2009-10. we then assume that the growth will decline in the subsequent years as the company reaches the maturity phase.
Note that the free cash flow to the firm is negative for the period from 2005 to 2011. The reason being the capital expenditure exceeds the earnings (which is also reflected by the fact that the historical reinvestment rate is more than the reported earnings). Hence it is obvious that Bharti Airtel funds its investments in long term assets through external borrowings and hence the free cash flow to the firm is negative. We have assumed that this trend would continue till the high growth phase (ie. till 2011). After that the investments would considerably reduce and can then be completely funded from the earnings of the firm. Thus the cash flow gets positive from 2012 onwards.
4. Depreciation: The depreciation for any year is calculated on the net block of the previous year plus additions in the form of work in progress of the previous year which would get completed in the present year. We calculate the percentage of depreciation on this value for the period 2005 to 2009 and take an average of the same. This average value is used as depreciation percentage on asset base for future periods till 2014.
5. Working capital: It was observed that historically the firm had a negative working capital. The primary cause was because Airtel has a major part of revenues coming from the ‘prepaid service’ model. Since these revenues are not accrued during the accounting period of the year they are treated as current liabilities. We assume that the trend will continue and the business in prepaid service will eventually expand. We calculated the working capital to sales ratio and averaged the same for the period 2005 to 2009. The average value is 33.33%. We have assumed the same percentage while extrapolating the working capital for the years 2010 to 2014. 6. Market risk premium: Our group has assumed a market risk premium of 8% as per the class discussion and inputs provided by the faculty regarding the research work done on Indian markets to estimate the market risk premium from 1991 to 2008. 7. Risk free Interest rate (Rf): The risk free rate is taken as 6.9% which is the yield on 10 year G-Sec Bond maturing in 2019. 8. Beta : The Beta of the stock, Bharti Airtel is estimated by taking the returns of Bharti Airtel and NIFTY for a period of 3 years from 2006 to 2009. (Note: Bharti Airtel was listed in NSE from 19th June 2006 onwards; hence data before this period is not available). The beta is then computed by taking the covariance of returns of Bharti
Airtel with NIFTY returns and then dividing the result by the market variance ie. Variance of NIFTY returns. 9. Cost of debt (Kd): Our group observed that the Debt ratio of Bharti Airtel varied from 47.6% to 29.44%. With such high variance, our group found it appropriate to use the last year’s (2009) debt and interest expenditure figures for computing Kd. Here an assumption was made that the debt ratio would remain constant for Bharti Airtel for all subsequent years till 2014. 10. Discounting rate: The cost of capital (Kc) is calculated using the values of cost of equity (Ke) and cost of debt (Kd. This value is used for discounting all future cash inflows. 11. Terminal value: The terminal value is calculated in 2014 using the formula FCFF(year 2014) X (1+g)/(Kc-g), where g is the constant growth of economy (assumed as 7%). 12. Intrinsic share value: The intrinsic value of share is calculated by dividing the present value of the firm by the total number of outstanding shares as on March 2009. The value thus obtained is Rs.217.74 which is significantly less than the market value of 299.95 as on 30th November 2009. Since the intrinsic value of the share is lower than the actual market price we would suggest investors to sell their holdings. References:
1. www.ibef.org/industry/telecommunications.aspx 2. www.nseindia.com 3. www.rbi.org.in 4. www.airtel.in
doc_577797793.docx
The documentation about telecom comapny Airtel in terms of Earnings growth, Tax rate, Capital Expenditure, Depreciation, Working capital, Market risk premium, Risk free Interest rate (Rf), Beta, Discounting rate, Terminal value, Intrinsic share value
Bharti Airtel Valuation
Assumptions for Bharti Airtel Valuation project 1. Earnings growth: The earnings growth has been computed by using the formula Growth = Reinvestment rate (b) * Return on capital. The growth for the period 2005 to 2009 has been computed and averaged out. The growth rate of telecom industry in India is around 26.6% (See References 1). Bharti Airtel has been consistently doing well till the second quarter of 2009. However with the launch of Tata-Docomo, the cellular tariff rates have been slashed to match the rates provided by Tata-Docomo. This will have a negative impact on the revenues of Bharti Airtel. We first calculated the historic growth rates from 2005 to 2009 and taken the average value. Incidentally this average value comes to around 26.65%. Hence our group has assumed this average historic growth rate (from 2005 to 2009) of 26.65% for the two years 2009-10 and 2010-11. (Thus we assume that in the prevailing competition Bharti Airtel will grow at the same rate as the Telecom Industry). We also assumed that the competitor intensity would increase after 2011 and thus the earnings have been gradually reduced to 18%, 15% and 14% in the subsequent years till 2014. After 2014 we assume that Bharti Airtel will attain the maturity phase and will then show a constant growth of 7% (which is also the rate of growth of Indian economy). 2. Tax rate: We have assumed a marginal corporate tax rate of 30% for all our calculations. 3. Capital Expenditure: The capital expenditure basically consists of two parts Increase in gross block Work in progress Our group has assumed that all work in progress will complete in 1 year time and be added to the gross block the next year. Hence while computing the capital expenditure we have considered the year on year increment in gross block less the work in progress of the first year (since its expenditure is accounted for in the previous year). We then add the work in progress for the current year. The grand total is assumed to be the capital expenditure for the current year. The average Y-O-Y growth rate of the gross block and work in progress is computed for the period 2005 to 2009. We assume that the gross block and capital work in progress would grow at these average rates for the first year ie. 2009-10. we then assume that the growth will decline in the subsequent years as the company reaches the maturity phase.
Note that the free cash flow to the firm is negative for the period from 2005 to 2011. The reason being the capital expenditure exceeds the earnings (which is also reflected by the fact that the historical reinvestment rate is more than the reported earnings). Hence it is obvious that Bharti Airtel funds its investments in long term assets through external borrowings and hence the free cash flow to the firm is negative. We have assumed that this trend would continue till the high growth phase (ie. till 2011). After that the investments would considerably reduce and can then be completely funded from the earnings of the firm. Thus the cash flow gets positive from 2012 onwards.
4. Depreciation: The depreciation for any year is calculated on the net block of the previous year plus additions in the form of work in progress of the previous year which would get completed in the present year. We calculate the percentage of depreciation on this value for the period 2005 to 2009 and take an average of the same. This average value is used as depreciation percentage on asset base for future periods till 2014.
5. Working capital: It was observed that historically the firm had a negative working capital. The primary cause was because Airtel has a major part of revenues coming from the ‘prepaid service’ model. Since these revenues are not accrued during the accounting period of the year they are treated as current liabilities. We assume that the trend will continue and the business in prepaid service will eventually expand. We calculated the working capital to sales ratio and averaged the same for the period 2005 to 2009. The average value is 33.33%. We have assumed the same percentage while extrapolating the working capital for the years 2010 to 2014. 6. Market risk premium: Our group has assumed a market risk premium of 8% as per the class discussion and inputs provided by the faculty regarding the research work done on Indian markets to estimate the market risk premium from 1991 to 2008. 7. Risk free Interest rate (Rf): The risk free rate is taken as 6.9% which is the yield on 10 year G-Sec Bond maturing in 2019. 8. Beta : The Beta of the stock, Bharti Airtel is estimated by taking the returns of Bharti Airtel and NIFTY for a period of 3 years from 2006 to 2009. (Note: Bharti Airtel was listed in NSE from 19th June 2006 onwards; hence data before this period is not available). The beta is then computed by taking the covariance of returns of Bharti
Airtel with NIFTY returns and then dividing the result by the market variance ie. Variance of NIFTY returns. 9. Cost of debt (Kd): Our group observed that the Debt ratio of Bharti Airtel varied from 47.6% to 29.44%. With such high variance, our group found it appropriate to use the last year’s (2009) debt and interest expenditure figures for computing Kd. Here an assumption was made that the debt ratio would remain constant for Bharti Airtel for all subsequent years till 2014. 10. Discounting rate: The cost of capital (Kc) is calculated using the values of cost of equity (Ke) and cost of debt (Kd. This value is used for discounting all future cash inflows. 11. Terminal value: The terminal value is calculated in 2014 using the formula FCFF(year 2014) X (1+g)/(Kc-g), where g is the constant growth of economy (assumed as 7%). 12. Intrinsic share value: The intrinsic value of share is calculated by dividing the present value of the firm by the total number of outstanding shares as on March 2009. The value thus obtained is Rs.217.74 which is significantly less than the market value of 299.95 as on 30th November 2009. Since the intrinsic value of the share is lower than the actual market price we would suggest investors to sell their holdings. References:
1. www.ibef.org/industry/telecommunications.aspx 2. www.nseindia.com 3. www.rbi.org.in 4. www.airtel.in
doc_577797793.docx