Bharti Airtel’s stock dropped 9.2% on a day the Sensex closed 0.7% down.

Bharti Airtel’s stock dropped 9.2% to Rs 285.40 on a day the Sensex closed 0.7% down.

Clearly, the markets were not pleased with the company’s announcement that it has entered into exclusive discussions with Kuwaiti telecom firm Zain for acquiring Zain Africa BV at an enterprise value of $10.7 billion. Bharti has made the offer for Zain’s operations in 15 African countries excluding Sudan and Morocco.

Penetration in the Indian telecom market has become challenging. The urban centres are getting saturated and while the rural market is growing fast, competition is intense and so, garnering subscribers is difficult.

Small wonder, Bharti has been looking beyond the country for growth opportunities. Last year, it was in talks with South Africa-based MTN to strike a merger, which fell apart a second time. However, the company recently acquired 70% stake in Bangladesh-based Warid Telecom International.

The bid for the Zain assets is Bharti’s third attempt to enter the African market, which is only 50% penetrated.
Analysts, however, feel the deal is expensive.

“The deal works out about 11 times EV/EBIDTA if 66% ownership is considered in Nigerian operations. The largest African operator, MTN , trades at 4.7 times EV/EBIDTA whereas Bharti itself is trading at 7.2 times EV/EBIDTA current year,” wrote Nishna Biyani of Prabhudas Lilladher in a note to clients on Monday.

“While some premium over MTN would likely be justified for 100% control & scale of operations, a 40-50% premium looks very rich to us,” Reena Verma Bhasin of DSP Merrill Lynch wrote in a note to clients on Monday.

At $10.7 billion for a subscriber base of about 42 million, the offer price for the Zain assets suggests a valuation of $255 per subscriber, which may be on the higher side.

Also, the business is making losses at the profit after tax level —- it posted an annualised net loss of about $0.15 billion for the first nine months of calendar 2009.

What’s more, while Africa represents around three-fifth of Zain’s customers, it contributes just 15% of the total net profit.

Zain intends to pay back the group’s debt from the proceeds of the deal. However, the quantum of debt on Zain’s books is not yet clear.

Bharti is expected to fund the deal through a combination of debt and equity. Lower gearing (Bharti’s debt-equity ratio stood at 0.05 at end-December) should help the company take more debt on its books. While that looks good, higher interest outgo would eat into its earnings if it finances the entire deal through debt.

“Assuming full debt funding, post-tax finance cost of 5% and zero earnings of acquired operations, Bharti’s earnings could be impacted by 20-25%,” an analyst who did not wish to be named said. It would be quite a task for Bharti to turn around Zain’s operations, say experts.

The stock is likely to be under pressure till the deal is approved and the details are out. Investors should wait for the outlook to improve to consider it.