Motilal Oswal downgrades Bharti Hexacom to neutral; check commentary & latest price target

Motilal Oswal Financial Services has downgraded Bharti Hexacom Ltd (BHL) from a previous rating, citing a steep 37% premium in its trading values compared to Bharti's Indian business. The financial services firm has adjusted its target price for BHL to INR 1,900, reflecting the challenges observed in the current market valuation. The downgrade highlights concerns over BHL's valuation which has surged significantly since its IPO, now trading at around 19 times forward EV/EBITDA.

The competitive landscape in BHL's circles is described as having lower intensity, theoretically offering better pricing power due to less competition. However, market share gains appear challenging given the concentration among the top two telecom operators in these regions. This competitive dynamics might limit BHL's growth trajectory despite its existing advantages.

A factor contributing to operational challenges for BHL is the 15% stake held by the Government of India, which limits operational freedom. This governmental stake has previously led to delays in strategic moves, such as the tower sale agreement with Indus Towers, due to procedural objections. The presence of this sizeable stake is seen as creating an overhang, potentially affecting future deals and strategic decisions.

Shares of Bharti Hexacom dropped more than 4 per cent during the trading session on Friday to Rs 1,800 with its market capitalization falling near Rs 90,000 crore. The stock had settled at Rs 1879.65 on Thursday. The stock scaled its all time high at Rs 1,938 on Thursday, June 4.

There is also concern regarding a potential merger with Bharti Airtel, which may lead to an unfavourable merger ratio for BHL shareholders. Given BHL contributes approximately 7.5% to Bharti's India wireless and home segment EBITDA, any merger could potentially see a valuation less favourable to BHL shareholders. This risk necessitates cautious consideration for investors.

BHL's valuation has grown significantly, expanding from a forward EV/EBITDA of 7x at its IPO to 19x, driven by expectations of growth and tariff improvements in the Indian telecom sector. The anticipated tariff hike in December 2025 is expected to boost BHL's average revenue per user (ARPU) by fiscal year 2027. This is part of a broader trend of ARPU growth expected to continue at an 11% compound annual growth rate (CAGR) up to fiscal year 2028.

Shares of Bharti Hexacom were listed at the bourses in April 2024. The company sold its shares at Rs 570 apiece, with a lot size of 26 shares apiece. The company raised a total of Rs 4,275 crore through its initial stake sale. The stock is up 230 per cent from its IPO price.

Beyond fiscal year 2028, tariff hikes are projected to be more gradual, with a predicted ARPU CAGR of around 5.5% from 2028 to 2035. This anticipated slowdown suggests a modest revenue and EBITDA growth of approximately 7% over the same period, reflecting a potential re-rating of growth expectations and valuation multiples for BHL.

BHL offers a distinct investment opportunity, providing exposure to Bharti's rapidly expanding Indian wireless and home broadband segments. Its growth potential is considered slightly superior to Bharti's, largely due to lower penetration in its service areas. This offers BHL a unique position within the market to capture growth opportunities.

The company has successfully advanced its premiumisation strategy, increasing the share of data subscribers to about 76.7%, thus narrowing the gap with Bharti's India wireless business. This strategic shift has been a key factor in driving BHL's strong performance in recent times, showcasing its effective market positioning.

Looking forward, BHL is projected to become net debt-free by fiscal year 2027, with free cash flow generation expected to rise to approximately INR 30 billion. Dividend payments are also expected to increase, reaching INR 30 per share by that time, indicating a positive financial trajectory supported by robust cash flow management.

Despite these positive indicators, Motilal Oswal's downgrade reflects caution, given the high valuation premium and associated risks, including government stake implications and potential merger dynamics. Investors are advised to weigh these factors carefully in their decision-making process.