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MANAGEMENT OF MERGERS AND ACQUISITIONS

ANALYSIS OF THE BHARTI-ZAIN DEAL

SUBMITED BY SWAPNIL AGARWAL (102) RITESH JAIN (107) SWATI SESHADRI (118) KRITIKA KAPOOR (206) VEDANT AGARWAL (302) AKANKSHA AGARWAL (426)

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PROLOGUE BRIEF SNAPSHOT Acquirer Seller Target Acquisition Consideration Mode of Payment Bharti Airtel Limited (BAL) Mobile Telecommunications Company KSC Zain Africa International BV Bharti Airtel acquired 100% of African operations of Zain USD 10.7 billion All cash deal a) USD 8.3 billion within 3 months from the date of closing; b) USD 700 million after 1 year from the date of closing; c) USD 1.7 billion as debt on the books of Zain. Leveraged Buy-out a) Bharti Airtel to borrow USD 7.5 billion from a consortium of banks led by SCB and Barclays Bank. a) Bharti Airtel to avail of a rupee loan of USD 1 billion equivalent from SBI Group.

Funding

On 11th February, 2010, Sunil Bharti Mittal, on behalf of the management of Bharti, confirmed that it is in an exclusive talk with Zain Telecom for buying the African asset of Zain (excluding Sudan and Morocco) for $10.7 billion. He declared that the company was going to raise a debt of $9 billion to finance its acquisition of Zain s Africa operations. And the rest amount of $1.7 billion would be met from the cash reserves of the Bharti. The share price of Bharti Airtel was Rs.311.85 on 11th February, 2010 on the date of declaration of this deal. The investor became pessimistic on this deal and with the bearish mood they sold out their holding shares. This behaviour pushed the price of the Bharti Airtel down to Rs. 272.8 in the first week of March.

BHARTI AIRTEL Bharti Airtel Limited, the flagship company of the Bharti Group. It was incorporated on July 7, 1995 and since it has grown to be the largest integrated telecom service provider. It commands a market share of 24% in the Indian Telecom sector and has its presence in all the 23 telecom circles. In the telecom space, Bharti Airtel notched up its 100 millionth customer last May and also overtook BSNL to become India s largest telco by revenues that year but there was continuous drop in the margin of profit over the years. Bharti Airtel provides mobile & fixed wireless services using GSM technology across all the telecom circles along with broadband & telephone services in 94 cities. All these services are provided under the Airtel brand. Bharti Airtel, also has licenses to operate telecom operations in Sri Lanka and Seychelles. The shares of the company are listed on NSE (national stock exchange) and the BSE (Bombay Stock exchange).t also has the I License to operate in Sri Lanka and Seychelles. The operations are sub divided into 3 SBU (Strategic Business Units)
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Mobile Services Provides GSM services in all the telecom circles and has the largest customer base in India Airtel Telemedia services Broadband and telephone service in 94 cities Enterprise services End-to-end telecom solutions to corporate customers and national & international long distance services to carriers 2|Page

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DETAILS OF THE TRANSACTION Bharti Airtel acquired Zain Africa at an enterprise value of USD 10.7 Billion which is at an EV/EBITDA of 9.8x making it one of the most expensive valuations for an emerging market telecom player. The financials are:
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USD 8.3 billion paid in cash three months after the deal closes Remaining $ 700 million will be paid one year after the closure of the deal Bharti will assume debt of 1.7 billion on the books of Zain Africa.

Bharti Airtel took a loan of USD 8.5 billion, the details of which are shown below. It decided to invest USD 1.5 billion from its own cash reserves. Sources of funds: Bank State Bank of India Standard Chartered Bank (lead arranger for dollar loan) Barclays ( joint lead advisor) ANZ, BNP, Bank of America Merrill Lynch, Credit Agricole CIB, DBS, HSBC, Bank of Tokyo Mitsubishi and Sumitomo Mitsui Banking Corporation Amount $1.5 billion ($500 million is dollar loan and the balance in rupee) $ 1.3 billion $900 million $600 million each

Bharti is paying around 80 basis points, or 0.8%, for the dollar funding of $7.5 billion, which will generate $60 million for banks. The dollar loan has been finely priced at 174-176 bps above Libor, with the total cost for the company, including fees to banks, coming at a spread of 195 basis points. The 10 year average of LIBOR is 3.75%, thus the cost of debt is Libor+195 bp which will result in an annual interest cost of USD 200 million. That means they have to improve EBIDTA by $500m just to pay for the deal; currently EBIDTA is $1.3bn, so it s got to scale by 40% for Bharti to get a chunk. They can definitely improve some bits tower costs in Africa have been 4x more than India, which can be lowered and internal efficiencies can be improved. The local mafia in Africa will be tougher to handle (they take the lucrative deals and back-peddle commissions) where in India Mittal s political connections would have helped in the early stages. Advisory fees earned by Standard Chartered Bank and Barclays, the main bankers for Bharti, are in the range of $15-30 million. These two banks could also earn some fees from forex and other derivative transactions. UBS Zain s banker may earn more, as fees in some of the offshore markets are much better.

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Dollar loan: USD 7.5 billion by a consortium of banks led by Standard Chartered Bank and Barclays Bank. Rupee loan: upto USD 1 billion equivalent INR by SBI Group. The board of Kuwait-based MTC, KSC ( Zain) approved the sale of its African assets to Bharti $10.7-billion deal signed in Amsterdam, the base of Zain s African unit.

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Valuation: The valuation seems overpriced considering that Bharti was quoting at an EV/ EBITDA of 7.2 times and it paid an EV/EBITDA of 9.8x for Zain. Some of the problems in the deal are: 1. Seven units of Zain are loss making. The cumulative losses in these segments till CY03 are $ 248 million offsetting the profits from the other segments. Nigeria poses a great threat as it is a large revenue earner but the current operations are not profitable. 2. The huge loss incurred for the acquisition will increase the financial risk of the company and servicing this debt will reduce it profits. 3. Bharti will also be exposed to foreign currency risk as capex expenditure will be incurred in dollars but revenues will be earned in the local currency. 4. The African region is marred with political instability, high Inflation and volatile currency A few important consideration before using the EV multiple to pass a judgement on the deal
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Start up operation such as Ghana have negative EBITDA which distort the EV/EBITDA The African operation deserves a higher multiple as the effective tax rate in Africa is less The valuation should take into account the control premium Zain has made cumulative capital investment to the tune of US$ 9 bn. Bharti Airtel will require a capital expenditure of only $ 800 million to kick start its operation in the highly densely populated in Africa region

The deal will be fully financed by debt which will improve the capital structure of Bharti Airtel. Unlike other telecommunication companies, it is comparatively under levered and has a net D/E ratio of 0.11x compared to the global average of 0.44 x. This has helped Bharti borrow at a cheap rate. The deal has been structured as an LBO. The company can leverage the African operation which also acts a hedge against currency fluctuation. The company has given guidance that it will be able to pay up most of its debt by FY 16/17 backed by its strong FCFF generating capacity and the deal will be EPS accretive by FY13. Bharti Airtel Limited formed two special purpose vehicles (SPVs) in the Netherlands and Singapore to execute the $10.7-billion deal with a lower financial risk. Special Purpose Vehicle in Bharti Zain deal A leveraged buyout, or LBO, is an acquisition of a company or division of another company, financed with a substantial portion of borrowed funds. The acquirer resorts to a combination of a small investment and alarge loan to fund the acquisition. Typically, the loan capital is availed through a combination of repayable bank facilities and/or public or privately placed bonds, which may be classified as high -yield debt. The debt will appear on the acquiring company s balance sheet and the acquired company s free cash flow will be used to repay the debt. In the alternative, the acquiring company could float a Special Purpose Vehicle ( SPV ) as a 100% subsidiary with a minimum equity capital. The SPV can leverage this equity to gear up significantly higher debt to buyout the

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target company. The target company's assets can be used as collaterals for availing the loan and once the debt is redeemed, the acquiring company has the option to merge with. The double-sided benefits of using a Special Purpose Vehicle strategy in a merger and acquisition transaction are: Prevent adverse impact on Parent Company s balance sheet: In the final phase of taking over Zain s African assets, Bharti Airtel Limited formed two special purpose vehicles (SPVs) in the Netherlands and Singapore to execute the $10.7-billion deal with a lower financial risk. These SPVs, whose dealings will be guaranteed by Bharti, will own the African assets of Kuwait s Zain. SPVs, are used to convey the impression to investors that companies are not taking huge dollops of debt. But Bharti will have to step in in case of a default. In this instance, the SPV has to repay the debt from the cash flows of the African business. In a move to take advantage of the benefits of using an SPV strategy to acquire Africa s Zain telecom Bharti Airtel routed $ 5.5 billion through the Netherlands entity and the rest ($2.8 billion) through the Singapore entity. Bharti s decision to opt for the SPV route makes sense since it will not impact the parent s balance sheet in the near term. At the end of the quarter to December 2009, Bharti s debt-equity ratio was 0.4. There was a possibility of this shooting up to 1.2 had Bharti taken the loan on its books. This might have limited Bharti s ability to raise funds in the future for expansion into new third generation technologies. Now that the Zain acquisition is to be structured in a way that it will be routed through an SPV, Bharti s standalone financials remain intact. However, that does not absolve Bharti from overall responsibility of a borrower since it has provided a guarantee to bankers for the loan that will be in the SPV s books. Tax benefits: From a taxation perspective, the main considerations will generally be the capital gains tax consequences to the vendor, and the capital gains tax planning opportunities available to the acquirer. It is common to incorporate a special purpose company to execute the acquisition because the sale of shares in the special purpose company may not give rise to capital gains tax liability. Bharti Airtel s move to acquire Zain through the use of SPV strategy also capitalizes on this tax advantage. This is achieved by mobilizing funding for the acquisition through the Netherlands and Singapore based SPVs which offer tax incentives. Considering the growth opportunities and huge scale presented the acquisition may be slightly expensive but will prove beneficial in the long run and will increase shareholder value. The final deal summary after the acquisition is as follows: Bharti Airtel Zain Deal Bharti Airtel Zain (Africa) 8.03 3.64 1.84 -0.1 3.30 1.2

$ bn Revenues Net Profit/ Loss EBIDTA

Combined 11.67 1.74 4.50

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RATIONALES FOR BHARTI S ACQUISITION Some of the major reasons behind the acquisition were:
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Zain Africa is a strategic investment for Bharti Airtel from a long-term perspective. Post acquisition, Bharti Airtel will become fifth largest service provider in terms of the number of subscribers. Acquisition of so many assets and access to so many markets through one single transaction happen very rarely. The size of Zain Africa's business diversifies Bharti Airtel's risk portfolio away from its concentration in South Asia Strong market position of Zain, it is the biggest operator in 10 countries, the second largest in the remaining 4 out of the 5 operators. Bharti Airtel can utilize the infrastructure and the facilities of Zain Africa to harness the potential of African markets. Low competition, only 4 or less telecom operators in 12 countries (out of the 15 countries in ZAF operation)

Few other reasons are as follows: Explo ng un apped ma et: Only one in two Africans owns a mobile phone and Zain has a strong presence in most countries. It has a 50-75% market share in seven countries and a 25-50% share in six, providing a strong platform for Bharti Airtel to build upon. Higher ARPU: Monthly average revenue per user (ARPU) on the Africa averages USD 7.5, which is higher than India s ARPU of USD 5.47. African customers use 100 minutes per month, versus 450 minutes per month in India. Geographical Diversification: The Indian telecom sector seems to have reached its saturation point with scope of expansion left only in the inner part of rural India. Bharti is a core telecom company and has already engaged in product diversification leaving geographic expansion as the only strategic alternative to counter slowing profit growth in India. Favourable Demographic:
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Aggregate population of 470m .The African population is expected to double to 2 billion people outpacing India and China. The median age is 17-18 compared to the Indian median age of around 25-26.It is forecasted that 25% of the world youth will reside in Africa.

Spending Po er: Consumer spending potential is estimated to be around $1.4 trillion. The GDP is growing at rate of more than 5% in 27 of the top 30 economies in Africa. Huge potential: Industry tele-density is only 20% with some countries as low 10-12%; Bharti management expects to grow this to around 60% 7|Page

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The presence of Zain in Africa is associated with its long-term strategic goal of positioning Zain as global player. Conse uently there is a high risk involved with this future growth opportunity. That is why there was a difference of opinions between shareholders of the company and wheth the company is able to er succeed in turning African assets into cash generating assets. It is apparent that Iraq, Sudan and Kuwait has the highest gross profit margin among Zains subsidiaries with 78.2 for Iraq, 75.8 for Sudan and 75.4 from Kuwait, while in terms of net profit margin Kuwait, Sudan and Jordan represent the highest with 42 ,40 and 36 respectively. Africa got the lowest margins with 69.5 gross profit margin and a humble 5.3 in net profit margin. Following Zain s Africa assets sale, Kuwait and Iraq will still maintain their position as the top contributors to the revenue and will be joined by Sudan with 21 .

y In terms of net profit, Kuwait has the highest contribution as of September 2009 with 28 , followed by Iraq 22 and Sudan with 21 .

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The h in Z in s ne profit didn t match the growth in revenue The reason behind it is the increase in General and Administrative (G&A) e pense and the Interest Expense G&A expenses increase was due to the increase in staff after the ac uisition and the concentrated spending on marketing and advertising campaigns to accommodate for the rebranding the regional corporate image of the company

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If Zains African assets where to be sold, it won t affect much their net income. As a matter of fact it might even earn higher net income and higher margins as their G&A will decrease significantly after selling off African operations.
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As for the cash earned from selling their African assets which is agreed to be USD 10.7 billion (equivalent to KWD 3.08 billion), management have several alternative as what do with this cash.

CONCLUSION Bharti Airtel cross border acquisition of Zain Africa operations has made it one of the top global players in the telecom industry. There is huge potential in Africa and if Bharti is able to leverage it with its management team capability and experience, to replicate its successful business model in Africa, the deal will be able to create tremendous shareholder value in the long run. Bharti has already declared to outsource core customer service operations
such as call centres and back office functions related to its mobile networks across Africa to the three firms IBM, Tech Mahindra and . This is in accordance with its Outsourcing model it practices in India.

Cross-border acquisition was also the best strategy for Bharti to counter the hyper competition India. It also provides it the much needed diversification in revenues. The funding of the deal is strategically done through an LBO providing Bharti Airtel the levy to consolidate its operations in rural India and in the 3G space. Though the potential is huge the road ahead is not easy, Bharti will have to turn around Zain s current loss making operations and grow at the rate of 22 to 25% to justify the valuation behind the deal. Given the cultural differences, challenging macro and business environment the turnaround this will not be easy for the Bharti Airtel management.

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