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Emerging Market Structure: Analysts’ views on the consolidating telecom industry

January 02, 2018
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The telecom sector is reeling under severe financial pressure. Rising debt levels and declining revenues have made operators’ liquidity position extremely fragile, raising concerns about their ability to meet their loan commitments. The turmoil is largely because of a substantial increase in the industry’s capex owing to high spectrum acquisition costs and other statutory levies. Reliance Jio Infocomm Limited’s entry has brought new challenges for operators, with a serious price war ensuing in the attempt to match its free voice and aggressively priced data offers. As a self-correcting measure, the industry has resorted to consolidation, with smaller players exiting the industry or merging with bigger players. While post-consolidation, the industry is likely to become healthier and more stable, there is a pressing need for government intervention to improve industry profitability. To this end, the Telecom Commission in September 2017 suggested various measures such as extending the tenors for spectrum payments by operators and lowering their interest burden on penalties related to payment of spectrum usage charges and licence fees. These proposals, which were in line with the recommendations of an inter-ministerial panel, are awaiting cabinet approval. Industry analysts comment on the changing credit and risk profile of telecom companies, consolidation in the sector and the future outlook…(From left to right – Inderpreet Kaur, Analyst, Ovum; Murtuza Onali Kachwala, Managing Director, Telecom, Media and Entertainment Industry Practice, Protiviti, India; Nitin Soni, Director, Asia-Pacific Corporate Ratings, Fitch Ratings)

With both voice and data tariffs at an all-time low, how has the risk and credit profile of telecom companies changed over time?

Murtuza Onali Kachwala

It all started with Reliance Jio Infocomm Limited’s (RJIL) entry and offers of free voice and cheap data services. Existing operators have been forced to merge or exit, whittling down the number of operators in the country, from a dozen early this year to possibly three going forward. The price war may continue through the first half of 2018.

The risk profile has changed owing to new factors such as very high spectrum charges and intense pricing pressure following the entry of RJIL in September 2016. High spectrum fee is a key reason for consolidation in the sector. While big telecom operators, buoyed by large balance sheets, were able to participate actively in the spectrum auctions, smaller operators were marginalised. With consolidation accelerating over the past two years, the sector is now headed towards a three-player oligopoly with Bharti Airtel, Vodafone-Idea Cellular and RJIL accounting for 95 per cent of the revenues.

Inderpreet Kaur

The financial disclosures by various telecom operators have clearly underlined that the sector is under tremendous stress, which is partly due to the pricing war and partly to the unsustainable spectrum prices and levies imposed on the sector. For both the incumbents and the smaller players, this price war has resulted in plunging profitability and high debt.

According to Ovum’s World Telecoms Financial Benchmarks, Bharti Airtel’s earnings before interest, taxes, depreciation and amortisation (EBITDA) margin decreased from 38.4 per cent in the quarter ended September 2016 to 35.6 per cent in the quarter ended June 2017, which is still above the industry average of 34.3 per cent (average reported for top 40 operator groups tracked by Ovum). In fact, there was a greater impact on its free cash flow to sales ratio, which declined to 5.6 per cent in the quarter ended June 2017, the lowest in the industry, from 17 per cent during the quarter ended September 2016. The industry reported an average of 17.4 per cent for the quarter ended June 2017.

While the incumbents have been able to sustain their operations, smaller players have been hit hard as most of them reported a decline in net worth and few even faced insolvency as they defaulted on debt repayment obligations. We see India going from a market with 12 players to a market with four players soon. Almost all the foreign operators are now looking to either exit the market or merge. With Reliance Communications (RCOM) facing insolvency, other smaller operators will have to join either Bharti Airtel or RJIL to make an exit. Tata Teleservices Limited, for instance, agreed to sell its consumer mobile business to Bharti Airtel on a debt-free and cash-free basis, making this Bharti’s seventh acquisition in the past five years. With the RCOM-Aircel merger having been called off, Aircel may also gradually exit and look to strike a deal with the incumbents.

Nitin Soni

The intense competition resulting from RJIL’s entry in the telecom industry has affected most of the existing operators, especially the smaller players. RCOM defaulted on its loans and is in the process of shutting down its wireless business. Bharti Airtel is the only incumbent that has managed to retain its existing rating of BBB/stable based on its robust spectrum assets and network position. Other operators including Tata, Videocon and Telenor have exited the industry.

Consolidation generally leads to stronger and larger players with higher market power. Do you think this is the case with Indian telecom players, especially the incumbents?

Murtuza Onali Kachwala

Yes, this is the case with Indian telecom players as well. This is because fundamentally, the demand for data and voice has not changed; in fact, it is continuously increasing. According to a recent research conducted by Ericsson, the monthly data consumption on every smartphone in India is estimated to grow five times from 3.9 GB in 2017 to 18 GB by 2023. In addition, the total mobile data traffic per month in India is expected to grow 11 times during the forecast period (2017-23), from 1.3 exabyte (EB) to 14 EB. There will be 1 billion 5G subscriptions for enhanced mobile broadband by 2023. Given the huge demand for data, there is a need for the three major operators, including the two incumbents, to have adequate infrastructure and a strong technology backbone. At present, RJIL’s entire network supports voice over long term evolution (VoLTE) calls, which are the upgraded version of the calls made using internet connections. Bharti Airtel too is gradually launching VoLTE services across the country.

Inderpreet Kaur

Looking at the recent developments, India is set to become a four-player market - three private and a more resilient Bharat Sanchar Nigam Limited (BSNL). Bharti Airtel, RJIL and Vodafone-Idea will share the market with BSNL. Going forward, a market structure with four to five large operators will be in line with many other developing and developed markets such as China where three operators manage a subscriber base of over 1.3 billion.

Nitin Soni

We believe that three strong telecom companies - Bharti Airtel, Idea Cellular and Vodafone India along with RJIL - will emerge from the current industry shakeout. We believe that this correction in the industry’s structure to three strong operators from over 10 operators is positive. Most of the Asia-Pacific markets have four or less telecom companies. In any telecom market, only the top two players make a reasonably good return on investment. Smaller operators typically struggle to generate more than 5 per cent return on investment.

However, we believe that the ongoing industry consolidation will not give pricing power to the existing operators. Pricing power will only improve gradually as RJIL changes its approach from being a so-called hunter to a farmer. Currently, RJIL is in hunting mode and is aggressively looking to increase its customer base. However, at some point of time in 2018, it may change its behaviour and start focusing on making money on its large $29 billion-$30 billion of investment.

What is the likely impact of the ongoing consolidation and crisis in the operator space on ancillary segments such as telecom towers and power?

Murtuza Onali Kachwala

As in the case of telecom service providers, the demand for telecom infrastructure has not witnessed a decline. Telecom infrastructure companies have doubled their tower footprint from 220,000 in 2009 to 450,000 in 2017. There has been a rapid change in network opex for all incumbents with RJIL showing that network opex costs can be reduced by running a single-technology network, operating on a smart mix of owned and leased towers and offering lower-than-market tower rental deals on a good proportion of sites. The other incumbents are also catching up on this front.

In addition, the Telecom Regulatory Authority of India’s recent proposal to establish a multi-stakeholder watchdog to enforce non-discriminatory internet access (net neutrality) may be a blessing in disguise for the incumbents. The regulator’s suggestion of exempting content delivery networks within an operator’s own network from the purview of net neutrality would benefit large integrated operators such as Bharti Airtel and RJIL, which have a presence in content platforms. Airtel has content platforms such as Wynk Movies, Wynk Music and Wynk Games, while RJIL has JioTV, JioCinema, JioMusic, JioCloud, JioMags, etc.

Inderpreet Kaur

The ongoing consolidation in the operator space is also affecting the ancillary segments, especially tower companies. A consolidated mobile market would mean the removal of duplicate assets and tenancy loss, and hence we could see some of the smaller tower companies also exit the Indian market. India has over 450,000 towers owned by eight tower companies. Indus Towers is the largest, followed by Bharti Infratel. The three largest operators jointly own Indus and the recent deal between Vodafone and ATC, wherein the latter will acquire around 20,000 towers of Vodafone, will consolidate ATC’s share in the tower market. Meanwhile, Bharti Infratel is looking to consolidate with Indus to form the largest tower company. For operators, exiting the tower business to strengthen their core telecom services business would be a medium to long-term goal. Bharti Airtel has sold part-stake in Bharti Infratel to a global consortium of private equity firms comprising KKR and CPP Investment Board. Besides, RCOM is also looking to exit the tower business by selling its stake in Reliance Infratel.

Nitin Soni

We believe that the tower industry will remain unscathed from the ongoing consolidation in the telecom space given that consolidation is not going to reduce the capacity requirements. Tower demand will continue to grow on the back of fast-growing data networks. Operators will increasingly need to provide a high quality internet experience, which may lead them to expand their 4G coverage and capacity, and consequently continue to increase the demand for telecom towers.

Going forward, what factors will affect the outlook for the telecom sector?

Murtuza Onali Kachwala

The government is formulating a new policy to encourage capital spending and restore the financial health of telecom operators battered by a bruising tariff war. Measures such as giving operators more time to make spectrum payments to the exchequer can help improve the sector’s financial position. As for telecom infrastructure companies, the government should consider them a part of the larger infrastructure sector. These companies need to be given “infrastructure” status and infrastructure providers (IP-1 players) should be included in the right-of-way rules. This will help these companies to be a part of centre-driven big-ticket programmes such as Digital India, the Pradhan Mantri Jan Dhan Yojana and the Smart Cities Mission.

Nitin Soni

We are closely watching the pricing behaviour of RJIL. Any indication of a gradual removal of discounts and promotional offers may show early signs that pricing power is returning to operators. We expect the data average revenue per user to improve in 2018, based on gradual and small increases in price realisations with a high growth in volumes. We expect data traffic to continue to grow by at least 30-40 per cent, driven by the proliferation of cheaper smartphones and the availability of compelling content.

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