3G or 4G, The Sector Is Not ‘Hot’ Yet For Investors

Telecom: Event Update

India is currently world’s second-largest telecommunications market registering impressive growth in the past decade and half. Telecommunication service is one of the key driving forces towards overall economic development for any nation. It is also one of the prime support services needed for rapid growth and modernisation of various sectors of the economy. To push this forward the Department of Telecommunications (DoT) is planning another bumper auction of telecom spectrum early next year and will include frequencies in the 2G, 3G and 4G bands. It is speculated that the prized 700 MHz band for 4G may also be offered among the bidders for the first time ever.

Funds from the spectrum auction will be important to meet the fiscal deficit target of 3.9 per cent of GDP in 2015-16. It is believed there will be a shortfall in disinvestment proceeds from the targeted Rs 69,500 crore. The Indian mobile economy is growing rapidly and will contribute substantially to India’s gross domestic product (GDP), according to a report prepared by the GSM Association (GSMA) in collaboration with the Boston Consulting Group (BCG).

During the last auction in March 2015, the NDA government mobilised Rs 1.10 lakh crore by selling 5 MHz each in the 17 circles totaling 85 MHz. However, despite auctioning the largest amount of spectrum earlier this year, telecom operators are not investing much in infrastructure leading to rising call drop issues. Therefore, the government wants operators to adequately invest in the existing airwaves first to fix call drops before another spectrum auction.

The spectrum held by many of the telcos comes up for renewal in 2017 including Reliance Communications in Gujarat, Tata Teleservices in Andhra Pradesh, Maharashtra and Gujarat and MTNL in Delhi and Mumbai. It is still unclear, if MTNL will put up its 800 MHz, 900 MHz and 1800 MHz spectrum for sale or extend its licenses at market price.

The union budget of 2015-16 has targeted raising Rs 42,865.62 crore as non-tax revenue from one-time spectrum charges and auction of 2G airwaves in the 1800 MHz, 900 MHz and 800 MHz bands. Since telcos are paying spectrum fee in installments, the government needs very good response from the domestic telcos before going ahead with the auction.

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Call Drop: Damocles Sword

Since last six months, there is a war of words on the call drop issue between the government and the telecom companies. TRAI finally found a solution to the annoying problem of the call drops. On October 16, 2015, Trai slapped Re 1 penalty on telcos for every call dropped subject to a maximum of three such calls in a day, with effect from January 1, 2016. Under new rules, the operator will have to send a message to the pre-paid customer within four hours of a dropped call with details of the amount credited to his or her account. For post-paid customers, the details of the credit would need to be provided in the next bill. However, the compensation will be given only if the call drop takes place due to the calling party’s network and not because of the receiving operator’s network.

For example, if the call drop has happened between Airtel and Vodafone, the consumer will not get any compensation. Also, even if the call drop has happened between Airtel-Airtel, the 'cause' of drop should be attributable to Airtel and then only a subscriber can get compensation. These conditions will be too difficult to verify and practically consumers will not get any compensation. Therefore, experts feel the rule will not benefit customers in a big way. The monetary benefits to consumers from the regulation may not be huge; but implementing it will be a challenge. It will force operators to have an adverse relation with customers. Director general of the lobby body of GSM players, Cellular Operators Association of India (COAI) Rajan Mathews estimated a hit of Rs 150 crore per day on operators.

Telecom operators have been blaming the call drops to the lack of spectrum availability and lack of sufficient mobile towers. There are other aspects as well: a) high charges for licenses and for spectrum, 10-12 per cent of revenues in addition to auction payments, b) imported equipment paid for with a weak stream of local-currency revenues, c) changes in spectrum holdings that require adjustment in equipment after older spectrum assignments lapse and new spectrum has been acquired, and d) the burgeoning need for new investments for 3G and 4G services and also the difficulties in getting additional sites, apart from the need for more capital. However, minister for communications and information technology Ravi Shankar Prasad welcomed the move. "We hope this would go a long way in addressing the concerns of consumers. I appeal again to all operators to address the issue seriously.”

We believe it is very complicated to implement and operators have already taken the legal route challenging the Trai order.

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Consolidation Begins Before 4G War Kicks Off

In the month of June, 2015 (Vol. 30 Issue no. 13) we have covered a story on telecom sector about a spectrum auction. In the said story we indicated consolidation in the Indian telecom industry. We have stated in that issue: “In the medium term, we think that the market will support six competitors from the current lot of 10 players as smaller and weaker telcos will seek M&A or exit the industry, given the high spectrum prices and stretched balance-sheets. However, they are waiting for easing of the M&A rules. RCom is in talks with MTS India for acquisition while Telenor may buy a major stake in Videocon Telecom.” In the month of November two consolidation events happen and big players trying to strengthen themselves before the 4G war starts.

On November 02, 2015, Sistema JSFC, which is the parent company of Sistema Shyam TeleServices Ltd (SSTL), which operates as MTS in India has officially announced the merger of the company with Reliance Communications Ltd. The deal is a completely cashless (stock- swap deal) deal worth around Rs 4,500 – 5,000 crore. As part of the merger, SSTL will get 10 per cent equity stake in RCom. In addition, RCom will assume the liability to pay the DoT instalments for SSTL's spectrum, amounting to Rs 392 crore per annum for the next 10 years. RCOM gets MTS’s 800-850MHz spectrum in 9 circles and this also allows it to extend its spectrum life in 8 circles to 2033.

After few weeks, Idea Cellular entered into a spectrum trading agreement with Videocon Telecommunications for right to use 1800 MHz in Gujarat and Uttar Pradesh (West) circles for Rs 3,310 crore. Paying whooping almost 2.5 times of what Videocon had earlier paid for the spectrum, Idea Cellular has the right to use the spectrum only till December 2032. In these two circles, Idea had only 2G and 3G spectrum and not able to acquire 4G spectrum during the two auctions of 2014 and 2015. This agreement will help Idea expand its 4G footprint across 12 service areas. Despite this purchase, Idea needs to acquire spectrum in five circles (Rajasthan, Bihar, West Bengal, Assam and Mumbai) where it does not have broadband spectrum. However, the company is willing to wait for future auctions as far as acquiring fresh spectrum is concerned.

Smaller telcos will continue to face problems such as paucity of spectrum, no clear visibility on 4G and license renewals. Therefore going forward, weaker unprofitable telcos including Aircel and Tata could exit the industry as they make operating losses and lack key spectrum assets and financial flexibility to invest in data networks. Such telcos will seek M&A among themselves or trade their spectrum to larger telcos.

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4G Rollout India

Bharti Airtel, India’s largest telecom group by sales became the first company to roll out superfast 4G mobile data packages across India in August 2015, offering its service in about 300 cities and towns. Whereas most awaited 4G from Reliance Jio is still delaying 4G commercial launch in India. On December 27, the company will start free 4G service for its employees as it claimed earlier in one of the press communiques.

Country's second-largest mobile operator, Vodafone 4G's presence is currently limited to only 10 towns in Kerala. The company will expand its 4G services to metros Mumbai, Delhi, Bengaluru and Kolkata by March next year. The country's third largest mobile operator, Idea Cellular plans to launch 4G services in 750 towns across 10 circles by the first half of 2016.

The continued delay launching Reliance Jio 4G service has given incumbent operators including Bharti Airtel adequate time to prepare for Reliance Jio's entry into the market. However the launch is expected to have a disruptive impact on the telecom sector, leading to continuing price pressure and more intense competition in data services.

Conclusion

Telcos may hikes tariff if DoT forced to pay call drop compensation. In last six month Telcos already hike tariff which we given an indication in the earlier issue. Overall, we see the financial strength of the telcos weak due to poor operating metrics and increased capex requirements. We stay cautious on the sector given the continued voice decline, slowing data growth and rising capex. Still our view is negative on Indian telecom sector for the next one and half years and financial performance may be muted for telcos.