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Case for Consolidation: TRAI’s recommendations on mergers and acquisitions

December 31, 2011

The draft National Telecom Policy (NTP) 2011, released by the Ministry of Communications and IT in October 2011, gives a major thrust to transparency, improvement of the investment climate and promotion of consumer interest. The policy is likely to bring some relief to the sector, which has been caught in a series of controversies regarding spectrum and licence issues, besides facing hyper-competition and declining revenues. In this context, tele.net organised a conference, “Impact of National Telecom Policy 2011”, on November 15, 2011. The conference covered key issues such as spectrum pricing and allocation; one nation, one licence; consolidation; and broadband. The following section presents the highlights of presentations made at the conference...

Akshay Grover, Vice-President, Transaction Advisory Services, Ernst & Young

Most countries around the world have four-five telecom operators with an average spectrum allocation of 17-20 MHz. In contrast, India has around 14 players with a maximum of 10 MHz of 2G spectrum allocated to an operator, per circle.

However, going by the subscriber and revenue market share, it is evident that there are seven dominant players and the new entrants are making only a minuscule contribution. This presents a strong case for consolidation in the industry.

The recent recommendations on mergers and acquisitions (M&As) by the Telecom Regulatory Authority of India (TRAI), to be included in the National Telecom Policy (NTP), 2011, aim to open up avenues for operators to achieve consolidation. The proposed regulatory environment is expected to be conducive to consolidation with operators likely to opt for one of the four possible strategies. These are as follows:

GSM incumbent acquires new entrant: Greater access to 2G spectrum would be the key driver as the target companies will not have a substantial subscriber base to add value for the incumbent. Industry incumbents, reaching their spectrum capacity limits, will feel the pressure to acquire another company (new player). Here, the proposed guideline to allow as much as 25 per cent shared spectrum will be a key enabler. Further, the three-year lock-in period for owners’ equity is nearing the end for most of the new entrants (who had acquired licences in 2008). This will encourage acquisitions. Analysts see the operators opting for this strategy during the first phase of consolidation, once the proposed guidelines are enacted.

GSM incumbent acquires GSM incumbent: The key drivers for such mergers are gaining a stronger foothold in the market, getting access to additional 2G spectrum and, most importantly, paring down the competition. Further, intense competition has led to a decline in operator margins, emphasising the need to bring about consolidation in the highly fragmented market. The existing regulations prevent any such potential opportunity. However, the proposed guidelines that recommend raising the consolidated share of a merged entity to 60 per cent (subject to TRAI’s special approval) and spectrum share to 25 per cent would make such a transaction a reality.

New entrant acquires GSM incumbent: The key drivers for such a scenario are network and market expansion. Here, the new entrants may refer not only to the operators who acquired licences in 2008 but also to potential entrants in the coming years.

New entrant acquires new entrant: At present, this is not seen as a viable option and operators are not likely to opt for it.

Valuation

Valuation remains an area of conflict with the common belief being that Indian players are mostly overvalued. Looking at the growth of earnings before interest, tax, depreciation, and amortisation (EBITDA) on a year-on-year basis, Bharti Airtel’s EBITDA growth was over 80 per cent in 2007 and its valuation was 15-20 times the projected EBITDA. With the entry of many new players, the growth has reduced with the enterprise value (EV)/EBITDA multiples currently ranging from 6 to 10x for the operator. However, this is still at a premium when compared to the EV/ EBITDA multiples of players in developed and emerging markets.

According to BNP Paribas’s analyst reports, incumbents like Bharti Airtel and Idea Cellular are expected to exhibit an EBITDA compound annual growth rate (CAGR) of 20 per cent during 2011-13. This shows that despite the industry experiencing declining revenues and 3G uptake not considered satisfactory, there is a general consensus that data will drive revenues and EBITDA upwards. And this growth remains significantly higher than that of any player in the other emerging or developed markets (an EBITDA CAGR of 10 per cent is expected for leading players in emerging markets during 2011-13). This growth finally translates into EV/EBITDA multiples, reiterating why Indian players continue to trade at a premium as compared to their counterparts globally.

Conclusion

Once the new guidelines pertaining to M&A activity find a place in NTP 2011 and are enacted, some spectrum-driven transactions are envisaged over the next few years, which will lead to industry consolidation. Going forward, some cases of overall consolidation among the incumbents and the entry of some large international players are expected in the Indian telecom domain.

 

 
 

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