The telecom tower industry in India is in the process of a structural overhaul. A change in the base transceiver station (BTS) technology mix (2G/3G to 4G), consolidation in the industry, and the gradual exit of smaller tower operators have changed the landscape significantly. The Indus Towers-Bharti Infratel merger, expected to be completed by late 2019, is set to create the world’s second largest mobile tower operator, with over 163,000 towers and 36 per cent tower market share in India. Post-merger, the industry will have three large players controlling over 70 per cent of the tower market. The balance will be shared among smaller towercos and telcos with captive towers.

Meanwhile, the telecom industry too is in the midst of structural changes. The consolidation wave has reduced the number of players to about five as of 2019, from around 15 players in 2012. With telecom operators divesting their tower assets, the tower industry is expected to shift to pure-play independent towercos from the operator-led model.

Towercos hit hard by tenancy losses

Consolidation in the telecom industry has changed the dynamics of towercos. The latter reported massive tenancy losses over the past one and a half years. For instance, the recent merger of Vodafone and Idea has resulted in over 57,000 tenancy losses. A further reduction of about 21,000 tenancies is expected in the first half of fiscal 2020. While exit penalties are expected to partially offset the revenue loss, the impact of tenancy losses is expected to spill over to fiscal 2020 as well. The telecom sector moving towards an oligopolistic structure, with three players accounting for more than 90 per cent market share, will pose challenges for towercos. This will put pressure on the rent revenue per tower as the number of tenants per tower would go down. Further, the stressed financial condition of the debt-laden telecom incumbents will restrain any material hike in rentals, at least over the medium term. In addition, although the towers added by Bharat Sanchar Nigam Limited and Reliance Jio Infocomm Limited account for a considerable share of captive towers, the revenue from these towers does not flow to the industry.

A look at tower rentals in the past 12 quarters indicates a stabilising trend till the first half of fiscal 2018 and then a drop for the first time in five years in the second half of fiscal 2018 owing to tenancy losses.

Our industry interactions suggest that telcos are currently focusing on the densification of 4G networks. The replacement of 2G and 3G BTSs with 4G ones will slow down net BTS additions to about 155,000 in fiscal 2020, against around 275,000 in fiscal 2019. The number of BTSs per tower is, however, expected to increase marginally to 3.85 this fiscal, compared with 3.67 in fiscal 2019, on increased loading by telcos to enhance their capacity per site and support existing coverage during high traffic and congestion. This loading results in a discount to telcos (they need to pay just 10-15 per cent of rent), which reduces the potential for a higher top line for towercos. Going forward, loaded sites are expected to account for a higher proportion of incremental tenancies. In addition, rentals might come under pressure during contract renewals as telcos have higher bargaining power. This is because telcos’ return on capital employed (RoCE) is less than 2 per cent, compared with towercos’ RoCE, which is as high as 19-20 per cent. Post a decline of around 7 per cent in fiscal 2019, CRISIL Research expects the rent revenue per tower to remain under pressure and decline by another 2-3 per cent in fiscal 2020.

Telecom companies betting to correct their debt profile with asset sales; however, valuations remain critical

Telecom sector debt remains elevated due to high network investments and spectrum price. CRISIL Research estimates the total debt to be Rs 4.3 trillion as of March 2019. Meanwhile, the continued deterioration in price realisation has led to weak cash accrual. Thus, telcos are resorting to measures such as selling stand-alone towers or reducing stake in existing tower subsidiaries to pare debt.

For instance, last year, Vodafone and Idea sold around 20,000 stand-alone towers to American Tower Corporation (ATC) for Rs 78 billion. Bharti Airtel has raised over Rs 120 billion through multiple rounds of stake sale in Bharti Infratel. Recently, ATC has acquired Tata Teleservices Limited’s residual stake of around 13 per cent in ATC Telecom Infrastructure for Rs 25 billion.

Bharti Airtel and the Vodafone Group are both in talks to slash their stakes in the Bharti Infratel-Indus Towers merged entity. Post-merger, Vodafone Idea has the option to sell its 11.15 per cent stake in Indus, which has an implied value of Rs 62 billion in cash at completion.

The sale of assets coupled with the recent rights issue of Rs 500 billion by various players is likely to reduce the debt of telcos in fiscal 2020, but the valuations of tower assets will remain a key monitorable.

Tower valuations declined in tandem with rentals; future valuations a key monitorable

The valuation of tower portfolios depends on factors such as geographical presence, clientele and master service agreements. ATC has been acquiring the tower portfolios of small players in India. Its Viom acquisition in 2015 made it a leading independent telecom infrastructure provider and helped it to compete with other big players such as Bharti Infratel and Indus Towers, and acquire 16 per cent tower market share as of fiscal 2019 from 2 per cent as of fiscal 2012. The valuation of telecom towers is based on defined cash flows to towercos, backed by long-term contracts with telcos. Typically, large telcos have 8-10 years of contract period with towercos. Between 2015 and 2017, tower rentals grew at 5-7 per cent year on year, with tower valuations rising in tandem. However, the decline in rentals in 2018 seems to have impacted the valuation of towers, as is evident from the accompanying chart. CRISIL Research believes the valuations will stay subdued in the near term as rentals are unlikely to go up. Besides, increased investment in newer technologies such as small cells, in-building solutions, massive multiple-input, multiple-output (MIMO), and Wi-Fi hotspots might also keep tower valuations in check.

By Hetal Gandhi,
CRISIL Research