There is a rule of thumb about competition in the telecom sector. If there are two operators in a market, both make money; three operators survive. Any more competition means overcrowding and an eventual shake-out.
A little over a year ago, there were a dozen players in the Indian telecom sector. Then, Reliance Jio Infocomm Limited (RJIL) launched its offering in September 2016. Now, the field has been whittled down to just about six players and these include two public sector companies.
A combination of developments has forced weaker players out. First, spectrum prices shot through the roof in the 2014 and 2015 auctions. The 2016 auctions received a subdued response, partly as a result of the higher prices realised in prior auctions. Higher spectrum charges compelled operators to take on a large quantum of debt to finance spectrum payments, followed by more expenditure to roll out networks. At the same time, they could not increase tariffs due to the intense competition.
Following service launch in September 2016, RJIL was allowed to offer free promotional services effectively for the next six months. That meant lower revenues for everyone, as they all offered promotional schemes so as to retain customers. Then, interconnect usage charges were slashed, which meant that established operators lost net revenue while RJIL gained. Moreover, while RJIL has only a 4G network, other operators have to service customers on 2G and 3G as well, which means more expenses on maintaining mixed networks.
As a result of all these developments, the telecom sector has gone into a downward spiral. Overall revenues have fallen. The Department of Telecommunications (DoT) has reportedly informed the finance ministry that its contribution will be lower this fiscal. DoT reckons that it will receive just Rs 295 billion in telecom revenue, that is, 37 per cent lower than the Rs 473 billion revenue estimated in Union Budget 2017-18.
Bankers have expressed concern over the sector’s ability to service debt. An analysis by Credit Suisse estimates that the share of telecom debt owed by companies with an interest coverage ratio of less than 1 has more than doubled since late 2016, and now accounts for more than 55 per cent of the total long-term debt. The vulnerable debt held by telecom operators with an interest coverage ratio of below 1 is now estimated at over Rs 1.5 trillion.
The price lines of most of the listed telecom operators reflected this stress by severely underperforming the overall market. The accompanying chart shows returns from the listed telecom companies since January 1, 2016, normalised and mapped against the market index, Nifty 50, with prices on the base date set to 100. Between January 1, 2016 and December 1, 2017, the Nifty 50 index has risen 27 per cent. The returns from Idea Cellular, Mahanagar Telephone Nigam Limited (MTNL) and Reliance Communications (RCOM) are negative through the given period. The price line of Idea is down 35 per cent, MTNL 5 per cent and RCOM a disastrous 86 per cent. Tower company Bharti Infratel is down 9.6 per cent. Vodafone India and Bharat Sanchar Nigam Limited are unlisted and hence, it is not possible to get a sense of the valuations there.
There are two outperformers. One is Bharti Airtel, which is up 42 per cent, beating the Nifty. The other is Reliance Industries Limited (RIL), which is the holding company for unlisted subsidiary Jio. RIL is an end-to-end player in the energy and petrochemicals industry with a huge balance sheet. Thus, its price performance is heavily influenced by other factors. RIL was up by 79 per cent during this period.
Second quarter results
The latest results from the second quarter (July-September 2017) confirm that the industry’s revenues and profits remain under pressure. A quick look at the significant results.
Jio’s finances are hard to disentangle from its parent and are not reported in much detail. This is the first quarter when it was earned significant revenues, so there is little basis for comparison. However, Jio reported far better numbers than the consensus estimates. One key fact: RIL has invested over Rs 2 trillion in Jio and it may continue to support the telecom business indefinitely.
Jio’s flagship plan during the quarter under consideration was Rs 399 for a period of 84 days, which computes to an ARPU of Rs 122 per month. Tariffs were lower in earlier months. However, Jio’s reported ARPUs of Rs 156 per month for the second quarter include revenues from an earlier scheme, Summer Surprise, which ran in March-April 2017. The scheme entitled users to three months of free services. Thereafter, from the fourth month, they had to pay Rs 303 (hence, the late reporting). It is difficult to adjust ARPU for this.
It is also hard to estimate if the expenses are realistic. One analyst claims that, if annualised, staff expenses, selling, general and administrative expenses, and finance costs in the second quarter were about half those reported for 2016-17. Since commercial operations began only in September 2016, network operating expenses are also difficult to estimate.
All those caveats must be borne in mind. The reported operating profits (profits before interest, taxes, depreciation and amortisation) were Rs 14.42 billion, and the earnings before interest, taxes, depreciation, and amortisation (EBITDA) margin was 23.5 per cent on revenues of Rs 61.36 billion. Jio also claimed an average subscriber base of over 130 million. That beat consensus estimates.
The stand-alone results of Bharti Airtel reflected a 63.71 per cent year-on-year fall in net profit at Rs 5.86 billion for the second quarter. That beat consensus but Airtel had reported profits of Rs 16.15 billion a year ago. Excluding exceptional items, profits were Rs 3.43 billion for the quarter (Rs 14.61 billion a year ago).
Consolidated revenues for the second quarter dropped 12 per cent year on year to Rs 217.77 billion from Rs 246.51 billion. Profit before tax fell 52 per cent year -on-year to Rs 12.99 billion. ARPUs stood at Rs 154, which was lower than the Rs 188 a year ago. The company claimed that there was a significant improvement of the underlying EBITDA margin by 9.1 per cent year-on-year to 32.1 per cent. On September 30, 2017, the consolidated net debt stood at Rs 914.8 billion, up from Rs 878.4 billion on June 30, 2017.
Idea Cellular reported a consolidated net loss of Rs 11.06 billion for the second quarter. It had a profit of Rs 915 million a year ago. Consolidated revenue was Rs 74.65 billion as compared to Rs 81.66 billion in April-June 2017 and Rs 93 billion a year ago. ARPU was reported at Rs 132. Idea Cellular had a net debt of Rs 541 billion on September 30, 2017.
The company stated that its board had approved the sale of its stand-alone tower business, held by “not a material subsidiary”, Idea Cellular Infrastructure Services Limited (ICISL), to ATC Telecom Infrastructure, a subsidiary of the American Tower Corporation. ICISL reported revenues of Rs 7.58 billion for 2016-17.
The combined Idea-Vodafone will have nearly 400 million customers entity, with approximately 42 per cent revenue market share. It will have revenues of about Rs 816 billion and operating profits of Rs 244 billion. The combined debt will be about Rs 1.08 trillion.
RCOM posted a consolidated loss of Rs 27.09 billion in the second quarter. It had a net profit of Rs 620 million a year ago. This is the fourth successive quarter of losses. Its total income declined 48 per cent to Rs 26.7 billion, down from Rs 51.42 billion a year ago – losses exceeded total revenues due to the heavy debt burden. RCOM is shutting down its voice services.
The corporate is reeling under a debt of over Rs 440 billion and is struggling to restructure it. It has been taken to court by suppliers. RCOM has pledged to repay Rs 2.7 billion by selling off towers, infrastructure assets and real estate. The company hopes the banks will convert about Rs 70 billion of its debt to equity under the strategic debt restructuring plan.
The industry is close to an existential crisis. Most of the smaller operators have been forced out and debt servicing is now impossible for RCOM. However, Airtel and Jio will survive, and probably thrive. Idea and Vodafone will pull through after the scheduled merger, given the sheer scale of the combined entity and the deep pockets of Vodafone’s global parent. Even for Airtel and Idea-Vodafone, debt servicing is a serious concern. Jio’s fortunes are linked to its parent, RIL, which has a huge balance sheet, strong cash flows from its refining business and the ability to continue supporting Jio. However, if there is a serious spike in crude prices, affecting refining margins for RIL’s refined products, there could be stress for Jio.