The telecom sector requires ample and continuous funding for its operations. Despite the government increasing the FDI limit in telecom to 74 per cent, foreign inflow of funds has been slow and rupee debt and internal accruals are often used. tele.net asked telecom and financial analysts for their opinion on the most preferred methods of telecom financing and other investment-related issues…
What are the key parameters taken into consideration while evaluating an investment in the telecom sector?
Jitender Balakrishnan: The key parameters are:
Resourcefulness of the sponsor ?? The telecom sector is highly capital intensive and requires continuous funding. It is, therefore, essential that sponsors have deep pockets to withstand initial cash losses.
Scale of operations ?? To achieve better economies of scales, the operator should ideally have a presence in at least one/two metros. Being present in all legs of a call improves the bankability of the project.
Basically, an operator who has ISD, NLD, access and ISP licences would be a more viable option than an operator who only has an access licence.
Financing mix ?? While lenders normally look at a debt-to-contributed equity ratio (DCER) of between 1 and 1.5, a lower DCER improves the project’s bankability.
Marketing strategies ?? In a highly competitive market scenario, the company’s marketing strategies and brand development are extremely important. Innovative packaging of tariffs and quick responsiveness to market changes are also important.
Control on capex ?? Since the sector is capex intensive, a more rigid control on capital expenditure and better bargaining ability with vendors are key factors in reducing project cost.
Spectrum availability ?? As more and more players enter the sector, availability of spectrum would play a key role, especially for new entrants.
Krishna Ramachandran: The focus today is on inorganic growth in new markets/new geographies more than on pure expansion. Expansion is currently funded by most operators through internal accruals and debt. Indian and Chinese telcos are looking at overseas buyouts in other emerging markets like Africa and elsewhere in Asia. The key parameters here are to replicate successful business models and to tap the potential these economies and telecom businesses have for rapid subscriber and revenue growth. Companies have been looking at markets with lower teledensity, good government support and potential for high growth.
Archana Sassan: One of the key parameters for evaluating investment in the sector is the potential for growth. However, it would also depend on the type of investment, and whether the same is made by a domestic company or by foreign investors. For instance, some of the main parameters affecting foreign investment would be the government policy vis? -vis foreign ownership, the degree of liberalisation in the sector, extent of repatriation of profits allowed, regulatory environment, number and strength of the incumbent, taxes, etc. To a lesser extent, parameters like bureaucratic hurdles would also determine long and sustained foreign investment in the country. Certainty of the regulatory environment would play as big a role in determining sustained investment as the government’s policy on private and foreign investment and the potential for growth of the Indian market.
Rajat Sharma: Analysing the soundness of the telecom project’s cost-benefit and risk analysis is the key parameter. The project should also be examined as to whether it is expected toimprove operational performance. The performance measures that will be used to monitor this are expected versus actual results. And lastly, the project’s return on investment (RoI) must be measured.
Ajay Kumar Singh: Telecom projects are highly capital intensive. Huge investments are required to meet the capital expenditure requirements and operating cash losses in the initial period of a project. The projects are financed on a debt-to-equity ratio of 1 to 1.5 depending upon the risk factors of the business model. The promoters’ financial strength and operational expertise are the critical factors for any telecom project, and for ensuring timely financial closure. For the viability of the business model, largescale operations with a strong focus on marketing and efficient network management are key parameters. These days, most telecom operators are outsourcing a significant portion of their network management, which allows them to give complete attention to customer management. To measure the financial viability of telecom projects, the debt-to-EBITDA, debt-to-equity, return on capital employed and loan-life ratio are critical parameters. For other non-telephony businesses like data management, the scalability of the business model and value contribution to the client’s operations are crucial for the viability of the business.
Which financing options are the most favoured for the telecom sector?
Jitender Balakrishnan: The development in the Indian telecom sector has been funded primarily by domestic rupee debt. Initially operators had opted for long-term rupee debt with back-ended repayment structures, primarily to match the cash flow of the project. However, once the companies started earning cash profits, there was an increasing tendency to refinance the long-term debt by way of short-term borrowings to reduce interest costs. But, the intrinsic risk in this is the liquidity risk that the companies need to carry on their books. Therefore, now, in a rising rate scenario, companies are moving towards mediumterm financing. Further, companies that have strong foreign shareholders have been able to leverage on that strength to raise foreign currency loans at fine rates.
Krishna Ramachandran: Incumbent operators have been funding their operations through a combination of internal accruals, access deficit charges and suppliers credit. Others have promoters’ funds, equity placements and debt. Operators are now moving in a very large way to outsource network infrastructure. This would result in larger off-balancesheet financing and improved cash flows, which help operators to expand rapidly without significant capital investment. As the operations begin to mature in size and profitability, the telcos look at public offerings as a preferred route for raising capital for future growth/unlocking value. Improved valuations are compelling promoters to invite overseas strategic partners for funding future growth and/or de-risking capital. In 2005, India witnessed over $4.5 billion changing hands by way of investments and buyouts.
Archana Sassan: The Indian telecom sector currently requires close to $37 billion to provide telecom facilities at affordable prices to the masses. Foreign investment has yielded rich dividends in the previous years. Therefore, for Indian telecom companies, raising finance through foreign investment is one of the most favoured options. However, the needs of some telecom segments are not met through foreign investment. For instance, public telephone booths, local internet service and cable TV operations have low profit margins and localised operation. Therefore, investment by a local company/individual works better in these areas. Notably, these are the most common mediums to reach the rural areas. The widespread availability of these facilities in the past couple of years is an excellent example of internal resource mobilisation. Therefore, to enable growth in the sector, both foreign and internal investments find favour.
Rajat Sharma: The financing life cycle has evolved over the years. The sector started with the traditional route by exercising the debtfinancing option. However, with the Indian telecom market picking up, vendors started extending vendor financing. Of late, the market has started witnessing financing through the equity route by either listing on the bourses or through strategic partnerships such as Bharti-Vodafone and Spice TelecomTelekom Malaysia.
Ajay Kumar Singh: Telecom projects are long term in nature. Hence, secured long-term rupee debt with a moratorium on repayment during the initial years is the most common financing option. Over the last few years, telecom companies have utilised the ECB route to benefit from low-cost funding. Similarly, companies also resorted to short-term rupee borrowings to benefit from low interest rates. Given the significant equity requirement for telecom projects, mezzanine products like preference shares and structured products like partly promoterguaranteed bonds have been part of the project funding. These mezzanine financings also help in reducing the promoters’ equity contribution.
What are the major constraints in attracting FDI in telecom?
Jitender Balakrishnan: There has been a substantial relaxation in the norms relating to FDI in the telecom sector in recent times. However, foreign investors are debating some of the present norms, particularly those relating to the appointment of the top management (the present norm stipulates that the CEO, CTO and CFO need to be Indians) and, the minimum holding of Indian promoters (as per present norms it is 10 per cent, which blocks the exit of Indian promoters).
Krishna Ramachandran: India has come full circle, with largescale FDI in the early 1990s, withdrawal and reduction towards the midand late 1990s, and large spurts of FDI inflow by way of acquisitions in the past two years. Frequent changes in the telecom policy and delays in decisions regarding spectrum allocation are some of the constraints in attracting FDI.
Archana Sassan: It is pertinent to note that though telecom giants the world over ?? including the US, Japan, Germany, Switzerland, Australia, France and Malaysia ?? had set up joint ventures in India to bid for mobile licences, today, very few foreign companies remain. Notably, no foreign telecom company left India because of the FDI cap or the foreign investment policy. Many quit because of different factors, such as their own financial constraints, underestimation of the Indian market in terms of the infrastructure requirements for reaching the rural market, the role of the incumbent and regulatory uncertainty.
Further, although the FDI cap in telecom has been raised to 76 per cent, many restrictions accompany this new policy. For instance, requirements like the majority directors on the company’s board need to be resident Indian citizens, non-transference to any person/place outside India of any accounting information relating to subscribers and no remote access to be provided to any equipment manufacturer or agency outside the country are significant deterrents to foreign investment. Greater regulatory certainty, fewer bureaucratic hurdles and removal of restrictions pertaining to ownership issues would give greater comfort to foreign investors. The government should also consider reducing the entry fees and revenue share fees. These fees tend to increase the cost of services for consumers, leading to slower telecom growth. This is more important in the current scenario since further expansion depends primarily on expansion in the rural areas where profit margins would be lower.
Rajat Sharma: There are no direct bottlenecks in terms of financial policies constraining FDI inflow. However, the international community of investors and operators is less bullish, primarily because there are certain issues that still need to be addressed. Issues like spectrum availability, unbundling of the last mile, high levies and tax rates and high IUC charges are deterrents. Thus, until these issues are sorted out, FDI will be slower than the potential the market has to offer.
Ajay Kumar Singh: FDI in telecom has been successful relative to other infrastructure projects as the sector has witnessed meteoric growth and has humongous potential for future growth. However, huge FDI is required to fuel this growth ?? rough estimates put the FDI requirement at $20 billion for the next four to five years. Though the Department of Telecommunications has, to a large extent, facilitated FDI in telecom by recently augmenting the cap to 74 per cent, there are a few constraints that can be further modified/removed to attract the required FDI.
The constraints are:
However, clearances can sometimes become a time-consuming exercise.
The telecom manufacturing sector has a huge potential to attract FDI. The government should provide attractive incentives for setting up manufacturing establishments in India.
What finance models are followed in other countries in the Asia-Pacific region?
Jitender Balakrishnan: I am not aware of these.
Krishna Ramachandran: Most operators in the Asia-Pacific region are funded by a combination of longterm debt and equity. In light of the current environment of booming telecom businesses and the privatisation efforts of state enterprises, many operators are unlocking their value by listing their stocks on the bourses. The proceeds of these issues are being used to retire debt, for additional rollout and, importantly, for overseas acquisitions.
Archana Sassan: In the last few years, most of the AsiaPacific countries have begun favouring financing models that are foreign investment centric. The huge untapped potential of the telecom market has made Asia the destination for nearly one in four global FDI dollars. China and India are currently the leading foreign investment destinations. This trend has, in no less measure, permeated into the telecom market as well. In China, for instance, policy changes to increase foreign ownership and reduction or elimination of geographic restrictions are also galvanising FDI confidence in telecom.
Singapore has recently started allowing foreign investment and encouraging competition to the incumbent Singapore Telecommunications. However, Singapore also follows finance models that not only include foreign investment but also investment through governmentlinked corporations (GLCs). As opposed to Singapore and China, in the Philippines, the bulk of the telecom traffic is operated by the private sector and foreign investors are given quite a few incentives for entering the market. However, it is pertinent to note that although telecom markets in Japan, Singapore, China, India and Hong Kong have allowed foreign investment to a great extent, GLCs, on account of their long-standing presence, continue to have an advantage over private players.
Rajat Sharma: Other countries in the Asia-Pacific region follow the newer model of financing such as initial public offerings, strategic partnerships, private placements, publicprivate funding and public funds.
Ajay Kumar Singh: In the Asia-Pacific region, telecom operators mostly use non-recourse debt with different tranches, each having separate security and financial terms for funding the debt requirement of projects. Some of the financing also involves credit enhancement by the promoters in the initial phases of the project to mitigate the risk for lenders. Telecom projects also get partly funded by credit received from equipment suppliers at low interest rates. More recently, telecom operators have been using secondary market offerings and equity-linked products such as exchange notes and guaranteed exchange notes to finance telecom projects, and mergers and acquisitions.
