India’s largest operator, Bharti Airtel has confirmed that it is proceeding with the acquisition of the Indian subsidiary of Norwegian operator Telenor. Althou­gh this would end the Norwegian service pro­­vider’s involvement in India, the Airtel-Tele­nor merger will create a unified entity, with a subscriber base of about 320 million and a revenue market share of around 36 per cent. However, the new combined entity may move down to number two slot, if the merger between Vodafone India and Idea Cellular goes through. The combined corporate entity of Vodafone and Idea would have about 395 million subscribers and hold around 40 per cent revenue share.

A third merger, between Reliance Communications (RCOM) and Aircel, is also on the cards despite some regulatory issues. Reportedly, RCOM is also in talks with the Tata Group and exploring the possibility of a merger with the unlisted Tata Telecom and the listed Tata Tele­services (Maharashtra) Limited.

Clearly, the Indian market is heading for major consolidation. This has been on the cards for a while. The financial situation started tightening as spectrum be­came expensive following the last two auctions. At the same time, the market remained hyper-competitive, making it impossible for service providers to raise tariffs and generate more revenue.

The long-awaited entry of Reliance Jio Infocomm Limited (RJIL) proved to be a trigger for this sequence of merger and acquisition (M&A) deals.  The operator, which offered six months of free voice and data to its users, claims that its network is now carrying the largest volume of data traffic in the world. In fact, RJIL’s 100 million users currently consume more data than all of China’s combined data traffic. But this situation could change from April 2017, once the service provider starts charging for its data. It remains to be seen whether there will be a sharp fall in data usage or churn in terms of subscribers.

The economics of running a telecom service business and making reasonable profits in India are questionable in the short and medium run. Overall, the industry has around Rs 4.6 trillion of long-term debt and it generates around Rs 2 trillion of annual revenues. The ARPU is almost flat and likely to remain so due to the competitive nature of the market.

The highest ARPUs are generated by Airtel and Vodafone in the range of Rs 195 to Rs 205, which are very low as per global standards. RJIL’s pricing and commitment to free voice calls has forced every operator to cut voice tariffs and rationalise data tariffs. Every operator is under financial stress and is in the process of arranging additional funds. Even RJIL is raising another Rs 300 billion in secu­red debt from its shareholders via a rights issue (RJIL is a subsidiary of Reliance Industries).

A glance at RJIL’s financials provides some basis for understanding the sector’s problems. About Rs 2 trillion (including the Rs 300 billion referred to above) will be invested in the service provider by the 2017-18 fiscal.  It has 100 million users at the moment, which is roughly Rs 20,000 of investment per user. Most analysts assume that the ARPU will be in the range of Rs 150-Rs 160. It would take either a dramatic improvement in ARPU, or a very long time to justify that investment in cold financial terms. A dramatic improvement in ARPUs seems unlikely for any operator, given the raging price war. So return on investment will take a long time to come.

Every operator has similar problems. The balance sheets have high debts, and operators are committed to large capex. There will be a long gestation period and a shakeout before return on investments becomes satisfactory.

So, what do operators receive in a merger? According to the M&A guidelines, the merged entity cannot hold more than 25 per cent of the total spectrum allocated in a telecom circle and more than 50 per cent of the spectrum allocated in a particular band in a given service area. The merged entity should also not hold over 50 per cent of the revenue market share or subscriber market share in a given circle. It cannot have two payments banks either.

But even while staying under these guidelines, multiple synergies are possible. In the case of Airtel-Telenor, for example, the merged entity would remain within the defined spectrum holding limits in the seven circles where Telenor operates. The merger could also lead to the rationalisation of marketing infrastructure and the workforce for ensuring positive synergies and cost savings.

Airtel seems to be getting a bargain in financial terms.  Telenor operates in An­dhra Pradesh, Bihar-Jharkhand, Guja­rat, Maharashtra and Uttar Pradesh (East and West). It also holds spectrum in Assam where it hasn’t started operations. These seven circles currently contribute about 35 per cent to Airtel’s total India revenues. These are densely populated in most cases, while the Bihar-Jharkhand and Assam circles are underserved.

Bharti Airtel will take over outstanding spectrum payments of around Rs 16.5 billion and also other operational contracts, including tower leases with Bharti Infratel and Indus Towers. It will not take over the debts of the Indian arm; Telenor Norway will settle those. Airtel will also absorb some of the workforce and take over Tele­nor’s customer base of 52 million subscribers across six circles.

Telenor has 700-800 employees on its rolls and deploys about 4,100 contract labourers. The merger would probably lead to the release of a significant proportion of that staff as otherwise, there would be duplication of functions.

“The decision to exit India has not been taken lightly. After thorough consideration, it is our view that the significant investments needed to secure Telenor India’s future business on a stand-alone ba­sis would not yield an acceptable level of return,” Sigve Brekke, Telenor Group’s global chief executive officer (CEO), said in a joint statement.

“On completion, the proposed acquisition will undergo seamless integration, both on the customer as well as the network side, and further strengthen our mar­ket position considerably in several key circles,” says Gopal Vittal, managing director (MD), Bharti Airtel.

Telenor has suffered a fair amount of grief after it entered India in 2009, in partnership with real estate company Unitech. All the licences were cancelled in the 2012 Supreme Court judgement on the so-called 2G scam. Telenor took sole charge in 2014 and bought spectrum in separate auctions in seven circles. Telenor India earned revenues of about Rs 48 billion in 2016, and it made operating profits of Rs 3.5 billion. However, it has accumulated losses of Rs 190 billion and it did not take part in the October 2016 spectrum auctions. The Indian assets (apart from spectrum) amount to just Rs 2.5 billion.

Industry analysts say that the value of Telenor’s spectrum would amount to about Rs 52 billion after deducting the amortisation. The total value of spectrum held by Telenor would be about Rs 70 billion at the 2016 auction prices. Since Airtel needs to pay just Rs 16.5 billion for that spectrum, it is getting an excellent deal. Moreover, Airtel did not buy 1800 MHz airwaves in Uttar Pradesh (West), Uttar Pradesh (East), Bihar, Andhra Pradesh and Gujarat, while Telenor owns spectrum in the 1800 MHz band in these five circles. This will enable Airtel to beef up its 4G services.

The acquisition is subject to regulatory approvals from the Department of Tele­co­m­munications and the Competition Com­mission of India. The companies expect the deal to be completed within 12 months.

As per Fitch Ratings, “The ongoing consolidation is likely to leave four larger operators — Bharti Airtel, RJIL, the combination of Vodafone India and Idea Cellular, and the combined RCom and Aircel. But the consolidation is not likely to return any pricing power to the operators in the near term.”

Gopal Vittal, MD and CEO, India and South Asia, Bharti Air­tel, says that the proposed transaction will create substantial long-term value for sha­­reholders given the significant synergies. Investors seem to be happy at the long-term implications since the Airtel stock was bid up on the announcement. But investors would also worry about how long is “long term”? A bigger entity has a better chance of lasting out this current phase of consolidation. But it could, in­deed, be a very long time before the over­­all industry prospects improve.

Devangshu Dutta