Jio jitters for telcos, as analysts downgrade earnings

Brokerages have started cutting earnings estimates for Bharti and Idea as the industry gets ready for a tariff war

The imminent launch of Reliance Jio's fourth generation (4G) wireless services is giving "jitters" not just to its rivals but also investors. The Street is now viewing the large listed incumbents (Idea and Bharti Airtel) with caution, as a full-blown data war is going to be an expensive proposition for incumbents — Bharti, Vodafone and Idea. The big three have already started shoring up their defence by bringing forward their capital expenditure plans to the current financial. They are also fortifying their customer base by offering attractive deals like cash-back plans to data users.

India's telecom industry is in the midst of a generational shift. Currently, voice accounts for nearly 77 per cent of industry revenues, but this is slated to change. Analysts do not expect voice revenues to grow any further from here on, as India's minutes of use is among the highest globally and unlikely to increase. Only incumbents who have the spectrum and capital to invest in building data capability are likely to grow.

 

Analysts at Goldman Sachs are of the view that while Bharti is well placed to defend its market share, Jio could be a greater competitive threat to Idea. Both Idea and Vodafone do not have any spectrum in the 2,300 and 2,500 MHz bands which, due to the larger allocated bandwidth, offer more capacity. "Consequently, we believe that Idea and Vodafone are likely to need significant investments to become more competitive on 4G."

High speed broadband access is clearly the future, and investors believe that not all incumbents are equipped to ride the wave. The extent of damage Jio's launch wreaks on incumbents will depend on the quality of service and timing of their 4G rollouts. Edelweiss Securities believes the state of preparedness of incumbents to counter the 4G offering is suspect, perhaps due to legacy investments in 2G and 3G networks and poor long-term evolution (LTE) eco-system.

 

Incumbents not only have to deal with a new entrant in the market with a new offering. Even ahead of Jio's launch, the big three operators are seeing data and voice realisations come under further pressure. While this may be good news for consumers, stretched balance-sheets and lower cash flows are not something investors reward. "The lack of price increases combined with higher capex outlays (both spectrum and network related) suggest that cash flows are likely to remain weak in the near term. As a result, the strength of balance sheets, which in turn affects the companies’ ability to invest, will be the key differentiating factor."

Going forward, margins are unlikely to expand for Bharti, Vodafone and Idea. On the voice side, the pressure on realisations are evident from Idea and Bharti's second quarter show. Even though there is still plenty of difference between headline tariffs and realised tariffs, telcos have not been able to increase prices for fear of losing customers and are taking a hit on their revenue market-share. Also, competitive intensity is back with smaller players launching aggressive voice plans.

The story is no different for data either. Earlier this financial year, telecom operators attempted to increase data prices, but most players had to roll these back by offering double data on existing packs. Average revenue per user (ARPU) has been inching up for most players as competition stabilised after 2012, but the shift to next generation mobile technology is unlikely to give ARPUs a boost, thanks to the declining trend in data prices.

As a result, several brokerages have started cutting earnings estimates for Bharti and Idea. Citi has cut EBITDA (earnings before interest, tax, depreciation and amortisation) estimates for both Bharti and Idea by four to 12 per cent. Analysts claim with Bharti's net-debt-to-EBITDA ratio of 2.4 times, the company has headroom to invest, unlike Idea which has a much higher ratio of 3.4 times.

Between the two players, the Street believes Idea is at greater risk thanks to its stretched balance sheet. Even though the company has stepped up its capex plans to Rs 6,500 crore, Barclays believes the company may not have sufficient capital to participate in future spectrum auctions and execute its 4G strategy at the same time (at least in the near term). Spectrum auctions of March have stretched Idea's balance sheet further with net-debt-to-EBITDA ratio touching 3.3 times in financial year 2016.

In contrast, Bharti is better placed as far as ability to invest in capital expenditure is concerned, but pressure on voice realisations will put pressure on profitability. If it continues to monetise its assets in Africa, it will allow the company to make the requisite investments in 3G and 4G rollouts, say analysts.

TAKING A CALL

Goldman Sachs: Bharti is well placed to defend its market share but Jio could be a greater competitive threat to Idea

Citi: Cuts Ebitda estimates for both Bharti and Idea by 4-12 per cent

Barclays: Idea may not have sufficient capital to participate in future spectrum auctions and execute its 4G strategy at the same time (at least in the near term)

Edelweiss: The state of preparedness of incumbents to counter Jio’s 4G offering is suspect