No 3G war, but margin worry remains

While the new service offers telecom providers an opportunity to improve ARPUs, applications hold the key to subscriber growth

Telecom stocks were down four to 10 per cent last week due to the 2G spectrum allocation controversy and worse-than-expected September quarter results. In addition to margin pressures, the markets are wary that a change of guard in the telecom ministry and the controversy may delay policy decisions. There is also a worry that the competitive rates launched by Tata Teleservices could create a new price war in the 3G (third-generation telecom) space. These rates are largely in line with existing broadband rates and not at a premium (as was expected).

Price war?
A recent HSBC report says there is low risk of irrational pricing, given that companies have paid large amounts for 3G licences. With the number of companies in each telecom circle being limited, competitors could collaborate to offer roaming services in circles they have not been successful in. Romal Shetty, the national head of telecom at KPMG, believes, “As in 2.5G (GPRS/EDGE technologies, which allow faster data access), pricing (for most players) will more or less be the same. The battle will be won based on how players are able to differentiate content.” He believes that given the licence fee (Rs 17,000 crore for pan-India services) and $1-2 billion capital expenditure for the rollout, the break-even point for incremental 3G spending has been pushed from four to six years.

Revenues and subscribers
Shetty believes 3G will have limited impact (as a percentage of revenues) in the first couple of years and wil take off based on the value-added services (VAS) that companies offer. VAS accounts for eight to 10 per cent of revenue for most. Data use, however, is likely to increase, as has been observed in the case of Tata Teleservices Maharashtra. Over the past year, it has seen its data income as a percentage of overall revenues rise from 14 per cent to 22 per cent.

Analysts say average revenues per user (ARPUs) per month for 3G users are expected to be in the range of Rs 350-550. Applications (m-commerce, health and education) could lead to a jump in ARPUs, as happened in the US, where these moved up by 20 per cent after the launch of iPhone and the thousands of applications that followed. Shetty estimates 60-70 per cent of post-paid users (who are five to 10 per cent of the 650-million mobile subscriber market) could switch to 3G.

Valuations
Telecom companies reported a mixed set of results for the September quarter. For Bharti Airtel, revenues and Ebitda (earnings before interest, taxes, depreciation and amortisation) were up 24 per cent and 20 per cent sequentially, respectively. Consolidated Ebitda was slightly below expectation due to higher network expenditure and cost pressures at Zain, believes a Citi report. ARPUs and MoUs (minutes of usage) were down, while the revenue per minute was flat, as Bharti did not participate in the circle-level rate cuts. At the current price, Bharti seems to offer the best value among listed stocks on 2011-12 estimates of price to earnings (13.7), price to sales (1.74) and EV/Ebitda (4.8).
 

3G SUBSCRIBERS
In million	FY12	FY13	FY14	FY15
RCom	4	10	15	19
Bharti	10	20	28	34
Idea	3	9	14	19
All figures are estimates                                                                 Source: HSBC
NEAR-TERM PAINS
in Rs crore	Bharti  Airtel	Reliance Comm.	Idea Cellular	Tata Tele. (M)
Sales	57,455	22,100	15,167	2,342
Ebitda	20,341	7,081	3,737	427
Ebitda (%)	35.4	32	24.6	18.2
Net profit	7,047	1,814	664	-430
P/E (x)	16.7	18.3	34.9	-
All figures are FY11 estimates                                            Source: Bloomberg

Reliance Communications (RCom) recorded flat revenues sequentially, due to a 6.6 per cent fall in ARPUs and a two per cent fall in broadband revenues. Ebitda margins fell 26 basis points sequentially to 31.1 per cent due to higher network operating expenses. While the controversies are a dampener, the company is likely to benefit from 3G services, as well as mobile number portability, as it can wean away the high-ARPU post-paid users of other GSM players. At current levels, there is a marginal upside.

Idea’s revenues were down marginally due to a 9.3 per cent drop in ARPUs. Though costs per minute declined sequentially, a higher fall in ARPUs meant Ebitda margins were down 170 basis points. The stock is expensive at current levels (26 times the estimated earnings in 2011-12) and analysts recommend a sell.

While margins in the latest quarter were down for all, analysts say these could improve in the latter part of 2011-12, which could see the first signs of consolidation, slowing in the fall of ARPUs, robust subscriber growth and higher revenues from VAS.