Ind-Ra: Cut in Interconnect Usage Charges to Impact EBITDA Levels of Incumbents by 4%-5%

The Telecom Regulatory Authority of India (TRAI) has reduced interconnect usage charges (IUC) - paid by telecom companies for calls originating from their network and terminating on other networks - to INR0.06 per minute from INR0.14 per minute, effective 1 October 2017. Moreover, TRAI is likely to reduce the charges to zero, effective January 2020.

According to India Ratings and Research (Ind-Ra), the reduction in IUC to INR0.06 per minute would have a 4.0%-5.0% impact on the EBITDA levels of incumbents (Bharti Airtel Limited, Idea Cellular Ltd. and Vodafone India Limited) (based on FY17 reported EBITDA). On the other hand, this could help Reliance Jio Infocomm Ltd. (RJio) to save INR35 billion-40 billion in IUC annually. This added advantage may incentivise RJio to continue with the discounted pricing strategy to increase its subscriber base. In July 2017, RJio had a 9.1% market share in terms of visitor location register demitting active subscribers.

The impact on EBITDA would be 7%-9%, if IUC are reduced to zero. At present, incumbents are already witnessing margin pressure due to declining industry-level average revenue per user after the launch of RJio in September 2016. Airtel and Idea reported a 700bp and a 1,000bp erosion in their EBITDA margin levels on a year-on-year basis for 1QFY18, respectively. Small telecom companies could marginally benefit, as their costs from calls to other networks would come down. However, they have been losing subscribers since the launch of RJio. Incumbents have also been on the receiving end with regard to subscribers. In August 2017, Airtel lost subscribers for the first time since August 2016, and Vodafone and Idea lost subscribers for the second consecutive month.

Ind-Ra estimates the impact of the cut on the standalone leverage levels of incumbents at 0.1x-0.3x (when IUC is reduced to INR0.06 per minute) and at 0.2x-0.6x (if IUC reduces to INR0.00 from INR0.14). Vodafone Mobile Services Ltd has been rated 'IND AA+'/Negative. Its rating outlook is negative, reflecting near-term pressure in the sector. Moreover, Ind-Ra has a negative outlook for the telecom sector, indicating expectations of a higher deterioration in the credit profile of telecom companies due to stiff competition posed by RJio, as well as of negative free cash flows due to a double whammy of weak earnings and capex.

The credit metrics of incumbents are deteriorating on a year-on-year basis, thus indicating a gradual stress build-up in the sector. Net leverage has been increasing after witnessing a recovery in FY15 and interest cover has been on a downtrend since 2015.

Against the backdrop of reduced IUC revenue, the telecom sector is likely to witness a delayed recovery in line with Ind-Ra's FY18 negative outlook.

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