Moody's: High Spectrum Auction Prices Are Credit Negative for India's Telecommunications Operators

On Thursday, India's Department of Telecommunications (DoT) concluded spectrum auctions across four bands of airwaves at a record-high price of INR1.1 trillion ($17.5 billion). This high cost is credit negative for the country's telecom operators because it will increase their debt and costs and reduce their ability to fund future expansion.

The total price the operators paid for the spectrum is around 35% higher than the government's pre-set minimum prices and higher than in any previous Indian spectrum auction, according to DoT results released after the auction.

"These high prices will cause balance-sheet debt to rise significantly for most operators, including Bharti Airtel (Baa3 stable) and Reliance Communications Limited (RCOM, Ba3 stable) over the then next 24 months and will limit their ability to make additional investments, possibly slowing the rollout of 3G/4G networks in India," says Annalisa Di Chiara, a Moody's Vice President and Senior Analyst.

Bharti paid about INR291billion ($4.6 billion) for spectrum, retaining all licenses for 900 megahertz (MHz) spectrum in its six renewal circles and added to this footprint in three additional circles, which were not due for renewal, providing it with a pan-Indian footprint for 3G services. Its payment is one of the highest among bidders and will raise the company's pro forma reported debt levels, when considering all spectrum deferred payments, by 27% to around INR1.0 trillion ($16.1 billion). Although in reality, the deferred payments for this new spectrum will come on the balance sheet in a staged process.

We expect Bharti will fund the upfront payment of around INR78 billion ($1.2 billion) as well as future payments from cash and cash flow rather than additional debt.

"Bharti's pro forma adjusted leverage will likely remain around 3.0x, and at the upper end of the range for its Baa3 rating. But we expect the company will continue to use cash flow from operations and proceeds from tower asset sales and other monetization activities to reduce debt levels further such that adjusted leverage trends towards 2.5x over the next 12-24 months," added Di Chiara, who is also the lead analyst for Bharti Airtel.

RCOM paid INR43 billion ($0.7 billion) for 48MHz spectrum to replace its spectrum 48MHz spectrum expiring in 2015, which is at the high end of our expectation. RCOM renewed only 25% of its expiring 900MHz spectrum, although this was compensated by acquisition of 5.0x the expiring spectrum in the 800MHz band.

"We expect RCOM to opt for a deferred payment schedule, which will limit its upfront cash outflow to around INR11 billion ($0.2 billion), but the deferred spectrum payment liability will keep leverage at the higher end of our tolerance and liquidity will remain strained," said Nidhi Dhruv, a Moody's Assistant Vice President and lead analyst for Reliance Communications.

As of 31 December 2014, RCOM had cash and cash equivalents, including short-term investments, of INR19 billion ($0.3 billion), against short-term debt maturities of INR70 billion ($1.1 billion). Cash flow from operations will not be sufficient to meet the company's funding needs, which include the spectrum payments and capital expenses, over the next 12-18 months. RCOM will need to raise about INR50-60 billion ($0.8-1.0 billion) over the next 12 months but, given the company's banking relationships, we do not consider the refinancing risk to be substantial.

Although we expect companies will look to raise tariffs in an effort to recover their higher costs, we believe the tariff increases will be gradual, leaving the companies' debt levels bloated for some time.

Growing demand for 3G data services will continue to drive companies' spectrum cost recovery. We expect operators to maintain rational pricing, rather than cutting prices in an effort to increase volumes quickly.

The companies will likely opt to defer their spectrum payments, which will mitigate the effect on their cash flow. This option requires operators to make upfront payments of 25% or 33%, depending on the spectrum band, within 10 days of the auction's close, with the balance payable in 10 annual installments after a moratorium of two years. These deferred payment liability obligations are treated as debt in audited financials, which means the operators' debt levels will remain elevated for the next two years.

Longer-term, the spectrum the operators secured will help them maintain their competitive positions, support their data-growth strategies and enhance cash flow generation. The auctions, whilst expensive, have also minimized any spectrum renewal risk over the next five years. Companies' high debt burdens may also pave a path for recapitalization events and further industry consolidation, which will ultimately benefit the incumbent operators.

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