Devangshu Datta: Telecom profits won't improve soon

Ongoing consolidation to benefit the sector over the long run

The “Jio effect” has accelerated an existing trend towards consolidation in the telecom industry. Reliance Communications (RCom)-Aircel, Vodafone-Idea, and now Airtel-Telenor are all potential merger or acquisition deals. RCom-Aircel has run into some trouble due to the ongoing 2G spectrum cases. There have also been credible rumours and denials of talks between RCom, Tata Teleservices (unlisted) and Tata Tele Maharastra (listed).  

If these deals come through, the merged entity, ‘RCom-plus’, would have about 260 million subscribers and about 18 per cent revenue market share. Similarly, if Vodafone-Idea happens, it would have about 395 million subscribers and about 40 per cent of revenue share (about Rs 80,000 crore). Airtel-Telenor would have a merged subscriber base of about 340 million and a revenue share of about 36 per cent. Given multiple SIMs with many subscribers, some SIMs may be relinquished. 

Regulations say the merged entity should not hold more than 25 per cent of the spectrum allocated in a circle and 50 per cent of spectrum allocated in a particular band in a given service area. The merged entity should also not have over 50 per cent revenue and subscriber market share in a given circle. It cannot have two payment banks either. Each of these points could prove to be a stumbling block. 

What do the merged entities gain? While assuming they stay within the spectrum limits, the merged entities could still have much better spectrum coverage in specific circles. They could also rationalise infrastructure in terms of marketing outlets and towers and equipment. They could start to rationalise workforce, not a comfortable prospect from the social aspect, given the likely job losses.  

Most operators are struggling with huge debt exposures in a flat market. The total long-term debt of service operators amounts to almost 3x of total revenues. Average revenue per user (ARPU) is also likely to decline in the short run, as Jio’s free voice-calling forces other operators to cut voice tariffs. 

Airtel and Vodafone have ARPUs in the range of Rs 195 to Rs 205 per month. Idea has an ARPU of about Rs 180. These three service over 650 million customers. Every operator also has to invest. Just servicing debt could be very difficult since many operators also have negative cash-flow.   

Do a quick rule-of-thumb calculation. Jio, despite being backed by the vast resources of the parent, will need to raise another Rs 30,000 crore, taking total investments to above Rs 2 lakh-crore. Given 100 million customers, that’s roughly Rs 20,000 capital expenditure per subscriber. Assume an ARPU of Rs 200. Most analysts assume Jio’s ARPU will be closer to Rs 150-160. But, let’s be generous — another way of looking at this is to assume Jio will gain another 25 million customers at an ARPU of Rs 150. The payback will take a very long time. Yes, that’s a very simplistic calculation. But, the numbers are daunting, whatever the metrics and assumptions. 

This long horizon creates difficult problems. There are 12 operators now and there will probably be half that number or less, by the time consolidation finishes. Jio will be spun off at some stage. These equity shifts will keep the market bubbling with rumours, inflated valuations and lots of share price volatility. There will be sudden trading opportunities. But, while all these exciting things happen, balance sheets will look terrible. Sunil Bharti Mittal of Airtel suggested that drastic regulatory changes may be required. For example, service providers might be allowed to share active infrastructure such as spectrum. That would help. 

We can draw analogies with more developed markets to get a sense of the long term. Hong Kong, for instance, has an ARPU of about $25, with seven million users. It’s a physically small market and 11 mobile operators survive. Given nearly one billion low-ARPU Indian customers, the market translates into the equivalent of 125 million customers with an ARPU of Hong Kong levels. It’s segmented across many circles. But, if there’s consolidation, using the Hong Kong analogy, six Indian operators should eventually make decent profits. But, there isn’t much visibility of such profits yet. We also don’t know if the profitability will justify the valuations. Eventually, demand for data and rising per capita income will surely drive growth. But, the long-term investor would have to bank on faith and hope it does not take too long.