Consolidation inevitable in telecom sector

This year can be make or break for the industry. A big shake-out could be triggered by the auctions

The next round of telecom spectrum auctions is due in September, with the existing frequencies of 800 MHz, 900 MHz, 1800 MHz, 2100 MHz and 2300 MHz, and two new ones, 700 MHz and 2,500 MHz being placed on offer. These frequencies are suitable for 4G data services and also voice.

This is by far, the largest ever spectrum auction, with 2300 MHz of airwaves on offer. The reserve prices are high. The pan-India base prices total to Rs 5.66 lakh crore. This is over five times the Rs 1.1 lakh crore raised in the spectrum auctions of March 2015 when 470 MHz was auctioned.

Can the telecom industry cough up such large sums? It's struggling to service huge debts. It also faces accusations of under-reported revenue and large associated demands for licence fees and penalties. By the end of 2015-16, the industry had nearly Rs 4 lakh-crore in debt dues. The entire industry generates about Rs 2.6 lakh-crore in annual revenue. The debt: income ratio is in danger zone.

The base price of Rs 5.66 lakh-crore is well over 20 times the annual free cash flow of the entire mobile industry. There is a chance that the response to auctions will be selective. In the auctions of 2014 and 2015, the industry committed to paying nearly Rs 1.8 trillion for airwaves.

An estimate by HSBC Global suggests auction targets are likely to be missed by a large margin. A lot of spectrum could remain unsold. HSBC Global projects that total auction revenue will amount to no more than $12 bn, or Rs 75,000-80,000 crore. That is barely 15 per cent of expectations.

The critical band is 700 MHz, which has a base-price of Rs 11,485 crore/ MHz. It is more than twice as expensive as the other bands. In total, 700 MHz band (around 35 MHz of spectrum is to be sold) is expected to contribute 70 per cent of auction proceeds. However, telecom majors such as Bharti Airtel, Vodafone and Idea Cellular have all stated they will not bid for 700 MHz at this price.

Auction receipts are staggered over the licence period, with one large upfront payment followed by 10 smaller equal instalments. The 2016-17 Budget projected that Rs 99,000 crore would be realised this financial year as revenue from telecom licences and spectrum auctions. Of this, around Rs 45,000 crore will accrue from prior commitments. The rest must come from the September auction receipts. If auction targets are missed by such large margins, there could be a higher fiscal deficit.

Apart from the impact of a low-key auction on public finances, the financials of leading telecom players indicate the industry would be stressed at such base prices. Bharti Airtel has a debt: equity ratio of 1.3, Idea of 1.42 and RCom of 1.3. Vodafone is unlisted but is reportedly contemplating an Initial Public Offering(IPO) where it will raise at least Rs 16,500 crore.

Reliance also looks set to finally enter the fray this year (2016-17), with its 4G offerings. The RJio - RCom agreement and RJio's possession of all-India spectrum makes it a formidable competitor. A price war could be triggered in the 4G data space. This would further affect the already thin margins.

Data is clearly contributing more to revenues and growth can only come via decent data plans and high quality data services. A shift to 3G and 4G is evident. Over half the smartphones sold in the second half of 2015-16 were 4G-capable. By March 2018, at least 200 million subscribers will be 4G capable and by 2020, that number could hit 800 million. The big drivers are video entertainment, e-commerce and mobile money transfers.

Changes in spectrum trading policy have triggered deals like the RJio -RCom partnership. RCom and Sistema Shyam are merging, and there are said to be talks for a merger between RCom and Aircel, too. There are also rumours of Idea Cellular and Telenor India exploring Mergers and Acquisitions(M&A). Such deals would further alter the operating landscape.

We can confidently expect further consolidation. No operator can seriously afford to stop investing in such a competitive arena. Most appear to have stressed balance sheets with high debt. This year could, therefore, be make or break for the telecom industry. A big shake-out could be triggered by the auctions.