Telecom companies' stocks could see upgrades

Outlook turns positive as number of players comes down to eight per circle and govt lowers auction reserve price

Over the last few years, telecom companies have been faced with intense competition and severe regulatory headwinds. As the total numbers of service providers had jumped to an average 13 in each circle, tariffs collapsed, as did profitability. After the spectrum auction in November saw no takers in the 1800 MHz band (for four key circles), the market believes the headwinds are receding.

As competitive intensity increased, telecom service providers started playing the volume game and revenue per minute (RPM) started slipping, as freebies and predatory pricing became the order of the day. November’s auction disaster suggests competition is coming down, as the average number of operators per circle has fallen to eight. Also, with Reliance staying out of the fray, the fear of another round of bloody tariff war has receded. Despite the cut in reserve price, not many may bid for the four key circles, analysts believe.

 

This is because most telecom service providers will find it difficult to fund their businesses, as most are sitting on huge piles of debt. Avendus Securities says: “While fund raising through asset sale or equity sale is becoming difficult, the possible strategy could be raising tariffs and/or cutting back operations. Our analysis indicates that Aircel may cut back operations in a few circles.” Also, players like Videocon and Telenor will scale back operations in circles where they did not bid for spectrum in November — thus, becoming regional players. The scaling back of operations by the newer players is good for the larger incumbents. Over the past few months, Bharti, Vodafone and Idea have seen their revenue and subscriber market shares move up.

The other big positive is the increase in tariffs. As competition becomes more rational, tariff hikes will also happen. In the second quarter, players have withdrawn promotional offers and freebies. Axis Capital is building in a 3.5 per cent increase in FY14 RPM for Bharti, as it expects margin to improve. Every one paise increase in RPM (Q2 was 37 paise) adds Rs 21 to value/share.

On the back of these developments, analysts believe the sector could see a re-rating as competition abates and regulatory payouts come down. After the 30 per cent cut in reserve price, pan-India spectrum reserve price is down to Rs 11,900 crore against Rs 14,000 crore. This implies gross regulatory payouts for Bharti and Idea will come down. For their stocks, Idea is trading at a 16 per cent discount to its 12-month high and 37 per cent discount to its 24-month high, and the discounts should narrow. For Bharti, Axis expects its EV/Ebitda to return to its three-year mean of 8x from the current 6.5x.