Telecoms in India? No thank you!

India is well known for many things, and one of them is cricket. In a busy Airtel mobile-phone shop in Delhi last month, you could have been easily tricked into thinking that cricket was no longer of interest to anyone anymore. The final game of the IPL (Indian Premier League) between KKR (that is, Kolkata Knight Riders) and Chennai Superkings was being played.  The star-studded teams were cheered by celeb-studded fans for the coveted end of season trophy. Yet Airtel’s store was completely full and bustling, even during the last 6 minutes of the game, with customers debating minutes included in each plan, not the minutes left for the end of the game. The next day, however, the impression that Indians had lost interest in cricket was quickly corrected. The shop was even fuller!

The other thing that India is well known for is its telecom sector. India has almost 900 million active mobile-phone subscribers (active SIMs), that is about three for every four people in the country, including babies, or as many subscribers as the whole of Africa and Middle East put together. It also has among the lowest prices in the World, and Bharti, India’s very own world-class champion operator. India’s mobile-phone industry inspires all types of feelings, good ones and bad ones. Many see it as vital to the nation’s development: a way of overcoming the red-tape and bureaucracy of the political system and providing services to everyone, not only the affluent. Mobile operators provide all sorts of services ranging from ringtones of the latest Bollywood blockbuster to accurate crop prices, and of course, voice services.

Yet the industry has been frustrating for many companies, at best.  Prior to the scam, the 2G license awards by the government in 2008 led to India having more than ten operators in most of its 22 geographical regions (called “circles”). Compare that to the likes of China (3 operators) or Indonesia (6 operators). Operators in India therefore have to make do with small parts of spectrum half the size of those issued in any other country and are forced to invest more in capex as a result.

Where’s the money?

October 2009 marked the beginning of hyper-competition in India, with voice prices falling almost 30% to Rs. 0.35 and the introduction of per second billing. Obviously this has been good for consumers: prices have fallen to a level the poor can afford, but bad for operators that suffer from poor margins. Separately the operators have paid large sums for the 3G spectrum auction that has impacted largely on the balance sheets. Also, with spectrum so tight, operators have to build much denser networks than they would do otherwise, costing billions in capex.

In an effort to be more efficient, firms have had to become much leaner. Bharti is such a case, the uncrowned king of outsourcing in telecoms. Most operators in India share their towers and have learned how to compress traffic more effectively. However, this has not been enough, and operators are right to worry about returns. Only Bharti, the largest operator, was close to recovering its cost of capital last year. Most of the foreign owned operators have cash-flushed parents, but the other operators are suffering from a large debt-burden. Middle-sized operators, meanwhile, are bleeding cash, badly. As a result of the price pressure driven by hyper-competition, margin compression, large investments in spectrum auctions and networks, returns on capital are nowhere to be seen.

When 3G spectrum was auctioned in 2010, four to five slots were sold in each geographic circle—less than the existing players in the circles, driving competition amongst the operators. Was it a good outcome? Only for the regulator. Only 3 out of 5 customers had 3G from their existing providers, unless they changed to a competitor for 3G connection. From an operator’s (with no 3G) standpoint, this meant a virtuous circle of decline. Operators, who were initially encouraged by the Indian government to enter the mobile market in the first place, either had to pay top dollar for 3G licenses or see their subscriber numbers (or at least their ARPU for sure) fall. In other words, for most of the operators, more cash to be bled. At the same time, India made it hard for the operators who wanted to leave to sell up and get out. Well, somewhat hard.

What scam are we talking about?

If a market is too fragmented, the ‘normal’ outcome would involve consolidation. Countries around the world with a number of different operators, different technologies and regional licenses have allowed consolidation as a form to naturally build a strong and competitive sector. It might be unfair, but not incorrect to say, that India has sought to the 2G scam instead. Instead of allowing unviable firms and their spectrum to be acquired, India has sought to a rather painful process.

The 2G scam has received significant press over the last 4 years, including the dispute on whether the former telecoms minister undercharged mobile operators for their 2G spectrum licenses, which some estimates suggest lost the country as much as $39bn in government revenue (go figure). In February this year, the Supreme Court of India issued a verdict revoking 122 telecom licenses issued from 2008 (including 22 licenses of Uninor) and a re-auctioning of these licenses at nearly 10x the original 2G price, and to top it all, no money would be returned to those who have had their licenses revoked. The decision has been very damaging to foreign owned operators such as Uninor and Sistema, which have taken large forced write-downs of ca.  $3bn since the cancellations of all of its 22 licenses affecting 42.4m customers. This probably wouldn’t bode well for any future investments in the telecom sector in India.

The verdict came against the backdrop of public and media scrutiny on the telecoms policy following the 2G scandal. Under pressure from media and public perception, the regulator may not want to be seen to be leaving a Rupee on the table, fearing any future witch-hunt or corruption charges.

To top it all, were the auction to take place, existing operators would have an additional debt burden of ca. $50bn over the next five years, a PwC report suggested. That would dangerously leverage all operators (which might not get the finance) or cause operators to decide against bidding for the spectrum, thereby reducing competition.

As Sunil Mittal, chairman of Bharti, said earlier this month, the industry faced “the most destructive period of regulatory environment (I have) seen in 16 years”.

Obviously to recoup their investments, operators would have to increase prices to consumers, potentially by an average of 70%-110% according to analysts, or as much as 250%-350% in Delhi and Mumbai. It remains to be seen if the regulator would allow operators to do this. Nothing should be a surprise anymore in India.

A blessing in disguise

Uninor, with a subscriber base as large as the population of Spain (42.4m customers), has been the most affected by the 2G scam, with all of its 22 licenses being revoked. Uninor (and its main shareholder, Telenor) may however realize soon enough that leaving India was probably a blessing.

Telenor entered India in October 2008 through a 60% controlling stake in Unitech Wireless, targeting EBITDA breakeven in 3 years from launch, OpCF breakeven in 5 years and peak funding (accumulated EBITDA less capex) of INR 155bn max (US$ 3.1bn).  The ambition though, was to reach >8% market share, 30% EBITDA margin and 20% OpCF margin overall.   Today, 5 years since, Uninor has spent 86% of the total investment it had earmarked, is still largely EBITDA negative and has only been able to achieve its market share position (thank god!). Uninor isn’t alone, most operators still haven’t broken even and those that have are generating very poor returns on capital.

Is that all? No. Uninor would have to shelve out another >US$ 3.2 billion (10x its original price in 2008 and even ca. 10% more than the 3G auction) to keep all the 2G licenses it held, and that too in a market in which it is (still) burning cash.

Even if Uninor cherry-picked the circles in which it had a strong position, say >5% market share, Uninor would still have to pay US$ 2 billion to keep its spectrum blocks, most of the investment probably coming from its main shareholder, Telenor. (See table to the end of this blog for a comparison of the price paid by Uninor vs. reserve price vs. price paid for 3G per circle)

So what happened when Telenor decided to pull out from India? Most analysts in fact, have upgraded Telenor’s target price ever since they made the decision to all together pull out from India. Analysts estimate that FCFE (free cash flow to equity) for Telenor would improve by 10-20% for the next 2 years, with an exit from India. It is as if the Indian government cleanly bowled out Telenor, and Telenor (and its shareholders) has never been happier about it.

India’s new telecom reality is shaping up – from low license fees which allowed a number of players to enter the market and lead to a hyper-competitive situation and very low prices; to (super) high license fees, few(er) competitors and higher prices charged to consumers to recoup investment. It would beg the question, after all, has anything changed in India?

2G auctions flop as 57% of spectrum remains unsold; govt gets less than a quarter of its revenue target (India)

The government has garnered just Rs 9,407 crore, less than a quarter of what it expected, as the much hyped second generation (2G) airwaves auctions evoked a tepid response from mobile phone companies, exacerbating concerns about the Centre’s ability to meet its fiscal deficit target

Norway’s Telenor and Videocon, which had lost pan-India permits when the Supreme Court quashed all permits issued by former telecoms minister A Raja, won back their licences in six circles each, and will shell out Rs 2,222 crore and Rs 4,018 crore respectively. Telenor emerged as the largest bidder in the auctions

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