Opportunities abound

Ram Prasad Sahu / Mumbai July 7, 2008, 0:29 IST

While new entrants seek to carve out a share of the Indian telecom market, intensifying competition and declining revenues per user would lead to further consolidation over the next three years.

The Idea-Spice Communications merger deal opens the way for further consolidation in the Indian telecom sector. While there are few smaller players left (HFCL Infotel, Shyam Telelink and Aircel), there are many new players waiting to roll out their networks in an already crowded telecom space.

While new players are aiming to grab a share of the rapidly growing Indian market, their existence will depend on their ability to develop and sustain a low-cost business model in the intensely competitive market.

This means, there could be more mergers and acquisitions over the next 24-36 months. But, the Idea-Spice deal, which appears to be at a premium, suggests that buy-outs won't come cheap. On the other hand, the plans of larger telecom players to foray into global markets also look convincing.

The Rs 3,200 crore that Idea paid for acquiring Spice indicates that operators are willing to pay a premium to grab a part of a sector which due to its low rates, cheaper handsets and network expansion has become the third largest telecom market in the world.

At Rs 77.30 per share, Spice has been valued at a EV/EBIDTA (EV is enterprise value and EBIDTA is earnings before interest, depreciation, tax and amortisation) of about 15 and EV/Subscriber of about Rs 14,000, which is expensive considering that India's largest player Bharti commands at EV/EBIDTA multiple of about 10 and EV/Subscriber metric of Rs 20,000.

Analysts, however, believe that the deal gives Idea a readymade network, spectrum, subscriber base in two key circles of Karnataka and Punjab where it had no presence and market shares of 10 and 22 per cent (as of May 2008), respectively in the latter two circles.

Considering that it costs upwards of Rs 2,000 crore to roll out a network in a circle and Idea is planning to launch its services in Mumbai, Orissa, Tamil Nadu and Bihar this fiscal, the two circles will complete its India footprint with only the North East, J&K and Kolkata to be tackled.

While Idea achieved synergy with a domestic acquisition, India's two largest players are eyeing acquisition targets elsewhere.

Reliance Communications (RCOM) is in talks to acquire a majority stake in Africa's largest telecom player MTN, while Bharti is on the prowl for a possible acquisition in Africa and West Asia. With the Indian telecom market adding 86 lakh customers every month, why are Indian firms seeking to expand to overseas territories?

Says Prashant Singhal, national telecom industry leader, E&Y, "Top Indian operators are trying to replicate their low-cost models (cost per call is over three times in overseas markets), which has yielded 45 per cent EBIDTA margins and 23 per cent profit before tax (PBT) margins. There might be large growth in subscribers which might double, but revenues will not rise proportionately."

Analysts believe that the Indian growth story will mature in the next two years and organisations will need to deploy excess cash they generate.

Says an analyst, "Operators can apply their experience in running a network, handling customers and rolling out the infrastructure across the country in the acquired outfit."

While the Indian telecom sector might see an increase in M&A activity, it is the opportunity for volume growth in subscribers that has led the existing players to maximise their coverage and rollout network infrastructure.

Growth From 10 lakh in 1999, the wireless subscriber base has rocketed to 32 crore in May 2008 recording an annual growth rate of 83 per cent. Despite its 32 crore subscribers who can talk at less than 90 paise per minute on handsets that cost less than Rs 1,500 a unit, the penetration levels are under 25 per cent.

The subscriber numbers are expected to touch 50 crore by 2010, increasing the penetration levels to 45 per cent and pushing India to the number two spot in subscribers behind China.

The growth is not only coming from higher subscriber numbers but is also driven by high talk time volumes. The concern for operators is the revenues per user which are coming down as the metros reach saturation point and they fan out to the smaller towns and cities in search of price sensitive rural markets.

Low tariffs to continue With existing players expanding their footprint and new operators playing the low pricing game in the short term to grab customers and market share, the explosive growth is likely to continue.

Unlike the established players which dominate the wireless telephony scene with a 75 per cent market share, it will cost much less for new entrants to roll out their network as they can share infrastructure of established players and independent tower companies. This low cost rollout could help the new operators to bring down tariffs.

Says Singhal of E&Y, "Tariffs, which are already low may fall in the short term impacting the margins of some of the leading players."

Moreover, churn rates are at 4 per cent because the customer mix is skewed towards prepaid cards where users are more price elastic and jump to take advantage of cheaper bundled packages and due to one off users.

Analysts believe that the effect of these declines and the cost of acquisition and retention going up, the average revenue per user (ARPU), which has been declining from about Rs 400 to about Rs 260 (35 per cent drop over the last three years), is likely to come down.

For the last year, market leader Bharti has seen its ARPUs move down by about 12 per cent. With 26-30 per cent of the revenue pie going to the government in licence and service charges and falling rentals, roaming, ISD and international long distance charges, operators will need to go beyond subscriber volumes and voice telephony to shore up their revenues.

Value added services Voice dominates revenues of telecom operators in the country. Analysts say that this is due to the fact that there is little difference in tariffs charged for voice and data applications unlike other telecom markets.

Proliferation of handsets such as Blackberry which can use various data applications is also low. Developed markets have a higher percentage of smartphones than India where its share is only four per cent of the total handset base. In addition to this, lack of awareness and ability to access applications has kept the share of value added services to single digits.

Says Girish Trivedi, deputy director, ICT Practice, Frost & Sullivan, "Poor marketing and lack of awareness about applications and charges has resulted in the low share of these services when compared to voice."

Analysts believe this figure will reach about 20 per cent in the next four years with applications such as mobile entertainment and commerce gaining ground and the onset of 3G networks. Currently this segment is limited to applications like ring back tones.

Says Ramesh Krishnan, director, Channel Sales, Bharti Telesoft, a VAS solutions provider, "Mobile audio and video applications will not only offer differentiation but also help improve margins."

While there is scope for margin improvement, the presence of up to eight players in certain circles which is almost double the worldwide average and rising capex costs is forcing the existing players to share infrastructure and bring down capital expenditure.    GOOD PROSPECTS   FY08 FY09E Bharti RCOM Idea Tata Tele Bharti RCOM Idea* Tata Tele Subscribers (mn) 66.80 48.00 26.10 25.5** 93.52 64.80 39.15 31.88 ARPU (Rs) 382.00 317.00 287.00 254.00 362.90 297.98 273.51 241.00 MOU/Subscriber (minutes) 507.00 430.00 411.00 338.00 532.35 438.60 452.10 354.90 Revenues (Rs cr) 27012.00 18827.00 6719.00 1789.00 37816.80 25416.45 9742.55 2236.25 EBIDTA Margin (%) 42.10 43.00 33.70 27.00 40.00 41.50 29.00 30.00 Net Profit 6395.00 5401.00 1042.00 -126.00 7993.75 5845.78 1229.56        - EPS (Rs) 34.19 24.97 3.96     -  44.45 30.96 3.81        - P/E (x) 20.95 17.55 22.31     - 16.12 14.15 23.21        - * Includes Spice,  E: Estimates                                         ** Includes Tata Teleservices Ltd

Prospects With established operators sharing tower infrastructure the proportion of capital expenditure is likely to come down, pushing up operating expenditure.

Higher EBIDTA margins in the mid-40s for players such as Bharti and RCOM has been due to higher capital expenditure and the resultant higher depreciation. But, since there is some movement from capex to opex (operating expenditure), which may reflect in lower EBIDTA margins, profit margins at the gross level may not see a major decline.

The rollout of 3G and the pricing of the same will decide the how much money operators will make to the new service offering. Valuations could also be rerated once the spectrum issue, which can help the players launch more value added services, is settled.

Of the listed telecom companies, Bharti with a subscriber base of about 6.7 crore and a market share of about 26 per cent, looks the cheapest on valuations parameters of EV/sales (4), EV/EBIDTA (10) and EV/Subscriber (Rs 20,000).

The movement of the RCOM scrip depends on acquisition newsflow as well as its ability to rollout its pan India GSM network. While it increases its cost of running networks based on different technologies, the rollout gives it a shot at the wider base of GSM subscribers.

Whatever the strategy of operators, it is the high growth of the Indian telecom sector which is giving the existing operators the size and funding options to acquire, enhance their networks and in the coming months bid for new technology licences such as 3G.

So, expect growth rates to remain strong for the next couple of years, consolidation to occur as weaker players sell out (over the next 2-3 years) and larger players foray into foreign markets in a bid to expand their global footprint.