Kumar Mangalam Birla is soft-spoken, as also a man of few words. That makes his acceptance of the new business realities surrounding one of his high-profile companies even more stark and noteworthy. Like recently when, at a public forum, Birla opened up about the possibility of Vodafone Idea potentially heading towards closure.
Speaking at the Hindustan Times Leadership Summit in New Delhi in January, Birla, chairman of VodafoneIdea—India’s third-largest telecom service provider by revenue—said: “If you ask me specifically, it is true that we will shut shop if we don’t get relief.” The relief Birla—whose $48-billion Aditya Birla Group is home to success stories such as cement major UltraTech Cement or aluminium maker Hindalco—sought was for the ₹53,000 crore that Vodafone Ideahas to pay to the government on account of past dues (including penalty and interest).
He also wasn’t ambiguous on whether the promoters of the firm—a result of a merger between Birla’sIdea Cellular and the Indian arm of multinational telecom giant Vodafone Group Plc—would infuse more capital into it to tide over the crisis. Birla’s direct answer was no. “It’s just not good business,” he said. “It doesn’t make sense to put good money after bad.” Bharti Airtel and Tata Teleservices(which sold its wireless business to Airtel in 2017) face similar issues to Birla, battling frail financial health as a consequence of a bruising price war exacerbated by the entry of the Mukesh Ambani-led Reliance JioInfocomm.
This crisis has arisen from a Supreme Court verdict delivered in October 2019. According to the ruling, these three companies have to fork out around ₹1 lakh crore by way of statutory dues to the government. The dues are a percentage of the telcos’ adjusted gross revenue (AGR)over the past 14 years, including penalty and interest. In its judgment, the apex court upheld the department of telecommunications’ (DoT) interpretation of AGR to include the non-core revenue of mobile operators, which the latter have contested in various courts over the years.
A subsequent review petition filed by the telcos was also rejected in January and, in February, the Supreme Court refused to modify its earlier judgment and asked the telcos to pay up by March 17. It also pulled up the DoT for not recovering the dues after it rejected the earlier review petition. A CNBC-TV18 report of February 16 stated that the DoT was likely to initiate action against telcos for not submitting their dues by February 14 (pertaining to the Rajasthan telecom circle only).
This has all but put paid to the telcos’ hope that, if the apex court allowed it, the government would engage with them to modify the terms and conditions of this payment—including a potential moratorium and/or spreading it out through instalments over a number of years. Airtel, Tata Teleservices, and Vodafone Idea have all said that they will pay their AGR dues. While Airtel (with dues of ₹35,000 crore) is well-funded and Tata Teleservices may rely on parent Tata Sons for additional capital, it is unclear how Vodafone Idea will handle this situation.
The penalty is an immediate problem, but it is far from the only one: It has been bad news all around for the industry. In just six years, India’s telecom sector—once a poster child of the country’s economic potential—has been reduced to shambles. Between FY17 and FY19, its revenue has shrunk by 30% to $22 billion. On the one hand, there is the ruthless tariff war between telcos to retain subscriber market share. On the other, heavy expenditure to acquire and retain spectrum and consistently upgrade networks. Both these factors have taken a heavy toll on profitability. Airtel’s operating profit margin, for instance, has declined from around 38% in FY17 to 32.5% in FY19.
With the Supreme Court leaving little room for government intervention in the AGR matter, the fate of the telecom sector, especially Vodafone-Idea, hangs in the balance. That said, it is in the government’s interest to help mitigate this blow. The sector, after all, is a key catalyst for economic growth, one of the largest job creators, a major source of revenue for the government, and critical to its much publicised Digital India mission.
Any support from the government will be welcome by the companies which, after years of declining mobile tariffs, have undertaken steep price hikes in recent times (Jio included) to boost their financials. In fact, the Telecom Regulatory Authority of India (TRAI) isn’t averse to the idea of putting in place a floor price for tariffs in the future. This will help prevent competition at the cost of financial viability, which has been part of the undoing of the sector. And the reason for Birla’s scepticism.
Things weren’t always this bad. Back in 2013-14, shares of Vodafone’s Indian arm were market gold. Successive Indian partners of the U.K.’s Vodafone Group benefitted in this period by selling their holding in the multinational telecom giant’s Indian business back to the parent.
The Mumbai-based Essar Group, led by brothers Shashi and Ravi Ruia, sold its 33% stake in Vodafonein 2013 for $5 billion.
Later, in 2014, the Ajay Piramal-led Piramal Enterprises sold its 11% back to Vodafone for ₹8,900 crore, making a neat 52% return on its investment in two years.
The Indian telecom sector was an investor's darling, and it isn’t hard to understand the confidence. Rising purchasing power in a country with a rich demographic dividend and underpenetrated telecom services saw millions of Indians buy mobile phones. Voice and data services were used for everything; from keeping in touch with loved ones to growing their business and consuming content on the move. Telecom companies reported record profits with each successive quarter, and their valuations soared.
Take Piramal’s deal with Vodafone, which implied a hefty valuation of ₹1,960 per share. Compare that now to the ₹3.44 per share at which Vodafone Idea’s stock closed on the bourses on February 14.
It is a smaller playing field too. Owing to increased competition, Vodafone India merged with the Kumar Mangalam Birla-led telcoIdea Cellular in 2018, part of the shake-up in the sector which has only three private sector players still standing—Bharti Airtel, Vodafone Idea, and Reliance Jio Infocomm. The two state-run players, BSNL and MTNL, are speculated to be heading for a merger. Of the 13 telecom operators in 2010, Tata Teleservices and Norway’s Telenor have exited by selling out to Sunil Mittal-led Airtel, while Anil Ambani-led RelianceCommunications is facing insolvency proceedings. Others like Aircel, Loop, and Videocon have also shut shop.
“The competitive intensity certainly went up [since 2016]. Almost everyone brought down tariffs and ARPUs (average revenue per user)declined significantly by as much as40%-50%,” says Sachin Gupta, senior director at credit rating firm CRISIL.“That is a huge margin in a business that has high operating leverage. Since there is practically no cost of raw material in telecom, profitability takes a big hit the moment tariffs and ARPUs come down.”
Compounding the doddering financial health of telecom companies is the declining quality of services. Though little structured data exists on this subject, it may well be argued anecdotally that completing a telephone conversation these days without a call drop or network disruption is nigh impossible.
You could call it the price of competing with a giant.
The Jio Effect
If the telecom sector is like the Wild, Wild West, then the gunfighter-in-chief is Jio, whose disruptive entry in2016 triggered the bloody tariff war. The wireless broadband and digital services arm of Reliance Industries Ltd (RIL), ranked No. 1 on the Fortune India 500 list for 2019, shook up the market with its digital services based on the new-age 4G LTE (longterm evolution) technology, which makes for more efficient use of spectrum and allows even voice to be carried over data.
As on December 31, 2019, Jio had 370 million subscribers and was India's largest telco both by revenue and subscriber market share. In FY19, Jio reported a turnover of ₹45,782 crore and a net profit of ₹2,964 crore. On financial viability charts, then, Jio is the no-contest leader. It, however, is averse to pinning its success on the disruption it is said to have caused. Instead, it points to other incumbents’ inability to make a timely transition to future technology as a more decisive factor.
“More than Jio, it has been new technology and operators’ [relative] alacrity and ability to invest in new capabilities that has led to consolidation in the sector,” Anshuman Thakur, head of strategy and planning at Jio, had told Fortune India in October 2019. “Existing operators weren’t agile enough while planning their path to transition to LTE, whereas Jio came in with its LTE-based, all-IP network that was more efficient in terms of cost and quality of service. Those who haven't been able to invest in upgrading their network infrastructure have found it difficult to sustain [themselves].”
Analysts appear to agree. “The whole game changed from voice to data. Since a new player was aggressively doling out large amounts of data at low prices, readiness of incumbents to match that offering required them to make significant investments in building their data capability,” says Gupta of CRISIL. For example, Airtel had to invest as much as ₹25,000 crore annually, consistently, over two to three years to match up to Jio.
The delayed launch of 4G services in India can also be attributed to the time taken by telcos to first increase the penetration of 3G services. Mobile operators had spent heavily to acquire 3G airwaves in 2010 (around$15 billion in all) but the offtake of those services, priced at a premium, was slow since 2G was still effective enough to carry voice. “The pace of 3G and 4G penetration in India was very slow since 2G services were expected to continue for a longer duration. Given the pace of 3G adoption, telcos took some time to invest in 4G,” says Sathish Gopalaiah, partner and leader of the telecommunications practice at consulting firm Deloitte. “However, since early2016, 4G adoption picked up pace and things moved rapidly.”
In that context, while existing players were constrained by debt, Jiocame in without any legacy issues and directly launched 4G services on a mass scale. Its 4G strategy was based on low pricing, as opposed to the existing premium pricing of3G, and higher penetration, with data being the centrepiece. According to a report by Swedish telecom equipment maker Ericsson released in June 2019, India’s data usage peruser is the highest in the world at9.8 GB per month.
The market was caught unawares and continues to play catch up.
Of woes and wins
The timing of the AGR pressure couldn’t be worse, then.
Of the current set of telecom players, Vodafone Idea appears to bein the most tenuous state, as Birlaseemed to indicate too. Its balance sheet is already stretched, and lackof relief on AGR-related payments will push the company over the brink. Not surprisingly, in February, Nick Read, Vodafone’s global chief executive officer, said during an earnings call that the situation in India was critical.
“The telecom industry in India has asked the government to take action urgently in order to support the continuation of a three-plus-one-player market,” Read said. “Specifically, we have requested an immediate two-year moratorium on spectrum payments, a lowering of licence fees and taxes, the waiving of interest and penalties on the AGR case, and the ability to make the payment on the principal over 10 years with a two-year moratorium.”
The uncertainties can have a significant impact on the company’s business and valuation outlook, says Kunal Vora, telecom sector analyst at BNP Paribas. “It lags in network investments and faces a difficult task of defending its market share, which continues to erode every quarter.”Between the second quarters of FY18and FY20, Vodafone Idea’s market share has declined by nine percentage points to 27.3%.
Jio leads the market with a 34.7% share, while Airtel, which has managed to hold on to its share of around 30.6%, appears to be the Street’s favourite in recent times. Reason: It has performed relatively better in making the transition to mobile broadband on 4G and also managed to raise much-needed capital; this could be to make AGR payments, or for growing its network, or both. As a result, in the last six months, Airtel’s stock price has soared over 53%.
In January, Airtel raised $3.1 billion of equity and debt capital from foreign investors and, for the third quarter of FY20, its ARPU rose to ₹135. “We are on track to shut down our 3G networks across India and re-farm the 900 and 2,100 MHzband spectrum to further boost our 4G footprint to serve the surging demand for high-speed data,” Gopal Vittal, managing director and chief executive officer, India and South Asia, Bharti Airtel, said in the company's earnings statement for the October-December 2019 quarter.
Airtel’s ability to attract foreign capital augurs well for Indian telecom. The potential collapse of Vodafone Idea, then, will send a wrong signal to investors, which the government will not want. “They cannot let Vodafone Idea go belly up, not just because they have 230 million subscribers but also because you need at least three players to have a competitive environment,” Rajan S. Mathews, director general of the Cellular Operators Association of India, had said a few days before the Supreme Court delivered its final verdict. “Even globally you have three players in most countries.”
Even Airtel doesn’t want Vodafone Idea to collapse. In a post-earnings call in February, Vittal said: “I think Vodafone Idea will remain and I wish it thrives... It is important that India remains a three-player market as that is good from all perspectives... investments, jobs, and reputation.”
In recovery mode
For those looking for signs, here’s an indication that the Centre is willing to work with the telcos to ease their pain: During a recent interaction in Mumbai following the announcement of the FY21 Budget, economic affairs secretary Atanu Chakraborty said that the government hadn’t taken AGR-related proceeds into consideration while arriving at the Budget Estimate for revenue in FY21.
Moreover, telcos have taken a concerted call (with a likely nudge from the government, say analysts) to repair the sector’s health by raising tariffs for the first time in years. Now that it has cornered a sizeable share of the market, even Jio, which stormed into the scene with free voice and dirt-cheap data services, is upping prices. Further, a consultation paper floated by TRAI mulling a floor price for tariffs has given some measure of confidence to investors that a stable market with likely four players (Jio, Airtel, Vodafone Idea, and the BSNL-MTNL combine) is still a possibility.
Steep tariff hikes of around 50% undertaken by telcos have the potential of doubling the industry’s Ebitda (earnings before interest, tax, depreciation, and amortisation) next fiscal to around ₹60,000 crore, says a CRISIL report. “This is a structural positive for an industry weighed down by weak cash flows and mounting debt,” the report states.
The industry’s ARPU is expected to grow 25% to ₹145 from around ₹119 in FY19, it adds, although Go-palaiah contends that ₹200-₹220 is needed for sustainability, while Vittalof Airtel pegs the number at ₹300 fora reasonable return on capital. But even the rise to ₹145 will improve its debt-to-Ebitda ratio to 4.6 times in the same period. (Around 1.3% of total loans, or ₹1.1 lakh crore, extended by banks is to the telecom sector.)
In the simplest terms, it is in the government's best interest to ensure the sector’s survival since it accounts for a sizeable chunk of the government's revenue by way of spectrum-and licence fees-related dues. This will not be possible if the telcos succumb to financial ill-health. Earlier too, the government had sought to offer relief to telecom firms by giving them a two-year moratorium on spectrum payments. However, more needs to be done, say industry observers.
For starters, the government needs to relook at the base pricing for spectrum, which has always been higher in India, compared to countries like the U.S. and SouthKorea, by as much as 30%-40%. This explains why mobile telephony companies were unenthusiastic about bidding for 4G spectrum at a government auction in 2016; ₹5.6 lakh crore worth of spectrum was on offer, but the government managed to mop up only ₹65,800 crore. “In the 3.5 GHz band (of 5G spectrum), TRAI has recommended a price of ₹50,000 crore for 100 MHz of spectrum. We can’t afford this. We believe it [theprice] is too high. We will not pick it up at those prices,” Vittal told analysts in the February earnings call.
The Indian telcos’ approach to business also needs to change, say experts. As it stands, they first acquire spectrum, invest in augmenting their backhaul infrastructure, and then rollout services. A longer time lag between buying spectrum and launching services impacts return on capital. Here, they need to consider their global counterparts’ strategy. Hetal Gandhi, director, CRISIL Research, cites the example of China Mobile, which launched 4G services in 2013, barely six months after acquiring airwaves; in India, telcos took five to six years to do the same, losing valuable time.
Also, adds Gandhi, “investment in backend infrastructure will ensure the penetration of optic fibre goes up from the current level of below 50% to at least 70%”. This, she says, “is also a prerequisite for 5G services and will set the stage for an early commercial launch and a quicker payback period”.
In any case, as Gopalaiah observes, the poor balance sheets of telcos have meant that India is a couple of years behind the rest of the world in terms of 5G readiness. “A major beneficiary of 5G will be the Make in India initiative as 5G private networks can connect a million devices per sq. km [10x of what is possible using 4G] and, with its low latency, reduce downtime in factories,” says Gopalaiah. “If India can’t transition to 5G quickly it may lose out to other countries like China when it comes to manufacturing investments, and that will have a much larger impact on the economy.”
Nobody wants that. Not the companies, not the government. And this commonality of purpose is keeping hope afloat.
(Ashish Gupta contributed to this story.)
(This story was originally published in the March 2020 issue of the magazine.)