The long road to recovery

THE AIRTEL CAMPUS ON National Highway 24 in Gurgaon, near Delhi, designed by star architect Hafeez Contractor, is like an ant colony. Everyone is busy, going somewhere. Glass doors constantly swing open, capsule elevators ferry thousands of employees, and there’s the hum of all those voices. Once inside, it’s easy to figure why Airtel is India’s largest telecom company—and so highly valued.

Yet, early this year, spirits in the company sagged significantly. First came the news that Sanjay Kapoor, Bharti Airtel’s India CEO was leaving. Between FY10 and the first quarter of FY14, Airtel’s profit had plunged 72% to Rs 689 crore in the first quarter of 2014. Kapoor and his team stood helpless as competition increased to between 10 and 13 players in each circle. Companies such as Tata Docomo were dominating the price game through tariff plans like 1 paise per second. Customers enjoyed huge discounts while operators’ margins eroded. Simultaneously, the auctions for the 3G and 4G spectrums sapped cash out of the system. These vexed the industry as a whole, but Airtel, being the market leader, was affected the most. Yesterday’s icon was today’s victim—the most conspicuous example of an industry in deep crisis.

Still, no one expected Kapoor to go. After all, he had spent 15 years and was part of the top team that built Airtel. While patriarch Sunil Bharti Mittal looked for a grander, statesman kind of role, Kapoor handled the plumbing—working with regulators, battling rivals, and so on. Some said he was given a long rope and could not deliver. Others saw his exit as part of a bigger plan that Airtel has been working on.

But before diving into what next for Airtel, let’s put the record straight on Kapoor. Though it can’t be completely ruled out that performance was an issue, Kapoor’s exit has a lot to do with his own ambitions. Word is, he wanted a role similar to Manoj Kohli’s—CEO of international operations. (Kohli was, till recently, working out of Africa.) Perhaps, he was even looking for a board position, which his successor Gopal Vittal was handed. But matters got delayed, at least by two years. And Kapoor wasn’t willing to wait till 2015. “I had done the same job for 15 years. I was looking to explore new challenges and had discussed it with SBM [Sunil Bharti Mittal]. But things were not moving. So I decided to pursue my own venture,” he says. Mittal wasn’t available for comment.

When the half-yearly results for FY14 were announced in September, the gloom gave way to a few cheers. In India (Airtel also has operations in Africa, Sri Lanka, and Bangladesh), though average voice revenue per user had dipped 3% quarter on quarter, it grew 8% year on year, showing how fickle the voice business had become. The data business, though, showed a clearer trend. In the first two quarters of the current fiscal, data usage had grown by 23% to 33,630 MB; over a year, that translated to a 112% jump. Average data revenue per customer had also grown 11% between quarters and 62% over a year.

Though data realisation had dipped by 2% quarter on quarter (and 7% over a year) to approximately 30 paise, Airtel’s data strategy seemed to be working overall. Data works differently from voice. If the latter is driven only by demand (the customer’s need to talk), the former is also influenced by supply (the availability of higher bandwidth and apps). Airtel understands this and is investing heavily to create a 3G network, and partnering with application providers like VuClip.

The anxiety lingers (profit margins are still tepid), but numbers indicate that the worst might be over. Three key parameters—average revenue per minute at 36.74 paise for voice, data usage at 231 MB per subscriber, and average data revenue per user of Rs 70—show an upward trend. The company’s free cash flow stands at Rs 4,693 crore, the highest for any quarter since March 2010. Akhil Gupta, MD and deputy group CEO, Bharti Enterprises, says even though debt in absolute terms may be high, as a multiple of Ebitda, it has dropped from 2.9 to 2.6 in the past three fiscals and is currently around 2.2. “We would like it to be below 2, but even with the current numbers we are comfortable,” he says. Bankers admit that though Airtel’s debt is high, it’s still a great investment target. “The trouble is that they don’t come to us,” says the head of a large public sector bank.

“What will I do with the money? I am generating enough cash for my needs,” says Gupta. That said, Airtel has been tapping into the public debt market, which he describes as “huge, mammoth, and humungous” with different maturity periods and benefits of diverse currencies. If it raised $1.5 billion (Rs 9,406.5 crore) through overseas bonds in May, a 5% stake sale to Qatar Foundation the following month raked in $1.26 billion. SingTel also increased its stake in Airtel to 32.24%, adding $302.2 million to the coffers. While Airtel used this money to reduce its debt, it recently raised €750 million (Rs 6,363.7 crore) from European investors, which will create the corpus for the spectrum auction early next year.

Like banks, analysts see Airtel as a promising investment. Sachin Salgaonkar of Goldman Sachs India says larger players such as Airtel and Idea are benefiting faster than expected due to declining competitive intensity. “We expect them to continue to gain momentum in [their] core business,” he says. Karan Mittal of ICICI Securities adds that the improvement in operating metrics of the domestic mobility business is heartening.

Singapore-based Nomura Equity Research in a September report upgraded its recommendation on Airtel to ‘buy’ and added that there is room for pricing to improve over the medium term, even though “the management of Bharti could not offer visibility on where prices will move beyond two to three quarters”. Since January, the stock has risen 7%, compared to the Sensex’s 5.4% rise.

Yet, at Airtel’s HQ in Delhi, the mood is circumspect. Gupta, the senior-most executive who spoke to Fortune India, isn’t showing any exuberance. All he admits is that “realised rates are going up, acquisition costs are going down, and data is growing”, which makes “the story very promising”. But he adds that the industry’s troubles are far from over. In the entire conversation, he stays cautious, choosing his words very carefully.

His reticence is instinctive. Though the contemporary telecom industry was built after de-licensing, the government still plays a considerable role in directing and regulating it. And all players feel that some of the regulations mandated by the state—think tiered fees for spectrum usage where large operators like Airtel have to pay a higher revenue share for every MHz as they own more spectrum—stem from the belief that telecom companies were creating inordinate amounts of wealth, which had to be shared with the state. Thus, a dismal portrayal of the sector is better than a cheery one, lest the state target the industry again.

MEANWHILE, THE SIXTH-FLOOR corner office that Kapoor occupied has been torn down and carved into two offices—one for Gopal Vittal, an old Hindustan Unilever (HUL) hand who replaces Kapoor as the India CEO, and the other for who returns from Africa Kohli’s relocation and Vittal’s appointment is a sign of the introspection underway for the past 12 to 15 months. Kohli’s recall means Airtel will push for more local management in Africa: He’s been replaced by Christian de Faria, a local sitting in Kenya. (de Faria has substantial on-ground experience in African markets; until January, he was group commercial officer of MTN, the South African telecom biggie.)

Vittal’s appointment represents a relook at how to juice out the existing subscribers and prepare for the data slugfest. The IIM Calcutta graduate began his career at HUL in 1990 as area sales manager. He worked at Airtel between 2006 and 2008, handling marketing. He then rejoined HUL as head of the home and personal care businesses and was given a board seat. He returned to Airtel in 2012 as director in charge of special projects and international business strategy. But when Kapoor exited, Vittal was made the joint MD and CEO of India operations, with a board seat.

Sunil Bharti Mittal is keen on using Vittal’s understanding of the rural market (Vittal was responsible for Project Bharat, which incentivised consumers in rural areas to try HUL’s products). But more than that, Mittal is trying to revitalise the company’s ideas machine that was bogged down by old, tried and tested methods. Vittal is expected to clean up retail, boost data usage, and improve customer quality by weeding out high-cost, low-realisation subscribers. He seems to be playing to his brief.

As the office was being readied, Vittal was on the road, meeting dealers, resellers, and customers. He has been writing blogs and updating his team on what he hears and sees. He’s also been trying to calm employees anxious about rapid changes within the organisation. (Other than Kapoor, six senior managers quit between December 2012 and January 2013.) “He has been meeting and having coffee sessions with employees. He appears to be a down-to-earth and shy person who likes to take decisions fast,” says one manager.

Despite repeated requests, Vittal wasn’t available for an interview. People working with him say he wants to prove himself first, and then talk. “Kapoor was a people-and-operations guy, Vittal is more of a strategic thinker,” says the CEO of a handset company who has worked with both. He adds that Vittal has no choice but to play the data game aggressively and raise tariffs.

Some of Vittal’s early moves give a peek into his thinking. Within weeks of taking over, he withdrew freebies and discount coupons to keep away customers who choose Airtel only for its time-bound schemes and leave once they expire. This helped Vittal control the churn, which is down to 3.2% from 8.5% in September 2012. He also streamlined retailer commissions to clean up distribution and control frauds in SIM sales and payouts. This helped keep sales and general administration costs down. “There is still lot of headroom to improve realised rates and cut discounted minutes,” said Vittal at a quarterly results meet, referring to high investments and “unsustainable tariffs”.

On the services side, he has experimented with Re 1 video clips and zero usage charge to access certain websites and attract data users. “There has been a huge improvement in customer acquisition due to the change in vocabulary,” said Vittal at the same meet, referring to how branding and sales pitches are geared towards selling data services rather than talking about discounts and low voice tariffs.

To get a perspective on how Airtel has been experimenting with different strategies, go back to 2010. Immediately after acquiring Zain’s Africa operations and Warid Telecom in Bangladesh, Kapoor was given the mandate to churn cash in India. That meant a shift from the old approach of acquiring customers and focussing more on a higher share of the wallet. “The debt forced us to go on the defensive, we lost our aggression. We used to bat on the front foot but the leverage taken for international operations changed everything in India,” says a former senior employee privy to boardroom discussions. But the focus on cash generation led to a market share loss of nearly 1.5%. This dip spooked Mittal. He immediately changed the mandate and pushed to regain market share.

The change was seen when Airtel began implementing two structural reorganisations. First at the corporate level, by clubbing customer-facing services. Thus, mobile, broadband, DTH, or IPTV services will now report to one person instead of different business heads. Enterprise services remain as they were and will engage with large, medium, and small companies to sell a full suite of connectivity solutions. The other change is at the circle level. Instead of three hubs controlling Airtel’s 22 circles, there will be eight.

The big idea is that each hub should run as a company. The circle CEOs will report to hub CEOs, who, in turn, will report to the director of market operations for the non-enterprise businesses. This, in turn, should result in efficiencies and cost savings. Though the local strategies will still be handled at the circle level, the hub CEO will drive the strategy to sell multiple products through the same channels. This is a typical consumer goods structure where multiple products are sold by the same sales reps.

The sales force which sold only SIMs will now sell data, DTH, broadband, and mobile wallets. The objective: get a higher share of spend, as well as market share. The challenge: The system is not yet geared to sell like this. “This needs a mindset change,” says Mohinish Sinha, MD, Hay Group, a consultancy that works on similar reorganisations. Some employees feel that these reorganisations create uncertainty. “At times, as a promoter, you begin to think that’s the solution to every problem. But staffers have little choice when it’s thrust on them. Airtel has been trigger happy with regard to organisational restructuring,” says a former top exec.

Gupta sees this differently. He feels that Airtel’s ability to constantly rejig itself is a sign of strength. And the reorganisation should stem from what the business needs of the moment are, and not from dogma. Today, within Airtel, everything is up for re-examination, even strategies that were earning it accolades just a few years ago.

Gupta says Airtel has to be supremely pragmatic. “In a business like ours, we need to keep re-orienting ourselves to be competitive and profitable. Hence, we should not restrict ourselves or put a boundary on what to sell or buy,” he says, referring to reports of Airtel’s Sri Lanka operations being on the block or Loop Telecom in Mumbai being seen as a potential acquisition target. For him, this is business, and it has to make profits and create value.

Airtel has scrapped a key outsourcing contract—the 50:50 JV with Alcatel Lucent for its broadband service. Things weren’t exactly working out, and Airtel’s willingness to walk away sent a strong signal that it would not hesitate in taking things into its own hands if it felt that the partner wasn’t able to manage the show. There’s also talk that an outsourcing contract with IBM, which was once a showpiece in the telecom business, would get broken into smaller bits, where Airtel would invite other potential partners.

But, if some of this work moves in-house, Airtel will need to build its own capabilities, especially as it pushes for more revenues from data. Unlike in voice, where everything, except branding and marketing, is non-core, Airtel now needs to understand customer usage patterns. Today, such capabilities lie with firms such as Google or Facebook. They have information on their users and are now using it to up-sell products and, hence, the true data revenue flows to their account. But more than direct app or content revenue, the real money lies with advertisers. Ashish Sharma, managing director at consultancy Booz & Co says, globally, voice still remains staple for telcos but data has changed the fundamentals of the industry. “If you are not aware of the changes how will you handle it? Look at what happened to AT&T when traffic surged due to unlimited data plans on iPhone,” he adds. (Back in 2008, AT&T hadn’t anticipated the huge increase in traffic when the iPhone was launched. As a result, its networks got clogged.)

Airtel perhaps knows what is coming and is getting ready. It has built a super network operating centre at Manesar, Gurgaon. From the centre, it can monitor who is consuming how much data, for how long the connection is active, on which device, the content being accessed, and the issues the consumer is facing. In a way, Airtel can control the device itself, if it wants.

THERE'S AN ASSESSMENT WITHIN Airtel that it misjudged Africa. For many who have left Airtel, Africa is a bet gone wrong, and for those who are still there, they say things are improving. The company, however, has been bold enough to acknowledge that its assessment of Africa was way off the mark. Africa generated some very ambitious but impractical expectations. “We are on track,” says Gupta. “The market already generates significant amount of operating free cash flow for us. It is only a matter of time that it will become self-sustainable. Going forward, we expect steady growth, since data growth there is very strong.” To drive home his point, he highlights the consolidation moves made by Airtel through in-country acquisitions. In April, it acquired Warid Group’s Uganda operations and in November it entered into a “definitive agreement” to acquire its Congo operations.

Even Kohli, who was confident about getting the numbers till a year ago, has moderated his statements. “Africa has been a tough market and growth has not been as expected. We are going through the same pain as any MNC would experience in any new market,” he says. He knows that to show profits he has to be No. 1 in any market. The good news is that there are 10 markets where Airtel is numero uno. The bad news: These markets are too small to have any real impact on the balance sheet. In the two big markets (Kenya and Nigeria) which can influence results, Airtel is No. 2 and No. 3, respectively.

Airtel misjudged the environment, particularly sociopolitical conditions, which are very fluid. Political moves like the declaration of emergency (as in parts of Nigeria) or changes in KYC norms can shut out millions of customers overnight. Add to this the uncertainty over interconnectivity charges: In the absence of a good backhaul in the continent, Airtel is still dependent on other operators to carry its traffic.

It hadn’t factored in operational issues early on. Unlike India, diesel is costlier in Africa and given the absence of grid power in remote areas, sites use gensets. Pilferage of diesel is also a problem. Airtel execs responsible for network expansion say that at times even entire towers are stolen.

“The $10.7 billion that Mittal paid was a bonanza for the Kuwaiti owners as they got to exit. Docomo had refused to move beyond $8 billion for the same countries,” says an Airtel official in the know. “How would you handle employees who go on stress leave if you ask them to work?”

Gupta, with the benefit of hindsight, says, from day one they knew that Indian strategies would not work in Africa. “People expected that we would somehow do the same magic [as in India]. We knew it could not happen. Business models, in terms of getting economies of scale and volume benefits, sure, but to say that we would halve the rate does not work there. The cost structures are completely different.”

He believes that while Africa will not show net profits before next year, this year (FY14) it’ll start generating free cash flows. “Africa will become self sustaining and will take care of its own interest, taxes, and capex. Will it be a runaway bride in terms of growth? I do not think so,” says Gupta.