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BUsiness – India;Telecom – Costly Fares

Ram Prasad Sahu

The markets have given a thumbs down to the pricing war between wireless telecom operators. The stocks of largest three listed companies—Bharti Airtel, Reliance Communications and Idea Cellular —have lost between 15-20 per cent since the price war began in early October. With the rollout of services by new entrants—Aircel and Systema Shyam—-and plans by other licence holders (Etisalat, Datacom, Telenor, Loop Telecom and S-tel) to roll out their networks going ahead and grab customers as quickly as possible, the competitive intensity will only increase.

Apart from the pricing war, while the implementation of the mobile number portability (MNP) is a looming threat, the auction of 3G license going ahead may also add pressure on the finances of telecom players.

Per minute to per second
The launch of a per second (60 paise per minute) billing by Tata DoCoMo in June as part of its nationwide rollout of its GSM network has forced another new entrant to the GSM market, Reliance Communications (Rcom) to also throw its hat into the ring. India’s second largest wireless telephony player launched ‘Simply Reliance’ plan which will charge customers 50 paise per call. Earlier, most players charged calls on a rupee per minute basis.

The price war is not restricted to the two players. All the wireless telephony service providers have launched a per second or competitive rate billing in some form across circles. While telecom services launch offers are nothing new (Rcom had offered a 90-day free talk-time facility on its GSM launch earlier this year), this is the first time that a major player has joined the fray in response to a competitor’s offer resulting in a price war that is pushing existing low fares further down. The reason, both the dual technology players Tata DoCoMo and Reliance Communications have introduced their plans, is to improve their significantly underutilised network capacity.

The impact on volumes…
Tata DoCoMo has had spectacular success in grabbing customers ever since its launch in June. For July and August the company added 28 lakh and 34 lakh new subscribers. For August, the latest month for which subscriber numbers are available, its net additions were the highest in the sector. Its market share, too, has jumped from 8.7 per cent in June to 9.4 per cent in August at the cost of all other players. The total telecom base in the country has now reached 49.4 crore with wireless subscribers at 45.6 crore, up a healthy 3.4 per cent month-on-month.

FY10E, in Rs crore Bharti Rcom Idea
Net Sales 42,271 25,688 12,847
*% change -1.4 -4.5 -1.2
Operating Profit 16,826 10,008 3,555
*% change -2.3 -6.8 -3.9
OPM (%) 40.0 39.0 27.7
Estimate change (bps) 70 90 70
Net profit 9,319 2,986 1,086
*% change -1.2 -18.0 -11.6
P/E 14.3 16.5 21.2
*Change in estimates is after the fare wars
Source:Analyst reports

On the back of robust growth at the rate of 1.5 crore subscribers every month for the sector, all the three major listed entities, Bharti, Rcom and Idea are expected to grow their subscriber numbers by 30 per cent y-o-y to 12.6 crore, 9.9 crore and 6 crore, respectively for 2009-10. Ratings agency, Fitch Ratings believes that the sector will grow at an annual rate of 25-30 per cent over the next three fiscals. While there is scope for growth with national tele-density at 42 per cent, future volumes (2010-11 and beyond) will depend on the semi-urban and rural geographies (urban penetration is pegged at 85 per cent) where penetration is low and the pace of 3G adoption by urban consumers.

…and profitability
With the latest round of fare cuts, revenues per minute (RPM) are likely to come down to about 45 paise from 58 paise in the June quarter, a fall of 28.8 per cent. Average revenues per user (ARPU), another profitability metric, is also likely to fall by 10-15 per cent believes Fitch. Considering that the operating cost per minute (CPM) for leading players is around 39 paise, there is little scope for further reduction in tariffs. Religare Hichens Harrison’s analyst, Himanshu Shah, in his report says that the existing tariffs while covering operating cost will leave little room for recovery of capex.

While companies can do little about revenue-based cost outgo such as licence fee, access charges and commissions, network costs (which account for about a third of the operating cost) remains the only component where companies can look to reduce costs. But, cost savings depend on the increase in usage. With use of multiple SIM cards by customers, the higher minutes of usage (MoUs) resulting from attractive offers is likely to get divided amongst players instead of adding substantially to the MoUs of a single player. However, it is unlikely that single-technology (GSM) players will be aggressive on the pricing front as unlike their dual technology players there is little scope for expansion in their spectrum-constrained networks. But, if they join the price war and this continues for a sustained period, expect operating profit margins for the two leading players to come down to 35-38 per cent levels from 40 per cent currently.

Two other events—3G auction and MNP –could also impact the fortunes of this sector going ahead. With the base price for 3G licences across India fixed at Rs 3,500 crore and the process likely to be completed by December this year, expect financials of the players to come under stress. Also, the process could see the competition intensifying further, if a new player is able to win the 3G license.

in Rs per share Bharti Rcom Idea
Core business 313 202 40
Tower business 60 25 19
Total 373 227 59
CMP 327.0 234.0 63.3
Difference (%) 14.06 -3.08 -7.28
The figures are sum of parts estimates as projected by analysts

The implementation of the MNP, which will allow a subscriber to switch between service providers while retaining their mobile number, could also add further pressure on existing players, in terms of lower tariffs and higher focus on quality of service in a bid to retain customers. Though MNP was to be introduced a year ago it has still not taken off. Analysts estimate that it will be implemented across the country by the first half of calendar year 2010. While MNP could result in churn, thus increasing the marketing cost of a company, analysts believe that it may not result in a major dent in the market share of existing operators.

We analyse the impact of the new tariff plans on the three major listed players.

FY10E Bharti Rcom Idea
Subscribers (nos in cr) 12.6 9.9 6.0
% change y-o-y 34.0 35.6 39.5
MoU/subscriber 481 368 412
*% change 1.8 2.8 -0.8
RPM (Rs) 0.53 0.51 0.52
*% change -3.4 -8.9 -3.4
ARPUs (Rs) 251 188 213
*% change -1.7 -6.5 -4.2
MoU=Minutes of Usage, ARPUs=Average revenues per user,
RPM=Revenues per minute * Revised post fare wars

Bharti Airtel
Thus far, India’s largest listed player has stayed away from participating in the tariff war with other players. The company already has a plan in place where it charges 50 paise per minute for calls that originate and end in its own network. So far, despite competition, Bharti has managed to maintain its net additions at 28 lakh a month for August. Its market share too is fairly steady over the last two months coming down 20 bps to 23.6 per cent.

Analysts believe that sooner than later Bharti will have to jump into the tariff game with its own plan. RPM’s currently hovering at around 58 paise are likely to trend down to about 42-45 paise by the end of 2010-11, a fall of 27 per cent. Expect margins to hover around the 40 per cent mark for 2009-10 and below the number in 2010-11 but how much will depend on cost saving Bharti can ensure on its cost base of 36 paise per minute. However, unlike other players, a major chunk of Bharti’s capex is completed and the company is best positioned in terms of cash flows and size of network to withstand competitive pressures.

While gains for the stock will be marginal over the next one year, 3G auction wins (and the price at which it does) and listing of its tower subsidiary could unlock value for the stock.

Reliance Communications
The stock price of Rcom, which was hammered down due to the fare cuts, came under further selling pressure on reports that the company under reported revenues to the telecom regulator. Service providers pay a share (up to 10 per cent) of their revenues as license fee and spectrum or access charge.

The amount that Rcom allegedly has not paid for fiscals FY06-FY08 at about Rs 300 crore is not very significant given Rcom’s cash flow, but will definitely dent its image. The stock lost 15 per cent over the last month and 5 per cent over the week. The fare war has led analysts to revise downwards their RPMs estimates for Rcom by nine per cent for 2009-10 to 51 paise; it is likely to be pushed down further as the fare war intensifies. With operating costs per minute at 44 paise (Q1, FY10), margins are likely to drop to around 37-39 per cent. Rcom has been bringing down its CPM over the years; 2008-09 CPM was at 49 paise and is now 44 paise. Considering that Bharti’s is around 36 paise, there is still scope for further cost cuts.

A positive for the Rcom’s stock has been infrastructure sharing deals it has signed recently, which will not only improve utilisation but also ensure revenues. There is little room for upside at these levels for the stock and like Bharti, the listing of tower subsidiary could bring the stock into the limelight.

Idea Cellular
Idea Cellular could be the worst affected among the three due to the fare war because it operates only in the voice segment. Furthermore, unlike Rcom or Bharti it is in the midst of a capex programme and will be hard pressed to protect its margins and at the same time ensure that it retains as well as captures as much new subscribers as possible.

The company has selectively reduced its tariff in select circles. In Mumbai for example, it is offering local calls at 40 paise per minute. The tariff cuts mean that the company’s RPM is likely to decline to 52 paise, a fall of over 3 per cent for 2009-10. The decline could be higher in 2010-11 with estimates pegging the figure at 45 paise, considering the launch of plans by new players and increasing competition from existing players. Idea’s cost base will reduce from around 42 paise per minute as its network stabilises and it is able to increase subscriber volumes.

Thus, expect operating profit margins, which are lower at 27 per cent (pure play wireless business), to slide to 22 per cent for 2009-10. Though the stock has lost 17 per cent over the last one month to Rs 62.50, a sum of parts evaluation which includes its tower business pegs the value of the stock at Rs 59.

The likely fall in RPMs due to the fare war has prompted Macquarie Research to put out a 12-month target of Rs 35 on the Idea stock.

October 20, 2009 - Posted by | Uncategorized |

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