TELECOM SECTOR. Telecom Sector: Trends & Outlook ICRA RATING FEATURE. Contacts: ICRA LIMITED 1

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1 TELECOM SECTOR F February 2015 Spectrum Auctions Incumbents to consolidate position; Debt metrics to deteriorate Fver Case for Payment Banks January 2015 ICRA RATING FEATURE Contacts: Sabyasach i Maju mdar sabyasach i@icraind ia.com Harsh Jagnan i harshj@icraind ia.com Mand eep Sin gh mand eep.sin ia.com Sachin Sachd eva sachin.sachd eva@icrain dia.com ICRA LIMITED 1

2 Summary Upcoming Spectrum Auctions: Incumbents face challenges, but likely to consolidate their position; Industry debt metrics to deteriorate a. A fresh round of spectrum auctions is proposed in February 2015, primarily triggered by license expiries in December 2015 and April The DoT would be auctioning sizeable spectrum across four bands i.e. 800/900/1800/2100 Mhz. The quantum of spectrum put for auction and the telcos which will be impacted by the impending license expiries, make the upcoming auction a significant event for the industry. DoT has finalised the reserve prices for three spectrum bands namely 800/900/1800 MHz, while the reserve price for 2100 MHz spectrum band is yet to be finalised. b. These auctions are to be centered around 900 MHz as the incumbent telcos (namely Bharti, Vodafone and Idea) who hold sizeable spectrum in this band would be keen to retain their existing spectrum. Any change in spectrum band would require capex for network reconfiguration. Also, this band has much higher efficiency and is better suited for providing data services. Change in 900 MHz spectrum holding significantly alters the competitive positioning and hence there is expected to be aggressive participation. c. Vodafone and Idea are the most impacted as 57% and 92% of their 900 MHz spectrum holding is due for expiry. Further, the circles of expiring spectrum contribute significantly to their revenues. Bharti on the other hand is in a relatively comfortable position given the limited quantum of spectrum which is expiring and the relatively moderate revenue contribution from the affected circles. Further, the amount of surplus spectrum it has acquired in 1800 MHz in February 2014 gives it a cushion. However, we do not expect this to moderate its particpation as it will look to regain its 900 MHz spectrum holding and possibly acquire additional spectrum. RCom is facing the expiry of its entire 900 MHz spectrum, however we expect that regaining this entire spectrum will be challenging as it will face significant competition from other telcos. d. The participation intensity would vary across circles. Telcos will face a situation wherein they may have to let go of a part/whole of 900 MHz spectrum in certain circles which are relatively less important (from revenue and market share perspective) and where they face intense competitive bidding. Another important factor is the level of spectrum crunch faced by a telco in a particular circle. ICRA analysis uses the metric of subscribers per MHz of spectrum, placing this ratio in a relative contextual position to judge the spectrum crunch (or absence thereof) faced by a telco in order to estimate the circle wise participation. e. ICRA expects the entire spectrum put for sale in 900 MHz band to be sold whereas in 1800 MHz band some circles are expected to witness muted participation. The final prices in 900 MHz are expected to be higher than the reserve price in most circles whereas the prices in 1800 MHz band are expected to remain in line with the reserve prices. The auction is expected to result in revenue of Rs. 656 bn (~Rs. 576 bn in 900 MHz and ~Rs. 80 bn in 1800 MHz) for the Government of India (GoI). The three incumbents are estimated to account for around 90% of the total value of the spectrum sold. f. With respect to 800 MHz spectrum band, DoT has approved pan India reserve price at Rs bn/mhz. This is significantly higher than the TRAI s last recommended price of Rs bn/mhz and the March 2013 spectrum auction reserve price of Rs bn/mhz. ICRA expects moderate auction participation in this band and the GoI is likley to raise Rs bn from the same. g. The 2100 MHz spectrum is also being auctioned in order to address the issue of paucity of spectrum on offer and to ease the competitive intensity for the telcos. TRAI had recommended offering 15 MHz spectrum which is proposed to be vacated by Ministry of Defence (MoD). The release of 15 Mhz spectrum by MoD is expected to take some time. Meanwhile, DoT has decided to auction the currently available 5 MHz spectrum in 17 circles. Limited quantum on offer in the upcoming auctions might result in enthusiastic participation. ICRA LIMITED 2

3 With regard to pricing, the TRAI recommended pan India reserve price is Rs bn/mhz, a reduction of 19% from Rs bn/mhz discovered in the 2010 spectrum auctions. However, the Telecom Commission has asked the TRAI to reconsider the pricing. As per the Telecom Commission view the reserve price works out to be Rs bn/mhz, 43% higher than the TRAI recommended price. ICRA expects the GoI to raise Rs bn from the 2100 MHz spectrum auction. h. Given the expected aggressive participation in the auctions the spectrum payouts for the telcos especially incumbents are likley to be sizeable. As per ICRA estimates the total spectrum payout is expected to be Rs. 900 bn Rs. 960 bn. The upfront cash inflow for GoI is exped to be Rs. 240 bn to Rs. 260 bn. The sizeable spectrum payouts would further elevate the debt levels for the industry and adversely impact the debt coverage metrics. Payments Bank extension of mobile wallet services currently being offered by telcos a. In November 2014, the RBI, issued the final guidelines for licensing of Payment Banks with the view to facilitate financial inclusion by providing small saving accounts and remittance services to a large un-banked population. Low level of financial penetration, specifically in rural and semi urban areas, and limited number of payment points (0.09 million branches & 0.11 million ATMs of commercial banks as on March 2013) in relation to the large population provide growth opportunities for a payments bank. The individuals per commercial bank branch metric for rural/semi urban areas stand at 16,729 as against 10,331 for urban/metropolitan areas. b. To be a payments bank, the key requirement would be deep retail presence with rural penetration. Telecom companies and FMCG players meet this requirement to a great extent. Given the existing services of mobile wallets being provided by telcos (Airtel Money, Vodafone m-pesa), they are expected to be meaningful players in the payment banking segment. Mobile wallets are an example of Pre-paid Payment Instruments (PPI) which facilitate purchase of goods and services, including funds transfer, against the value stored, paid in advance by the user. c. The top three telcos namely Bharti, Vodafone and Idea are well positioned to benefit if they choose to secure a payments bank license. The top three telcos have garnered a substantial rural subs base in addition to the well entrenched distribution infrastructure in rural/semi-urban geographies. In addition, these telcos have strong brand recognition in the industry which should mitigate the trust issue, a key to persuading subs to transact on the mobile banking platform. d. Operating as a payments bank would enable telcos to add interest and service income as a new revenue stream. Though the direct revenue contribution would be meagre, there are other benefits to derive such as data revenue growth, subscriber retention and strengthening of brand image. e. Telcos are likley to face challenges in terms of ability to maintain adequate liquidity at service/payments point, competition from full scale banks, ability to provide adequate and reliable service and to offer competitive interest rate to attract customers while managing the transaction costs to be profitable. Overall industry continues the upward trajectory a. The growth momentum witnessed in the telecom industry in last few quarters continues to persist. The industry has reported steady improvement in both operational and financial metrics. In the last few months, the industry reported healthy subs addition, which had been muted for more than two years. The other key metrics primarily ARPU and MoU have exhibited steady and measured growth in the last few quarters. The financial performance of the telcos also reported steady improvement with the telcos witnessing growth in revenues and improvement in profitability. ICRA LIMITED 3

4 b. During Q1FY15 average industry RPM has increased to 43.0 paisa from 41.8 paisa in Q4FY14 registering q-o-q growth of 3% and y-o-y growth of 4%. Further the total minutes have reported steady growth of ~3% q-o-q in Q1FY15. The total minutes for Q1FY15 were 1046 bn as against 1013 bn in Q4FY14. This is accompanied by growth in average Minutes of Usage too. c. The improvement in operating metrics has resulted in improvement in the financial metrics of the industry. The industry is reporting healthy growth in turnover with industry-wide Adjusted Gross Revenue (AGR) increasing by 9% q-o-q in Q1FY15 and 14% y-o-y in Q1FY15. Further breakup of revenues shows that the AGR of the four largest telcos (4LT) of the industry 1, namely Bharti, Vodafone, Idea and RCom for FY14 reported slightly better growth rates than that observed by the industry. d. As has been stated earlier the data services continue to show upward trend. The number of data subs has shown healthy growth over last few quarters, accompanied by increased data usage. The total data subs of 4LT have increased from mn in Q1FY15 to mn in Q2FY15 registering q-o-q growth of 3%. The average data usage per customer per month of 4LT has increased from 413 mb in Q1FY15 to 467 mb in Q2FY15 registering q-o-q growth of 13%. Moreover the average data realizations have also shown some stability in last few quarters as against declining retaliations in the past which should help the industry improve its profitability going forward. e. There had been some deleveraging in recent past with companies raising equity to repay debt. Idea has raised ~Rs bn through qualified institutional placement (QIP) and preferential share issue and RCom has raised equity funds through QIP and warrant issuance to promoters for a total of Rs 61.0 bn. This has resulted in deleveraging to some extent. Further the companies are trying to divest stake in noncore assets to raise funds and repay debt. The total debt of 3LT (three listed telcos namely Bharti, Idea and RCom) has declined from ~Rs bn as on March 31, 2014 to ~ Rs bn as on September 30, This coupled with gradual improvement in industry s profitability; the debt coverage indicators too have shown some improvement. However, going forward, the debt levels and debt coverage is expected to deteriorate due to the sizeable spectrum payouts. 1 Considered as indicators of the industry performance; these four players together constitute 77% of the industry active mobile subs base (June-14) and account for a 78% revenue market share ICRA LIMITED 4

5 Table of Contents A. Introduction 6 B. Upcoming Spectrum Auctions Key Industry Event; Incumbents face challenges, but likely to consolidate their position 7 1 Auction of 900/1800 MHz Spectrum Band aggressive participation in 900 MHz expected Reserve prices vs. auction determined prices in February MHz is where the action is 9 Incumbent telcos to be affected Bharti has some breathing space, Vodafone & Idea most impacted, RCom likely to lose some spectrum in MHz 1.4. Circle-wise dynamics each telco faces win some, lose some situation 11 2 DoT finalises the reserve price for 800MHz band spectrum; moderate participation expected 13 3 Telecom Commission asks TRAI to reconsider its recommendations for 2100 MHz spectrum reserve price 14 C. Payments Bank extension of mobile wallet services currently being offered by telcos 15 1 RBI unveils the guidelines for licensing of Payment Banks - telcos likely to be the major player given their existing services platform 16 2 Relatively low level of financial penetration and payment access points; telcos with deep penetration expected to provide the required platform 18 3 International Experience 19 4 The case for telecom industry not a significant contributor financially but non-monetary gains 20 D. Telecom Continuing Upward Trajectory 22 1 Subs growth continues at moderate pace with focus on revenue earning customers 22 2 Continuing trend of Industry-wide improvement in operating metrics leading to growth in revenues and improvement in profitability 22 3 Data services continue upward trajectory; average realizations show some stability 24 4 Telcos raising funds to partly deleverage their balance sheets and to prepare for the upcoming auctions and likely increase in capex 25 ICRA LIMITED 5

6 Please contact ICRA to get a copy of the full report CORPORATE OFFICE Building No. 8, 2nd Floor, Tower A, DLF Cyber City, Phase II, Gurgaon Ph: , Fax; REGISTERED OFFICE 1105, Kailash Building, 11 th Floor, 26, Kasturba Gandhi Marg, New Delhi Tel: Fax: MUMBAI Mr. L. Shivakumar Mobile: rd Floor, Electric Mansion, Appasaheb Marathe Marg, Prabhadevi, Mumbai Ph : , Fax : shivakumar@icraindia.com GURGAON Mr. Vivek Mathur Mobile: Building No. 8, 2nd Floor, Tower A, DLF Cyber City, Phase II, Gurgaon Ph: , Fax; vivek@icraindia.com CHENNAI Mr. Jayanta Chatterjee Mobile: Mr. Leander Rayen Mobile: th Floor, Karumuttu Centre, 498 Anna Salai, Nandanam, Chennai Tel: , /9659/8080 Fax: jayantac@icraindia.com leander.rayen@icramail.com KOLKATA Ms. Vinita Baid Mobile: A-10 & 11, 3rd Floor, FMC Fortuna, 234/ 3A, A.J.C. Bose Road, Kolkata Tel: / 8839, , Fax: vinita.baid@icraindia.com AHMEDABAD Mr. Animesh Bhabhalia Mobile: & 908 Sakar -II, Ellisbridge, Ahmedabad Tel: /2008/5494, Fax: animesh@icraindia.com HYDERABAD Mr. M.S.K. Aditya Mobile: , CONCOURSE, 3rd Floor, No , Ameerpet, Hyderabad Tel: , Fax: adityamsk@icraindia.com PUNE Mr. Amit Khare Mobile: A, 5th Floor, Symphony, S. No. 210, CTS 3202, Range Hills Road, Shivajinagar, Pune Tel : , /196, Fax : amit.khare@icraindia.com BANGALORE Mr. Jayanta Chatterjee Mobile: 'The Millenia', Tower B, Unit No. 1004, 10th Floor, Level 2, 12-14, 1 & 2, Murphy Road, Bangalore Tel: , Fax: jayantac@icraindia.com ICRA LIMITED 6

7 ICRA Limited An Associate of Moody's Investors Service CORPORATE OFFICE Building No. 8, 2 nd Floor, Tower A; DLF Cyber City, Phase II; Gurgaon Tel: ; Fax: info@icraindia.com, Website: REGISTERED OFFICE 1105, Kailash Building, 11 th Floor; 26 Kasturba Gandhi Marg; New Delhi Tel: ; Fax: Branches: Mumbai: Tel.: + (91 22) /53/62/74/86/87, Fax: + (91 22) Chennai: Tel + (91 44) /9659/8080, / 3293/3294, Fax + (91 44) Kolkata: Tel + (91 33) / / / , Fax + (91 33) Bangalore: Tel + (91 80) /4049 Fax + (91 80) Ahmedabad: Tel + (91 79) /5049/2008, Fax + (91 79) Hyderabad: Tel +(91 40) /7251, Fax + (91 40) Pune: Tel + (91 20) /95/96, Fax + (91 20) Copyright, 2015 ICRA Limited. All Rights Reserved. All information contained herein has been obtained by ICRA from sources believed by it to be accurate and reliable. Although reasonable care has been taken to ensure that the information herein is true, such information is provided 'as is' without any warranty of any kind, and ICRA in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness or completeness of any such information. Also, ICRA or any of its group companies, while publishing or otherwise disseminating other reports may have presented data, analyses and/or opinions that may be inconsistent with the data, analyses and/or opinions presented in this publication. All information contained herein must be construed solely as statements of opinion, and ICRA shall not be liable for any losses incurred by users from any use of this publication or its contents.. ICRA LIMITED 7