The formal merger of Vodafone India and Idea Cellular in early September 2018 created an entity of great size — Vodafone Idea Limited (VIL). VIL is today the largest service provider in the country in terms of both revenue market share and subscribers. However, in the three-way tussle that’s now taking place, it could be overtaken by Bharti Airtel or Reliance Jio Infocomm Limited (RJIL).
Looking back, the dynamics of the sector changed abruptly when RJIL launched commercial services in September 2016. At the time, there were close to a dozen mobile service providers in most circles. The average subscriber was voice-oriented. Networks were largely 2G, utilising legacy technology. RJIL’s entry changed the paradigm entirely.
In record time, it weaned away 100 million-plus subscribers. Second, it had a strong behavioural effect in turning subscribers into “data junkies”. Within a very short time, India became the world’s largest data consumer.
The incumbent service providers were dragged into a price war and were compelled to offer cheaper voice services along with heavily discounted data offerings to retain subscribers. The smaller players with less deep pockets could not sustain this and recorded losses that quickly forced them out of the market.
That led to an accelerated process of consolidation, which has culminated in the VIL mega-merger. While Vodafone India and Idea have merged, Airtel has made a string of acquisitions that have increased its market share. RJIL is in the process of closing a deal wherein it will buy the assets of the bankrupt Reliance Communications (RCOM) for a consideration of Rs 240 billion. Policy changes have also made a difference to market dynamics. In the initial stages, RJIL sustained large revenue outflows because it was not only offering free voice calls, but also paying a high interconnect usage charge (IUC) for every call that terminated outside its network. IUC favours incumbents with large subscriber bases since it is paid to the network where the call terminates. In September 2017, the Telecom Regulatory Authority of India (TRAI) announced a substantial reduction in IUC, from Re 0.14 per call to Re 0.06 per call. That made things even harder for the incumbents.
Now there are only three private players left in the game, along with government-owned Bharat Sanchar Nigam Limited (BSNL). The trio have gained market share as subscribers have migrated to their networks. According to TRAI data, as of June 2018, the merged VIL had a combined subscriber base of about 443.32 million while Airtel claimed about 344.56 million Indian subscribers and RJIL about 215.25 million. This accounts for about 88 per cent of the Indian mobile subscriber market, with BSNL contributing another 9.8 per cent.
When it comes to revenue market share, RJIL has made inroads. It has kept its promise that it would never charge for voice calls, since it utilises voice over long term evolution technology on its 4G network. The company claims to hold 22 per cent revenue market share as of June 2018, even though it accounts for only 19 per cent subscriber market share. VIL has about 32 per cent revenue market share despite holding 36 per cent of the subscriber base. Airtel holds just under 32 per cent revenue market share. It is estimated that VIL has lost 6-7 per cent revenue market share to RJIL.
Clearly, the future will be all about data and driving ARPU will be an uphill task. Data generates higher ARPU and there is a huge potential market, if we are being optimistic. There are 400-450 million Indians using smartphones and the mobile broadband base is restricted by equipment choices. There are 650-700 million subscribers who can potentially be converted into broadband users with an attendant rise in ARPU.
Targeting that market will be the preferred strategy for the three giant service providers. RJIL has major advantages on that front. First, since it has a 4G network, it does not have to service “legacy” subscribers, unlike the others. Second, the company claims that the average RJIL subscriber consumed 10.6 GB per month in the second quarter of 2018, and it carried 76 per cent of the total 4G traffic in India. In terms of usage, RJIL subscribers consume over 3.4 billion hours of video content per month, amounting to 15.4 hours of video consumption per user per month. Third, RJIL has already pushed out cheap data-capable feature phones, offering phone and data plans in bundled packages to compel 2G migrations.
In marketing terms, RJIL is already preaching to the converted and has a head start. Every subscriber is already using broadband and has easy access to content. Airtel and VIL have to persuade legacy subscribers to swap old handsets for smartphones, or for data-capable feature phones, and then persuade these users to subscribe to data plans. Apart from persuading subscribers to upgrade, these service providers must also continue to invest heavily to ensure that networks have sufficient capacity and speed to service an increasingly demanding user base. Indians love videos, movies and news channels. But delivering that content without lag to somebody on the move is quite a challenge.
According to CLSA, the merged VIL will have at least Rs 100 billion in incremental funding needs (besides debt repayment). The merged entity’s capex would be around Rs 140 billion per annum for the next two years. Airtel is likely to spend around Rs 260 billion per annum as capex in 2018-19.
RJIL is moving to create the JioFiber network, which promises to deliver fast direct-to-home (DTH) content. Apart from rolling out fibre networks in 1,100-odd cities, this entails tying up with a multitude of TV channels and other content generators. Airtel has been in the DTH game for quite a while and will, presumably, increase its focus in this area. VIL also has a presence in this space though it is less top of the mind. This is very different from the classical telecom network service provider. It involves alliances with many partners including MNCs (Netflix, Amazon Prime, HBO, Sony, Hotstar, etc.) and local houses like Balaji Telefilms.
Of course, this also means competing with pure-play DTH service providers and figuring out the mechanics and financials of the DTH business. It will be interesting to see how this particular battle pans out. Success here is existential since there is no other obvious route for creating a demand for data, and pushing data consumption is the only way to generate higher ARPUs.
The trio will obviously try to develop other revenue channels too. Digital payments are one such area. All three control payments banks and all three have pushed their banking services hard. This is a nascent sector. Payments banks cannot lend out (except to the government by buying treasuries). Their revenues come from providing services for fees and they operate on very thin margins. In the Indian context, they can be distributors for financial products such as mutual funds, but their most stable income stream is fees for managing transfers of domestic remittances.
This model has been highly successful in unbanked and underbanked regions such as sub-Saharan Africa. Vodafone, for example, has a lot of African experience with its M-pesa brand recognised across the continent. It could work in India too, given that the domestic remittance market is quite large at an estimated Rs 1.2 trillion. A rural network is crucial. Here, VIL scores since it has a large rural network. Airtel too has a fairly large rural presence. However, telecom payments banks will face competition from fintech operators and from the new India Post Payments Bank, which has a vast rural network.
In financial terms, the telecom industry is on the edge of a crisis. Falling revenues have led to losses and, of course, many telcos have shut shop. The trio of survivors all have huge debt on their balance sheets. This has not been a problem so far for RJIL, since it is a subsidiary of Reliance Industries Limited (RIL), which derives large free cash flow from its petro-refining and other businesses. RIL can leverage its own excellent financials to raise funding for its subsidiary, RJIL. It could also tap the equity market if it chooses to launch an initial public offering.
The government has recognised the debt overhang problem to some extent and tried to ease the situation by creating an easier schedule for spectrum payments. Nevertheless, there is a problem. It is hard to raise funding for investments. If there are losses, debt servicing could become an issue.
It is quite hard to make a concrete estimate of the financials of RJIL and VIL. Vodafone India was unlisted, so there is a paucity of data. RJIL is unlisted. Meanwhile, Idea Cellular has sustained serious losses in the past two financial years.
High debt is a problem for Airtel and VIL since both the entities seem to have debt levels verging on the dangerous. Airtel has an interest coverage ratio of 0.98, which is in the red zone. The consolidated balance sheet has a debt equity ratio of 1.6, which is also in the red zone.
The merger has costs, though there will also be savings as redundant staff is downsized and synergies come into play. For one thing, the company will appeal to the Telecom Disputes Settlement and Appellate Tribunal and try to reclaim Rs 72.5 billion, which it had to pay upfront to the Department of Telecommunications. The merger is also expected to generate Rs 140 billion in annual synergies, including opex synergies of Rs 84 billion. On June 30, 2018, VIL’s net debt was Rs 1,092 billion. This would drop to about Rs 920 billion after the Indus Tower sale. That is likely to be six to seven times the operating profit or earnings before interest, taxes, depreciation and amortisation (EBITDA) and it will make debt servicing difficult and leave little leeway for fresh investments. Both Vodafone and Idea recorded revenue decline in April-June 2018.
In the first quarter of 2018-19, Bharti Airtel reported net profits of Rs 973 million, down 74 per cent year on year, and consolidated revenues of Rs 200.8 billion, down 9 per cent year on year. This was after adjusting for exceptional gains of Rs 5.16 billion from a deferred tax asset in Nigeria. Minus the Africa tax gain, Airtel would have a consolidated loss of Rs 3 billion, compared to a net profit of Rs 4.06 billion last year. RJIL claimed to be making net profits of about Rs 6.12 billion in April-June 2018 and it logged higher revenues than Vodafone. It had a capex of Rs 170 billion in the quarter, which is more than what VIL is expected to spend on capex in the entire fiscal year. Most analysts reckon that RJIL is still hugely cash negative. But it is hard to clarify revenue numbers since it has schemes that include full-year subscriptions. Rating agency CRISIL estimates that the telecom sector’s EBITDA margin will contract by 150-200 basis points in 2018-19 as the price war continues. CRISIL also expects the sector’s annual revenues to shrink 6-8 per cent year on year.
Under these circumstances, VIL looks the most vulnerable of the big three. Based on December 2017 data, Motilal Oswal estimated that VIL would hold a subscriber market share of 36 per cent and a revenue market share of 42 per cent. Six months later, those numbers, particularly the revenue market share, have deteriorated a lot, with RJIL gaining ground. Moreover, VIL exceeded the merger and acquisition limits of 50 per cent subscriber share, 50 per cent revenue market share and 50 per cent of total spectrum in eight circles. This means enforced spectrum sales at the least.
The concentration limits will prevent any of the trio from gaining absolute dominance. But clearly, RJIL has an edge in this three-sided war. Airtel might be able to rely on its strong position in the DTH market and improvement in its Africa operations to buttress its efforts. VIL has a better chance as a single entity than either operator did on its own. But it will be an uphill task.