While high bids could drag telcos’ financials, 3G licence winners will get to enjoy an edge over competition.
The 3G platform allows operators to offer bandwidth-intensive applications such as video conferencing, gaming, video downloads and broadband internet. While operators have opened their wallets, is there a business case for such high bids?
| CHALLENGING TIMES AHEAD | |||
| In Rs cr | Bharti | RCom | Idea |
| Sales | 43,400 | 26,500 | 14,262 |
| Ebitda | 17,100 | 9,300 | 3,583 |
| Ebitda margin (%) | 39.50 | 35.30 | 25.10 |
| Net profit | 9,000 | 3,400 | 789 |
| Net profit margin (%) | 20.70 | 14.40 | 5.50 |
| Total capex | 13,500 | 10,515 | 3,000 |
| P/E (x) | 12.50 | 9.10 | 23.30 |
| EV/Ebitda (x) | 6.50 | 6.20 | 7.00 |
| Free cash flow | 6,300 | -1,800 | -1,759 |
| E: Analysts’ estimates | |||
| IN DEMAND | ||
| In Rs crore | Bid price | Prem. (x) over RP |
| Mumbai | 2,128 | 6.65 |
| Delhi | 2,080 | 6.50 |
| Karnataka | 1216.00 | 3.80 |
| Maharashtra | 1,105 | 3.45 |
| Andhra Pradesh | 1029.00 | 3.22 |
| All India | 12,000 | 3.43 |
| As on May 8; RP: Reserve price | ||
A pricey first-mover advantage
Experts are not surprised by such high bid prices. Frost & Sullivan’s Deputy Director (ICT Practice) Girish Trivedi says: “In a market where there is little to differentiate one service provider from another and where new offers are replicated quickly, the introduction of 3G could give some operators the competitive advantage they seek.”
Considering the demographic profile, disposable incomes and presence of high-end customers, analysts believe a 3G service, likely to be launched towards the end of the year, will be introduced initially in top 100 cities. Over the next three years, the service is expected to spread quickly, with existing subscribers upgrading to 3G.
KPMG Advisory Services Executive Director Jaideep Ghosh says: “The number of subscribers using 3G services on ‘handhelds’ may reach 40 million in 2014, with a large portion being 2G upgrades to 3G.” He believes while the average revenue per user (Arpu) for plain 3G could be Rs 350 or so, 3.5G-based services (which allow access to richer content at higher speeds) could command an Arpu of Rs 550 since the start.
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Current 2G services command monthly Arpus in the range of Rs 180 and are unlikely to move up any time soon. Considering the upgrades, Ghosh believes there is a business case for 3G and early movers (three-four operators) will clearly have the advantage. However, the costs are likely to strain companies’ balance sheets.
Cost pressures
In addition to the licence fee of Rs 12,000 crore, analysts believe the pan-India winner will also have to shell out more to pay to upgrade the base station (about Rs 12 lakh a tower) to operate at the 2.1 GHz frequency, as against the current 900 MHz and 1,800 MHz. For example, Bharti Airtel has about 1,00,000 sites. Considering that half of them are in urban locales, the bill for upgrades will be about Rs 6,000 crore ($1.3 billion).
The total cost would, hence, be in the region of Rs 18,000 crore, or $4 billion. Assuming a debt-equity of 1:1, it would result in an interest outgo of about Rs 700 crore (besides depreciation and amortisation charges).
Ghosh believes the breakeven point on this incremental 3G spend is estimated to be four-five years at best and will depend on the types of circles won and the price paid.
Funding options
Another issue for companies struggling for more spectrum, such as Bharti, is that the 3G auction will push up prices of 2G spectrum when bids are called for the latter. The Bharti management has indicated that wireless margins will be impacted to the tune of 150 basis points if spectrum fees are hiked.
For now, the news on the operational front may improve. Telcos have indicated the current rate levels are likely to stabilise, which means the fall in Arpus might not be as dramatic as was observed recently. This should help sustain cash flows.
While operators such as Bharti (free cash flow of Rs 8,000 crore for 2009-10) and Idea Cellular (cash profit of Rs 3,000 crore) will depend on existing cash flows to an extent, both will have to raise additional debt or dilute equity if they are to pay for the higher costs (including 2G and 3G plans).
Another option for raising money would be selling stakes in tower arms. These might fetch good valuations, given that tenancy ratios (number of operators per tower) are rising. If each tower is valued at Rs 70 lakh, Bharti’s 30,000 towers will fetch Rs 21,000 crore.
Listing of tower arm Indus could also free up cash, which both Bharti and Idea could use to expand existing networks. Reliance Communications, too, has lined up an initial public offering for its tower arm, Reliance Infratel.
Unlike its two larger listed players, analysts, however, believe Idea could look at bidding for key circles rather than the all-India licence to keep its debt in check.
Bearish outlook
The outcome of the 3G auction could be a game changer for the sector. The implementation of mobile number portability towards the end of the year and introduction of 3G will mean that operators unable to win the auction will have a hard time retaining high-end customers with Arpus in excess of Rs 500.
Companies that win could see their balance sheet weaken in the medium term due to auction fees and capital expenditure on upgrading their infrastructure.
Also, a larger marketing and product launch budget could keep marketing costs high.
Investors in the three listed entities are likely to see falling margins on the back of 3G haves and have-nots trying to retain customers. While most analysts are bearish on the sector, investors can take exposure to Bharti if they have an investing period of not less than two years.