Telecom: Changing gear

SPECIAL REPORT

Telecom scrips have been rallying along with the buoyant stock markets. But a look at individual scrips reveals that not all have the potential to maintain the momentum.

Among the three listed players - Bharti Tele-Ventures, VSNL and MTNL - Bharti gained the most over the last one year, posting a 556 per cent rise in its stock price to its current levels of Rs 142.85.

VSNL gained 75 per cent and is now hovering around Rs 188.5. MTNL gained the least - a 45 per cent increase to Rs 136.45. With the much-needed reforms in the sector now finally on their way, which one of them will shine in future?

According to analysts, Bharti is the clear winner. "Bharti's growth is looking robust and should be viewed at a 12-15 month horizon," says an analyst with a domestic brokerage.

He expects current prices to sustain and says that concerns about Reliance Infocomm stealing Bharti's market share are unfounded.

"Reliance is actually helping expand the market rather than grabbing share," he says. "VSNL," says Anant Katare, telecom analyst with Khandwala Securities, "is slated to see some gains through traffic improvement but MTNL remains a concern."

Katare expects the sector to underperform the broad market going forward. "There are no major triggers in the industry and the reforms underway are not likely to benefit the listed players except Bharti," he explains. With no significant price appreciation slated for MTNL and VSNL, Bharti is hogging the limelight for now.

If telecom is shining less than brightly, one reason is the fact that the sector is under-represented in the stock markets, with only three major players being among the listed.

However, since the industry is growing at a lightning speed, it is only fair to expect the entry of major players into the market.

The market expects a spate of public issues over the next two years, with Reliance Infocomm's public issue slated for later this year. The issue amount is expected to be around a whopping Rs 5,000 crore.

The country's largest basic services provider, BSNL, is also expected to come up with a public issue of Rs 5,000 crore. Also expected to enter the market is Hutchison Max, which is expected to raise Rs 700 crore.

Though Tata Teleservices is not looking at an issue currently, Idea Cellular - in which the Tatas are major partners - is expected to be out with an issue aggregating Rs 650 crore.

THE RESURRECTION
The main reason for this heightened interest in telecoms is the new optimism in the sector following the speeding up of reforms.

The first booster shot came in the form of the unified licensing regime, which has ended the mobility Vs limited mobility (WLL) controversy, paving the way for explosive growth in the sector through market expansion, lower tariffs and better technology and applications.

The increasing subscriber base and ever expanding penetration levels point to boom times. A closer look at the stats reveals the reasons behind the optimism.

According to a study by Federation of Indian Chambers of Commerce and Industry (FICCI), the Indian telecom market has grown at 14 per cent compounded annual growth rate (CAGR) over the last five years to reach a size of Rs 38,250 crore and the growth is likely to continue steadily, resulting in revenues of about Rs 58,500 crore by 2007.

The cellular subscriber base has increased by 110 per cent over an year to 21.9 million in December 2003, according to data compiled by the Cellular Operators Association of India (COAI).

Research consultancy Gartner predicts that 2004 will see mobile phone connections overtaking fixed phone subscribers in India.

Says Gartner: "Cellular penetration will nearly double during the year. Cellular penetration in India stood at 2.7 per cent at the end of 2003 and is predicted to increase to about 5.2 per cent by the end of 2004. Provisional forecasts suggest that cellular connections will reach 56 million by the end of 2004, representing 96 per cent growth compared with 2003." For a longer-term, Crisil Ratings forecasts a 100 million subscriber base in 2007-08.

Analysts see a close parallel between the growth in the personal automobiles market and cellphones. One assumption is that the minimum base for telephone ownership is the size of vehicle ownership in the country, currently estimated at around 645 million.

As against this, the fixed-line subscriber base is around 41.26 million (four per cent penetration) and wireless customers add up to around 28.18 million (2.7 per cent penetration).

UNIFIED LICENSING
Unified licensing has created a level-playing field for all mobile and basic services operators. The regulation essentially means that all basic or WLL players will now be able to provide mobility services like GSM operators and like-wise all GSM operators will be able to enter the arena of fixed lines.

The implementation of unified licensing will remove restrictions on the kind of technology that can be used to offer wireless telephony services.

Opportunities are immense in terms of expanding businesses, technological flexibility and economies of scale. But being a part of the levelled field constitutes an entry charge.

By paying an additional entry fee, basic or land-line operators who are currently offering WLL services can make themselves eligible to offer mobile services.

The entry fee is set as the difference between the winning bids for the fourth cellular licence and the entry fee for fixed-line operators.

Cellular operators will be automatically eligible for a unified licence without paying any additional entry fee as their cellular licence would entitle them to offer basic or WLL services. Here, Bharti is planning to offer fixed-line services in select pockets which could provide its business an additional boost.

In the WLL segment, the additional entry fee is about Rs 1,500 crore (including penal interest from the date of signing the agreement) for Reliance Infocomm and Rs 500 crore for Tata Teleservices. Both the operators have already shifted to the new licence regime by paying the entry fee.

WHO GAINS, WHO LOSES
The unified licensing regime clearly demarcates the prospective losers and those who will remain in the race. The winners so far are the ones who will leverage their existing economies of scale to provide competition to smaller, niche players.

"The move towards unified licensing will force operators to re-examine their macro strategies on a continuous basis," says Sheriar Irani, associate vice president with IDBI Capital.

Smaller players like Shyam Telelink, Spice, Escotel, Hexacom, RPG Cellular and Aircell run the risk of competitive pressures as they have a limited service bouquet, capacity to invest and economies of scale. " The only way out for them is to sell out," reiterates Irani.

Other threats for these players include technological obsolescence since they will be unable to make huge investments on infrastructure with their limited revenue bases. Bigger players also have the capacity to crowd out other operators.

The unified licensing regime thus clearly paves the way for future mergers and acquisitions coupled with competitive prices for subscribers. Industry sources feel that a sharp cut in tariffs is unviable for small operators.

Companies thus have to target high-end users to increase their rate of return and lower the pay-back period in an investment-driven sector. Currently, borrowings by telecom companies are in excess of Rs 14,000 crore.

The Gartner report thus concludes that only "...four cellular groups will survive and thrive through 2004: Bharti, Reliance, Tata and BSNL... and other operators will survive as niche market players, or be absorbed through mergers and acquisitions."

CALL CHARGES
Another change that will affect the fortunes of various players is tariffs. There is now fairly widespread agreement that call charges will not fall too much from current levels. Local rates are expected to settle at current levels, with no increases or decreases expected in the near term.

National long distance (NLD/STD) calls will, on the other hand, witness a correction due to changes in interconnect charges from February 1, 2004. This is expected to increase cell-to-cell NLD/STD charges whereas fixed-to-fixed charges will come down. This is because the access deficit charge (ACD) was earlier levied only on calls originating from fixed lines but now ACD will be levied on cellular/WLL telephones also.

This means both Reliance and Bharti will increase their STD call rates that are currently lower than others in the industry. However, this move is not expected to impact their revenues much in the long run though the immediate impact is negative.

"As their subscriber base widens, the impact will eventually wea-off," says one analyst. As for ISD calls, there is still some potential for a downslide. From the current Rs 9 per minute, analysts expect the levels of Rs 6-7 over the year.

Given below are main strengths and weaknesses of major telecom players:

Reliance Infocomm
The biggest gainer from unified licensing, according to analysts, is Reliance Infocomm. The company has been very aggressive in reaching out to subscribers with very competitive tariffs.

The company has the advantage of deep pockets - it has the capacity to make the huge infrastructural investments required in the field.

Another skill the company has is that of reaching out to the remotest customer - it scores in terms of geographical coverage. One of the biggest competitive advantages the company has is that it has managed to buy equipment at prices that are about 50 per cent lower than other operators.

The migration to unified license regime will also enable the company to tap high value customers who preferred to stick with GSM services due to the roaming and other value-added services offered by them.

Bharti Tele-Ventures
The company already has a good reach, a favourable mix of services and the requisite profitability. It has applied for fixed-line licences in several circles.

"Bharti's high operating leverage and proven ability to manage costs mean that the growth in its earnings will outpace the topline," says Rahul Singh, telecom analyst with SSKI Securities.

Analysts are also considering a huge upside in Bharti's subscriber base with consolidation. Singh also estimates Bharti's market share in incremental subscribers at 20 per cent based on current trends.

Analysts also believe that Bharti will not have to pay extra licence fees to migrate to the unified licensing regime in the circles where it now offers fixed line services since it also operates cellular services in all these circles.

BSNL
The largest basic telecom service provider in India should now use its position to advantage. The geographical reach that the company has makes it one of the strong contenders in the game.

But this obviously requires some serious efforts to bring itself upto scratch in terms of operational efficiencies and customer service - not a major strength so far, given its monopoly status in many circles.

"BSNL has to get more pro-active and aggressive in its approach," says Irani. BSNL is also planning a huge investment of Rs 13,000 crore in the year 2004-05.

Tata group
The Tata telecom companies (VSNL, Tata Teleservices, and Idea Cellular) are well positioned in the game, but they will face fierce competition from the likes of Reliance and Bharti.

The best option now available to the Tata group is to merge these companies and integrate operations. Their position will depend on how successfully the integration of the three companies can be carried out.

The Tata group is said to be investing Rs 9,000 crore in Tata Teleservices over the next two years for expansion for their CDMA networks. This should enable them to get a strong foothold in areas where they operate with Reliance and Bharti.

THE LOOSE ENDS
Though it may seem that everything is settling down in the telecom sector, the key thing to watch is the pace of consolidation in the industry in the wake of the new norms for M&A - the guidelines indicate that mergers will be allowed only if there will be at least three players left in any circle after the mergers.

Moreover, there is a spectrum ceiling of 15 mhz specified for mobile companies that merge. Firms with a combined market share of over 67 per cent also cannot merge.

Whether or not consolidation will take place depends on how proposals in this regard actually clear these hurdles. The issue of increasing the FDI limit in telecom to 76 per cent is also hanging fire.

"Telecommunication has a high entry cost in terms of setting up of infrastructure, which necessitates high investments," says Irani.

What also remains is integration of licences issued in phase one (single licences to basic and cellular operators) with other telecom service licences - domestic long distance (DLD), international long distance (ILD), Internet telephony, etc.

This exercise will be carried out in phase , which is still at a preliminary stage. The roll-out obligations of basic operators will be relaxed under the unified licence regime to make them comparable to those of cellular operators. The major concession for basic operators is that performance bank guarantees will also stand reduced.