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Fragmentation has caused much pain to the Indian telecom industry. There are 10 to 12 telcos in each of the country's 22 telecom circles. As a result, tariffs are at rock bottom. The need of the hour is consolidation. But the much-awaited merger and acquisition (M&A) policy for the telecom sector, which the government notified last month, has failed to excite the industry. The final guidelines, which need to be approved by the Union cabinet, have made it tougher for the bigger incumbent telcos to merge among themselves, while new entrants may not have too many exit options.
One of the key dampeners is that the buyer will have to pay a hefty amount to the government in addition to what it would pay the seller. The guidelines say if a telco is acquiring another telco which owns spectrum allotted by the government (at Rs 1,658 for all India, a huge discount to the market price), the acquirer has to pay the price difference to the government. This (all-India) spectrum is now worth at least Rs 10,000 crore. Market analysts say this will push up the cost of acquisition. "Payouts to the government could be a serious dampener for deals," says Mohammad Chowdhury, head of telecom practice, PricewaterhouseCoopers India.
Based on the market-discovered price of spectrum from the February auction, the adjusted market price for spectrum (GSM plus CDMA) of Tata Teleservices, which is reported to be a target, is estimated at over Rs 3,700 crore, in addition to its estimated debt of about Rs 26,000 crore. For Aircel, which is also a speculated target, the adjusted market price for the GSM spectrum it holds would be over Rs 4,900 crore, in addition to its debt of about Rs 22,900 crore. Debt, naturally, would be a part of all deals: the industry is sitting on a cumulative debt of more than Rs 250,000 crore, which will only increase in the coming years as many licences are due for renewal.
"The M&A guidelines may not provide full benefits of consolidation in terms of costs, especially of spectrum. The larger question is whether the so-called 'market discovered price' of the auction is a fair price for determining the differential to be paid at the time of the merger, considering that auctions were held when the telcos where under compulsion to bid aggressively for the spectrum to remain in business," says Hemant Joshi, partner, Deloitte Haskins & Sells.
Joint liabilities
The list of disappointments for the telcos who have been waiting for the policy is long. The next is the stipulation that the merged entity cannot have more than 50 per cent market share in terms of both subscribers and revenue in any of the 22 circles. While the objective is to avoid monopolies, and the restrictive practices it can give birth to, this leaves big telcos with no scope for merger between themselves. Based on data published by the Telecom Regulatory Authority of India, or Trai, the top two companies, Bharti Airtel and Vodafone India, together cross the 50 per cent cap in 15 of the 22 circles (70 per cent in Rajasthan) in terms of combined revenue, and in three circles in terms of combined subscriber base. This means they will be unable to explore any merger.
"Taking revenue as the parameter could discourage companies from going for possible mergers. Subscriber market share can be adjusted by cutting inactive customers," says Jaideep Ghosh, partner (telecom), KPMG India. That's because each telco has a long tail of inactive subscribers which can be pruned to achieve the target of 50 per cent. Revenue could be a different matter. "Companies will certainly be interested in increasing their revenue market share, instead of reducing it," Ghosh adds. However, both on subscriber and revenue market share, mergers are possible between Vodafone and Aircel, Idea Cellular and Aircel, and Reliance Communications and Aircel, where the merged entities do not cross 50 per cent market share in any of the 22 circles. (See Permutations and Combinations)
No exit
The new M&A rules limit the exit options for new entrants, and this suggests that they will need to revisit their strategy, says Rajiv Sharma, analyst with HSBC Securities and Capital Markets (India). That's because the guidelines have said that the lock-in period of three years, during which the telco cannot sell its spectrum, will hold in acquisitions too. In other words, an acquirer will have to run the acquired company as an independent entity till the lock-in gets over. Economic benefits of an acquisition flow in only after a merger. This could dampen the enthusiasm for mergers & acquisitions in the sector. "There is no justification of the lock-in period when the spectrum is bought at market determined price," according to Rajan Mathews, director general, Cellular Operators Association of India.
"The only hope for newcomers is spectrum trading but there too the recovery will be restricted to the value of the 3G spectrum with them (not enough to retire their debt)," Sharma adds. Sharma, in his analysis, also points out that the fee for spectrum that was bought at administrative price would dilute interest in new entrants as their value proposition with low-quality subscribers will not be value accretive for any potential buyer. However, he believes that the quasi-consolidation is likely to continue. The country's top three operators - Bharti Airtel, Vodafone India and Idea Cellular - have increased their revenue market share from 66 per cent to 69 per cent.
Fund constraints
Incumbent operators, in any case, will have to renew a lot of 900 MHz licences next year, while auctions of 3G spectrum and 700 MHz band are also expected to be conducted within the next few years. This will leave very little money with the debt-laden telcos to pursue acquisitions. As the government has decided to permit trading and sharing of spectrum, telcos are likely to look for those options, rather than going for outright acquisitions. While there is a fee for sharing or trading bandwidth also, it is far lower than the cost of an acquisition and a merger.
Last, but not least, the new M&A guidelines do not provide clarity on whether deals will be allowed for each circle on a standalone basis. If the government decides to permit circle-wise merger, the industry could possibly see drive circle-specific consolidation, as even the top telcos get most of revenue from just nine or ten circles.
