Upcoming auctions could give more pain to telecom companies

The Street seems to be ignoring the fallout of aggressive bidding, according to experts

Telecom stocks, which had outperformed the broader markets in February given the delay in RJio’s launch and expectation of a data uptick, could come under pressure in the coming quarters if the government’s assumption of higher proceeds from the latest round of spectrum auctions materialises.

The government is looking to raise $25 billion from the current round of auctions and will include spectrum from the 700 MHz band. The government expects Rs 99,000 crore from the telecom sector in FY17 and about half of this will come from upfront payments, which are 25-30 per cent of auction sales.

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Analysts at Credit Suisse say if the government achieves these numbers, it would be a significant negative for the sector. The consensus view, according to them, has not built in outflow from spectrum sales. Depending on how the companies decide to bid in the auction, it could further stretch their already stretched balance sheets, say JP Morgan analysts. After the 2015 auctions and including deferred payments, net debt to Ebitda for Bharti Airtel, Idea and RCom are pegged at 2.5, 3.3 and six times, respectively.

The other negative is the 0.5 per cent Krishi Kalyan cess on services, which would increase service tax to 15 per cent. Given the competitive nature of the space, it might be tough for telecom operators to pass on such increases to customers thereby hurting their profitability.

The key worry for the Street, then, is worsening of the operating metrics. While data growth driven by volumes continues to be strong, it is not enough to overcome the steady weakness in voice segment. While data has been supporting blended average revenue per user (Arpu), it will not be an incremental Arpu driver for an indefinite period; it may start eating into voice revenues as data gains scale. Despite the high data growth rates, voice brings in about 70 per cent of the sector’s revenues. The worsening of blended Arpu is best depicted by Bharti Airtel’s December 2015 quarter blended Arpu, which fell for the first time in 14 quarters. Both Bharti and Idea saw data realisations fall 13-17 per cent year-on-year in the December quarter.

Part of the overhang is reflected in sector valuations, which at six times enterprise value to Ebitda is at a 31 per cent discount to historical averages. Despite the undemanding valuations, analysts are not too bullish about the sector in the backdrop of these issues.