While telecom stocks have run up quite a bit, uncertainties in the form of competition, high debt, regulations remain.
Telecom stocks have moved between 12-25 per cent over the last month on reports that incumbents are best placed to take advantage of a bottoming out in competitive intensity. Though the stocks have given up some of the gains over the last couple of days, the run up was largely attributed to a Credit Suisse report that said concerns related to competition, regulation, 3G auction fee and the entry of Reliance Industries (RIL) are overdone.
While Credit Suisse has taken a positive stance on the current scenario, other brokerage houses are, however, circumspect and cautious due to stretched balance sheets, deep-pocketed players who could start a fresh round of competition and negative surprises on the 2G excess spectrum issue.
We look at the key issues that the sector faces and future prospects for the players:
Tackling leverage
Debt concerns came to the fore on the back of record 3G and BWA prices. The high licence fee outgo, according to a Morgan Stanley report, will on an average increase the net debt to levels of earnings before interest, taxes, depreciation and amortisation (Ebitda) – for Bharti, RCom and Idea Cellular – to three times in the current fiscal from half that number currently. Credit Suisse, however, believes the 3G payments will turn revenue-accretive over the medium-term. The research firm justifies the 3G price on twin counts of spectrum scarcity and upsides from higher data usage through such new products as smart phones. What worries analysts is that regulations on the one-time excess spectrum fee, if changed, could lead to further stress on balance sheets.
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Overall, analysts are of the view the debt overhang will be a concern for about two years before the companies turn free cash-flow positive. Moreover, if Idea and Bharti follow in RCom’s footsteps, or partly monetise their tower assets, their debt situation is likely to improve. Morgan Stanley estimates that Idea’s and Bharti’s tower assets could fetch $2.7 billion and $8.2 billion, respectively.
Competitive scenario
While debt is a concern, the initial downgrades for the sector started with the price war that the incumbents got into since October last year. However, Credit Suisse believes that severe price-undercutting has come to a halt (or bottomed out) with some operators even hiking tariffs and such incumbents as Bharti losing only 120 percentage points of revenue market share.
Credit Suisse believes the high 3G prices will force players to maintain profitability rather than engage in price undercutting. Morgan Stanley also says that there have been no tariff cuts over the last two quarters, but adds that once number portability is implemented over the next six months, there could be a tariff war to grab the post-paid subscriber base (10 per cent of total) since they pay 24 per cent more than pre-paid users.
IIFL, however, is of the view that the competitive scenario may ease only if there is consolidation (merger and acquisition norms make it difficult). However, with such players as RCom getting deleveraged, a stable tariff environment does not seem realistic. The entry of Reliance Industries could also skew the broadband business for players such as Bharti which, unlike CDMA players, could struggle for bandwidth.
Operational metrics & valuations
Ambit Research believes the drop in tariffs, coupled with higher subscriber growth, has led to a strong rise in network traffic in the last few quarters. The research firm believes that any reduction in traffic would have an adverse impact on an operator’s revenue growth. For the June quarter, network minutes are up eight per cent for Bharti and Idea, while they are up five per cent for RCom, quarter-on-quarter.
Margins, believes Morgan Stanley, will come down by 112 basis points sequentially for the industry due to one per cent higher licence fee to be paid to the government from April 1, 2010. On the market share front, Bharti seems to have done the best. While its subscriber market share for the March quarter is 21.8 per cent, its revenue market share is 28.5 per cent — a gap of 670 basis points. The gap for Idea is 170 basis points. However, for RCom, the gap is 270 basis points, but with more subscriber share than revenue share.
Given the recent run up, analysts advise investors to await a correction before taking an exposure, with Bharti being the favoured bet.
