Voda-Idea synergy of limited use if govt policy not fixed
That an industrialist of the calibre of Kumar Mangalam Birla has been compelled to collaborate with a rival—Vodafone Plc—in the telecom business is a reflection not merely of the increasing competitive intensity in the space, but also the government’s total disregard for the health of the sector. With a 42% market share, the combined Vodafone-Idea will be better placed to fight the RJio onslaught because of synergies—estimated at $2.1bn in the fourth year—and a better balance sheet will help raise much-needed funds. But if government policy continues to bleed the sector—telcos need to keep buying spectrum to meet subscriber needs—even the merged Vodafone-Idea will find the going difficult. Compared with 11% in FY07, the government took away 32.4% of telco top line in FY17 by way of recurring licence/spectrum charges and auction costs—this goes up to an even higher 47.4% if service taxes are included.
But with the government not showing any signs it will relent, and with the tariff war only intensifying, Birla has had little choice but to throw in the towel. A prudent decision, since fighting back on his own would not only have been debilitating or even suicidal for Idea Cellular, it may have jeopardised the operations of group companies. Already, the telco is highly leveraged with a net-debt-to-ebitda at close to six times based on FY17 earnings. Indeed, Birla had planned a restructuring of his group and analysts were convinced this was aimed at allowing Idea Cellular to access cash from other firms in the stable. Even though Vodafone is a strong partner, Idea will nevertheless need to contribute its share of capital, at least a couple of billion dollars annually, not a small amount even for the deep-pocketed Birla.
The fact is that while India’s telecom market may grow from $29 billion to an estimated $38 billion (R2.6 lakh crore) at a compounded 6.6% between FY16-21, the margins are unlikely to get better even if voice revenues account for more than 50% of total revenues. Moreover, it will remain a cash-guzzling business because spectrum is unlikely to get cheaper. And while RIL may have the financial wherewithal to chase its ambitious target of a 50% plus revenue share by FY21, having already committed $25bn, Birla may not. Telecom is becoming an increasingly difficult space to operate in since it is harder to predict how technology will evolve and to what uses it can be put. The dramatic fall in tariffs after RJio’s entry has pressured revenues; industry revenues fell 3.6% sequentially in Q3FY17 on the back of a 7% y-o-y drop in ARPUs. While fringe players were the worst hit, it’s noteworthy that both Vodafone and Idea’s shares remained by and large flat. More important, the pressure persisted in the March quarter, and although RJio’s product is no longer free, tariffs may well fall further even as costs rise.
Over the medium-term, it is important to keep in mind that for Sunil Mittal, telecom is a core business and Bharti Airtel is on a strong footing with a 33% revenue market share, a 24% subscriber share and 1,489MHz of spectrum across different bands. Even though it has a leverage of 2.8 times, it is well-positioned to put up a good fight against RJio. Again, Vodafone is essentially a telecom player and the merger with Idea will help it become India’s biggest telecom player with a 42% revenue market share and 1800MHz of spectrum. For Birla, however, while the alliance with Vodafone comes as a lifeline, it might make sense to cash out at some point after the business gains in value.