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Telecom
India
Earnings power of Indian telcos – the story of a magical three-legged stool. We
expect the Indian telecom stocks to remain range-bound in the near term. News-flow
and ‘new’ hope-driven belief in improving earnings power could face reported earnings
check as 3G-related expenses start hitting the P&L from 4QFY11E onwards. In any case,
Street estimates and trading multiples already build in a fairly benign scenario, leaving
little scope for much medium-term upside. We remain Cautious on the sector.
The story of magical three-legged stool
The story is simple and goes like this – there is a three-legged stool. The stool is stable because it
has three legs. Take one away and it will fall. However, this magical stool does not fall because
when one leg is taken away, another one grows to replace it.
We believe the Street’s belief in the Indian telco’s earnings power is like the three-legged stool
We see similarities between the Street’s belief in the earnings power of the Indian telecom
companies and the magical three-legged stool. To cite an example, the ‘3G payouts are value
destructive’ opinions immediately after the auction close (May 2010) have now started turning into
‘potential value accretion from 3G (despite the payouts)’ sound bytes. We are not suggesting
against flexibility in one’s thesis and opinions, but the issue is this – a bull case for Indian telcos at
the current valuations (6.8-7.5X FY2012E EV/EBITDA, a 30-40% premium to emerging market
peers) appears to build in a lot of hope, in our view. We believe the real threat to the Indian telcos’
earnings power remains the high competitive intensity and the associated demand/supply
mismatch – we do not see this changing in a hurry.
Exhibit 1 takes a look at wireless subs, revenue, and EBITDA growth for a few players over the past
6 quarters, depicting the earnings power impairment for the industry players on account of
increase in competitive intensity.
Our thoughts on how the competitive scenario could play out over the coming quarters
Competitive intensity in the low-end voice segment remains high with the new 2G entrants (and
this includes the likes of RCOM, TTSL, and even Aircel and Idea in select circles) focusing on urban
low-end churn to gain subscribers. We expect competitive intensity in the high-end segment
of the market to increase with MNP rollout and 3G network launches. Data usage increase,
expected to usher the next phase of strong growth in the Indian telecom market, has
already attracted enough interest to keep operators honest and returns in check. One
would also do well not to ignore the large data capacity likely to be brought on board by the BWA
players (holding better-quality spectrum, in our view than 3G); Qualcomm and Infotel Broadband
(Reliance Industries) have started conducting TD-LTE trials and could roll out their data networks in
top cities as early as end-CY2011E, per press reports.
Traditional M&A - ‘M’ may not happen, ‘A’ may not be good
In addition, traditional M&A-led consolidation does not seem imminent with unfavorable
regulations and stretched balance sheets of most incumbents (a new player buying stake in an
incumbent does not consolidate the industry). We took a close look at possible M&A scenarios in
our sector note dated Dec 1, 2010 and concluded that – (1) a material merger (‘M’) may not
happen on account of regulatory and valuation challenges and (2) a material acquisition (‘A’) may
not be good for the industry as it would likely replace a weak balance sheet with a stronger one.
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