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Telecom
India
3G—value creation challenging. Value accretion from 3G, in light of the stiff price
paid for 3G spectrum, demands what in our view is an ‘improbable trinity’ – reasonable
penetration AT good incremental revenue per user WHILE keeping incremental capex
low. We are believers in the data growth potential in India; however, we struggle to
build a positive NPV case for a (theoretical) pan-India 3G player despite building in the
most benign assumptions. Remain Cautious on the sector.
A closer look at the improbable trinity that value creation from 3G demands
Our analysis of 3G economics for a (theoretical) pan-India 3G operator suggests that value
accretion from 3G investments demands – (1) reasonable 3G penetration at (2) good incremental
ARPU while (3) keeping incremental capex low. Exhibit 1 on the next page of the note depicts our
analysis. We have essentially tried to assess the subscriber base – incremental ARPU combination
required at varying scale of 3G rollout to generate value (ROIC > 12%) from 3G investments. Our
analysis for various scale levels is as below
For a small-scale 3G rollout (10,000 cell sites pan-India, barely enough to cover the top-10
cities), an operator would need 5 mn subs at incremental ARPU of Rs1,251/month.
A mid-scale rollout (40,000 cell sites, possibly sufficient to cover the top 150-200 cities)
demands 18 mn 3G subs at an incremental ARPU of Rs396/month.
A large-scale rollout (70,000 cell sites, Bharti has ~114,000 2G cell sites today) demands 28 mn
subs at an incremental ARPU of Rs264/month.
Note that our analysis is for one operator – one needs to multiply the required subs base by 4 to
assess the industry-wide value-accretion requirement. Of course, this assumes equal market share
for all, which may not be the case and it can be argued that there exists an opportunity for the
market share leader(s) to create value. However, market leadership would come from higher scale
of cell-sites given that we have already assumed, what in our view, should be the maximum subs
supported per cell site without compromising on 3G user experience – and a compromise on user
experience would not let one remain the market share leader for too long. In that light, the fact
that value accretion looks challenging even at the highest scale in our scenario analysis clearly
suggests that 3G value accretion may not even be a market share game. We emphasize that the
assumptions built into our analysis are reasonably benign –
Target ROIC of 12% (clearly a low hurdle rate for someone like Bharti, if not others).
Fully-loaded incremental capex per site of US$35,000 for a small-scale rollout (10,000 sites)
progressively going down to US$25,000 for a large-scale rollout (70,000 sites). This implies a
total incremental capex of US$350 mn for a 10,000-site network and US$1.75 bn for a 70,000
cell-site network – very benign, in our view.
Incremental EBITDA margin of 50% for a small rollout case progressively going up to 60% for a
large rollout case.
500 users per cell site for a small rollout case, progressively declining to 400 for a large rollout
one. We believe user experience would suffer beyond these levels. Also, anecdotally, our
discussion with EVDO operators seems to corroborate the view.
Tax rate of 20%.
Upside to our scenarios improbable, in our view
Upside to the scenarios we have built in can come in three ways
Higher number of users per cell site. Possible, but has two issues – (1) 3G data
bandwidth for users sharing the same cell site is a shared resource. Hence, higher the
number of users per cell site, lower the available bandwidth per user. This has
implications for user experience and may kill the case for 3G data premium, in the minds
of the users, and (2) Bharti, the most efficient operator in India has ~1,350 2G users per
cell site – now the numbers we have used in our scenarios (400-500 3G users per cell site)
are 30-37% of 2G users per cell site – we do not see the possibility of a higher 3G
penetration. Of course, an operator can increase the capacity per cell site through
network upgrades from WCDMA to HSDPA to HSPA – 3G cell sites can be configured for
a capacity ranging from 3.6 mbps to 21 mbps. However, this has capex implications and
may not change the ROIC math much.
Higher incremental revenues per 3G user. Higher data usage is possible but again, this
has two issues – (1) data appetite and ability to pay – an average iPhone user in the US
today uses 400-500 MB data per month. Current 3G plans in the market imply a blended
price/MB of Rs0.5-0.6. Even assuming a similar usage in India, this would imply an
incremental ARPU of Rs200-240, lower than the incremental ARPU ask-rate even in the
large-scale rollout scenario. Essentially, this means that 110+ mn users in India use more
data than an average iPhone user in the US today – an unlikely scenario, in our view. Also,
we expect 3G price/MB to come down in India over time, and (2) higher incremental
revenues can presumably come only from higher usage and not higher unit price – this
again would pose capacity challenges at the access as well as backhaul layers and has
capex implications.
Higher incremental margins – companies have suggested incremental margins higher
than our assumption of 50-60%. However, we note that our margin assumptions are
closely tied with our capex assumptions – we do not include meaningful fiber build-outs
in our capex numbers and hence assume backhaul leasing costs in our EBITDA margin
assumptions. In any case, incremental regulatory fee, incremental S&M, and nonbackhaul
incremental network expenses could total up to 25-30% of incremental
revenues.
3G (or in general data usage uptick) does offer growth but not accelerated
growth for the industry
We now look at the revenue growth upside potential from a data usage uptick in India. Pure
data revenues (non-SMS, non-ring tone, non-IVR) contributes to only about 2.5-3% of
India’s current wireless revenues base of US$27 bn per annum, in our view – a US$700-800
mn market. Data usage uptick will happen at two levels
Small-screen – smart phones and feature phones. Even assuming a 3G small-screen
subs base of 120 mn (10% overall pop penetration, ~15% of unique wireless subs) and
an incremental ARPU of US$3 per month per 3G sub in 5 years, incremental revenues for
the industry work out to a little over US$4.3 bn. We believe that our 120 mn 3G subs
base assumption is reasonable and the ARPU assumption of US$3 may be on the
aggressive side. The top-173 cities in India have a total population of 215 mn. Hence, a
120 mn 3G subs base can be seen as a ~55% penetration in the top-173 cities or a 35%
penetration in top-173 cities + a 5% penetration in the rest of India. Higher penetration is
possible but would come at the expense of ARPU and may not change the overall
revenue upside, in our view.
Large-screen. This is a market difficult to forecast, given the very low levels of PC and
broadband penetration in India today. India’s BB penetration is still <1% (~11 mn BB
subs). Also, unlike the small-screen market which is likely to be dominated by the 3G
players, the large screen market will have many competing technologies including DSL,
cable, fiber, 3G, EVDO, Wimax and LTE. Assuming large screen subs market expands 4X
in 5 years to 44 mn subs, with an ARPU of US$12 per month, one is looking at ~US$6.3
bn market, or an incremental US$3.7 bn revenues (over the current base of US$2.6 bn,
implying an ARPU of a little less than US$20 per month). Assuming various wireless
technologies (3G, EVDO, Wimax, and LTE) capture 75% of the incremental large screen
market, one is looking at incremental revenues of US$2.8 bn for the wireless industry.
So, there is US$7.1 bn incremental data revenue potential for the wireless industry over the
next five years. This would translate into a cumulative growth of 26.3% on the current
revenue base of US$27 bn, or a 4.8% kicker to industry 5-year revenue CAGR (see Exhibit 2
below). There is some, though not much, growth left in the industry’s voice revenue pie and
some kicker is possible from incremental 2G data and VAS usage as well. Nonetheless (1) all
put together, wireless industry revenues are unlikely to grow faster than a high single-digit
CAGR over the next five years, and (2) there would be new players like Reliance Industries
eyeing the data opportunity, especially on the large-screen side. Hence, all the growth may
not accrue to the current wireless industry players.
We also note that our current revenue estimates for Bharti and Idea imply a 5-year (organic)
India wireless revenue CAGR of 10% and 12%, respectively. This is higher than the
expected CAGR for the industry, thus building in revenue market share gains. We also note
that the fragmented nature of 3G spectrum wins across circles would potentially lead to a
more democratic distribution of 3G revenue upside.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Telecom
India
3G—value creation challenging. Value accretion from 3G, in light of the stiff price
paid for 3G spectrum, demands what in our view is an ‘improbable trinity’ – reasonable
penetration AT good incremental revenue per user WHILE keeping incremental capex
low. We are believers in the data growth potential in India; however, we struggle to
build a positive NPV case for a (theoretical) pan-India 3G player despite building in the
most benign assumptions. Remain Cautious on the sector.
A closer look at the improbable trinity that value creation from 3G demands
Our analysis of 3G economics for a (theoretical) pan-India 3G operator suggests that value
accretion from 3G investments demands – (1) reasonable 3G penetration at (2) good incremental
ARPU while (3) keeping incremental capex low. Exhibit 1 on the next page of the note depicts our
analysis. We have essentially tried to assess the subscriber base – incremental ARPU combination
required at varying scale of 3G rollout to generate value (ROIC > 12%) from 3G investments. Our
analysis for various scale levels is as below
For a small-scale 3G rollout (10,000 cell sites pan-India, barely enough to cover the top-10
cities), an operator would need 5 mn subs at incremental ARPU of Rs1,251/month.
A mid-scale rollout (40,000 cell sites, possibly sufficient to cover the top 150-200 cities)
demands 18 mn 3G subs at an incremental ARPU of Rs396/month.
A large-scale rollout (70,000 cell sites, Bharti has ~114,000 2G cell sites today) demands 28 mn
subs at an incremental ARPU of Rs264/month.
Note that our analysis is for one operator – one needs to multiply the required subs base by 4 to
assess the industry-wide value-accretion requirement. Of course, this assumes equal market share
for all, which may not be the case and it can be argued that there exists an opportunity for the
market share leader(s) to create value. However, market leadership would come from higher scale
of cell-sites given that we have already assumed, what in our view, should be the maximum subs
supported per cell site without compromising on 3G user experience – and a compromise on user
experience would not let one remain the market share leader for too long. In that light, the fact
that value accretion looks challenging even at the highest scale in our scenario analysis clearly
suggests that 3G value accretion may not even be a market share game. We emphasize that the
assumptions built into our analysis are reasonably benign –
Target ROIC of 12% (clearly a low hurdle rate for someone like Bharti, if not others).
Fully-loaded incremental capex per site of US$35,000 for a small-scale rollout (10,000 sites)
progressively going down to US$25,000 for a large-scale rollout (70,000 sites). This implies a
total incremental capex of US$350 mn for a 10,000-site network and US$1.75 bn for a 70,000
cell-site network – very benign, in our view.
Incremental EBITDA margin of 50% for a small rollout case progressively going up to 60% for a
large rollout case.
500 users per cell site for a small rollout case, progressively declining to 400 for a large rollout
one. We believe user experience would suffer beyond these levels. Also, anecdotally, our
discussion with EVDO operators seems to corroborate the view.
Tax rate of 20%.
Upside to our scenarios improbable, in our view
Upside to the scenarios we have built in can come in three ways
Higher number of users per cell site. Possible, but has two issues – (1) 3G data
bandwidth for users sharing the same cell site is a shared resource. Hence, higher the
number of users per cell site, lower the available bandwidth per user. This has
implications for user experience and may kill the case for 3G data premium, in the minds
of the users, and (2) Bharti, the most efficient operator in India has ~1,350 2G users per
cell site – now the numbers we have used in our scenarios (400-500 3G users per cell site)
are 30-37% of 2G users per cell site – we do not see the possibility of a higher 3G
penetration. Of course, an operator can increase the capacity per cell site through
network upgrades from WCDMA to HSDPA to HSPA – 3G cell sites can be configured for
a capacity ranging from 3.6 mbps to 21 mbps. However, this has capex implications and
may not change the ROIC math much.
Higher incremental revenues per 3G user. Higher data usage is possible but again, this
has two issues – (1) data appetite and ability to pay – an average iPhone user in the US
today uses 400-500 MB data per month. Current 3G plans in the market imply a blended
price/MB of Rs0.5-0.6. Even assuming a similar usage in India, this would imply an
incremental ARPU of Rs200-240, lower than the incremental ARPU ask-rate even in the
large-scale rollout scenario. Essentially, this means that 110+ mn users in India use more
data than an average iPhone user in the US today – an unlikely scenario, in our view. Also,
we expect 3G price/MB to come down in India over time, and (2) higher incremental
revenues can presumably come only from higher usage and not higher unit price – this
again would pose capacity challenges at the access as well as backhaul layers and has
capex implications.
Higher incremental margins – companies have suggested incremental margins higher
than our assumption of 50-60%. However, we note that our margin assumptions are
closely tied with our capex assumptions – we do not include meaningful fiber build-outs
in our capex numbers and hence assume backhaul leasing costs in our EBITDA margin
assumptions. In any case, incremental regulatory fee, incremental S&M, and nonbackhaul
incremental network expenses could total up to 25-30% of incremental
revenues.
3G (or in general data usage uptick) does offer growth but not accelerated
growth for the industry
We now look at the revenue growth upside potential from a data usage uptick in India. Pure
data revenues (non-SMS, non-ring tone, non-IVR) contributes to only about 2.5-3% of
India’s current wireless revenues base of US$27 bn per annum, in our view – a US$700-800
mn market. Data usage uptick will happen at two levels
Small-screen – smart phones and feature phones. Even assuming a 3G small-screen
subs base of 120 mn (10% overall pop penetration, ~15% of unique wireless subs) and
an incremental ARPU of US$3 per month per 3G sub in 5 years, incremental revenues for
the industry work out to a little over US$4.3 bn. We believe that our 120 mn 3G subs
base assumption is reasonable and the ARPU assumption of US$3 may be on the
aggressive side. The top-173 cities in India have a total population of 215 mn. Hence, a
120 mn 3G subs base can be seen as a ~55% penetration in the top-173 cities or a 35%
penetration in top-173 cities + a 5% penetration in the rest of India. Higher penetration is
possible but would come at the expense of ARPU and may not change the overall
revenue upside, in our view.
Large-screen. This is a market difficult to forecast, given the very low levels of PC and
broadband penetration in India today. India’s BB penetration is still <1% (~11 mn BB
subs). Also, unlike the small-screen market which is likely to be dominated by the 3G
players, the large screen market will have many competing technologies including DSL,
cable, fiber, 3G, EVDO, Wimax and LTE. Assuming large screen subs market expands 4X
in 5 years to 44 mn subs, with an ARPU of US$12 per month, one is looking at ~US$6.3
bn market, or an incremental US$3.7 bn revenues (over the current base of US$2.6 bn,
implying an ARPU of a little less than US$20 per month). Assuming various wireless
technologies (3G, EVDO, Wimax, and LTE) capture 75% of the incremental large screen
market, one is looking at incremental revenues of US$2.8 bn for the wireless industry.
So, there is US$7.1 bn incremental data revenue potential for the wireless industry over the
next five years. This would translate into a cumulative growth of 26.3% on the current
revenue base of US$27 bn, or a 4.8% kicker to industry 5-year revenue CAGR (see Exhibit 2
below). There is some, though not much, growth left in the industry’s voice revenue pie and
some kicker is possible from incremental 2G data and VAS usage as well. Nonetheless (1) all
put together, wireless industry revenues are unlikely to grow faster than a high single-digit
CAGR over the next five years, and (2) there would be new players like Reliance Industries
eyeing the data opportunity, especially on the large-screen side. Hence, all the growth may
not accrue to the current wireless industry players.
We also note that our current revenue estimates for Bharti and Idea imply a 5-year (organic)
India wireless revenue CAGR of 10% and 12%, respectively. This is higher than the
expected CAGR for the industry, thus building in revenue market share gains. We also note
that the fragmented nature of 3G spectrum wins across circles would potentially lead to a
more democratic distribution of 3G revenue upside.
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