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Regulatory risks versus pricing power. Concerns about potential negative regulatory
developments on spectrum-related issues (pricing, refarming) and roaming charges have
resurfaced recently. Success in recent tariff hike experiments could aid the industry,
especially the incumbents in neutralizing the impact of regulatory developments
through further price hikes. Eventual outcome would depend on the competitive
response from challengers (relatively better-off on the regulatory front). We believe the
incumbents are in a sweet spot on pricing and remain positive on Bharti and Idea.
Revisiting potential regulatory headwinds
One-time excess spectrum charges and spectrum renewal charges. TRAI had made certain
recommendations on 2G spectrum pricing, which if accepted by the DoT, would be used to
determine (1) the one-time levy on operators holding more than 6.2 MHz of 2G spectrum, and
(2) spectrum fee on renewal for all operators. While noting that these are still just
recommendations and are subject to DoT’s acceptance, we estimate the total NPV hit (one-time
+ renewal) of Rs35/share for Bharti, Rs28/share for Idea, and Rs20/share for RCOM. We note
that our computations are based on TRAI’s February 2011 pricing recommendations. We see
both of these (excess spectrum charge and higher spectrum renewal charge) as near certainties;
however, the quantum could be lower than recommended by TRAI.
Spectrum refarming. TRAI had also recommended refarming of 900 MHz GSM spectrum;
refarming would involve taking back 900 MHz spectrum from operators holding such spectrum
(mostly incumbents) and issuing them similar quantity of 1,800 MHz GSM spectrum in lieu. This
has substantial capex and opex implications given the relatively inferior spectral characteristics
of 1,800 MHz spectrum. Assuming this recommendation is accepted and implemented, we
estimate an NPV hit of Rs32/share on Bharti, Rs21/share on Idea, and marginal for RCOM.
Partial/complete removal of roaming charges on home network. Recent press reports
suggest that the DoT is considering a change from the current 22-circle structure for telecom
licenses to a single pan-India license. This would mean an end of ‘outside home circle’ roaming
charges (on incoming as well as outgoing calls, data usage and outgoing SMS) as long as the
subscriber is on his service provider’s network. We believe that the move has merit as there are
very little incremental costs of access on roaming if the subscriber is in the home (same
operator’s) network. We note that roaming charges contributed 8.3% of GSM operators’ and
5% of CDMA operators’ revenues for the March 2011 quarter as per TRAI reports. Complete
abolition of roaming charges would have a negative valuation impact of Rs28/share on Bharti,
Rs12/share on Idea, and Rs7/share for RCOM (assuming implementation on April 1, 2012).
Further cut in termination rates. TRAI is in the middle of an interconnect regime review
process – a consultation paper has been floated and responses received from operators and
other industry bodies. We note that the last review of IUC charges by the TRAI in early CY2009
resulted in a 10 paise cut in termination charges to 20 paise from 30. We do note that a cut in
termination rates should theoretically be EBITDA neutral (despite being revenue-negative) for
large operators who have broadly equal termination revenues and costs. The trouble is that cuts
in termination charges typically result in off-net call rate cuts by smaller operators – this may not
be the case this time around given that smaller operators are looking at means to shore up their
financials. Nonetheless, a 5 paise cut in termination rates, if passed on, has a negative valuation
impact of Rs22/share on Bharti, Rs13/share on Idea, and Rs8/share on RCOM.
We summarize the potential regulatory headwinds and impact on Bharti, Idea and RCOM
under various probabilistic scenarios below (Exhibits 1-3). We note that the probabilities
should be looked at as a combination of event occurrence and quantum. For example, a
50% probability of one-time excess spectrum charges can be seen as a 100% chance of the
event happening at 50% of TRAI-recommended spectrum pricing levels. Our base-case
probability estimates for various events are highlighted as shaded cells in the Exhibits – we
note that our base case depicts our best guess of probability/quantum combination at this
point; our models and/or fair value target prices for these stocks do not build any impact.
Incumbents could respond to increased regulatory costs by raising tariffs further
We see a more-than-even probability of the incumbents attempting to recover the
increased costs of doing business (higher spectrum costs, potential spectrum
refarming, abolition of roaming charges, etc.) from the consumers by raising tariffs
further. Challengers’ response to such a move would be critical to the eventual outcome.
We note that challengers are in a relatively better position on the regulatory front – (1) most
of them do not have excess (>6.2 MHz GSM) spectrum and/or 900 MHz GSM spectrum, (2)
their licenses expire later than incumbents and hence PV of spectrum renewal charges is
lower as compared to incumbents, (3) roaming revenues as a % of total is lower than
incumbents, and (4) termination rate cuts make them more competitive in the market.
However, reeling under severe balance sheet stress and under pressure from their lenders
and strategic investors to improve financial performance, the challengers could continue
with their defensive stance, i.e. participate in the price hikes with the incumbents rather
than eyeing the same as a volume market share gain opportunity. We had discussed our
views on what’s driving the challengers’ defensive stance in detail in our August 29, 2011
‘The weak shall not inherit the earth’ note. A 1 paise/min higher-than-expected RPM
(assuming no impact on volumes) has a positive impact of Rs26/share on Bharti’s fair value
estimate and Rs16/share on Idea’s.
A closer look at the RPM math
Flow-through of headline tariff increases on RPM is not straightforward. There are several
components to the RPM equation. One, RPM definition divides total wireless revenues by the
total minutes carried on the network, both incoming and outgoing. Now, realization on
incoming minutes is fixed – zero for on-net and regulated Rs0.2/min for off-net. Hence,
changes to outgoing call rates have a lower impact than the headline change given that the
denominator of the RPM equation includes incoming minutes as well. Two, there are several
non-volume (voice) linked revenue streams like SMS, rentals, data, VAS etc. that do not get
impacted by headline call rate changes. We do note that operators have taken effective
price increases in SMS/rental components as well while data growth (3G led) is also RPM
accretive (increases the numerator of the RPM equation without changing the denominator).
We discuss the various components of RPM below.
Call charges (52% of revenues) – revenue realization to operators on outgoing (on-net
and off-net) and incoming (off-net) calls. Effective ‘pure call’ realization is different for
different types of calls (local, STD, ISD, on-net, off-net) and also depends on postpaid plan
structures and prepaid special tariff vouchers. These contributed to ~52% of GSM
revenues as per TRAI’s March 2011 data.
Rentals (19% of revenues) – this revenue stream comprises monthly postpaid rentals and
effective rental on prepaid connections. Effective rental on prepaid connection comes in
the form of first recharge coupons on new connections, validity recharges, special tariff
vouchers (fixed payment for lowering call rates on specific types of minutes for a specific
period), and administrative charges levied on talk-time recharges. Likely decline in gross
adds in the industry is negative for revenues from new connection FRCs. However,
operators have been increasing effective realization from STVs and administrative charges,
which should mitigate any negative impact. We also note that postpaid rentals and
prepaid STVs lower the ‘pure call’ realization on outgoing minutes by bundling free calls
and/or offering discounted tariffs.
Roaming (8% of revenues) – inter-circle roaming within India and in-roaming revenues
from international visitors to India. There could be potential downside pressure on
domestic roaming rates from competitive factors and/or regulatory intervention (as
discussed earlier in the note). We do note that a change in regulation would not take this
revenues stream down to zero. Roaming premium will go away on outgoing calls, though
the subscribers would still pay base rates. Incoming roaming revenues, of course, would
go down to zero. We also note that roaming charges would still remain applicable
if the subscriber moves out of the home network to some other operator’s
network – this could make incumbents with larger coverage more attractive for
roaming subs.
SMS/data/VAS/others (21% of revenues) – as discussed earlier, all these revenue segments
are non-volume-linked and hence are RPM accretive/dilutive if absolute growth in the
segment is higher/lower than voice traffic (volume) growth. We expect SMS and VAS
revenues to grow slower than voice volumes while pure-data revenues, led by 3G, should
grow faster driving RPM accretion on a net basis.
Exhibit 4 looks at a rough break-up Bharti’s FY2012/13E revenues/RPM on the above lines.
We note that this does not reflect the way we model but can be seen as a representation of
the workings behind our RPM forecasts. For example, the roughly 1.75 paise yoy increase in
RPM modeled in our numbers for FY2013E comprises
2 paise effective incremental RPM from call charges – this is a combination of tariff hikes
(we model an effective 10% increase in per minute pure-call realizations (which drive
<5% increase in RPM – the flow-through factor we mentioned earlier) across various
types of minutes as well as a modest change in composition of minutes towards higher
yield long distance (national and international) minutes.
An effective 0.6 paise/minute decline from the ‘rentals’ component. Even as some subcomponents
of ‘rentals’ are seeing an increase (changes in STV prices and/or validity,
reduction in talk-time on recharges), we model a decline to factor in the impact of sharp
decline in gross adds for the industry. This leads to a top line dilution as revenues from
first recharges go down; we do note that reduction in gross adds is accretive at the
EBITDA level given the high cost of subs acquisition.
Decline of 0.15 paise/minute on roaming and SMS components. We have not built in the
possibility of roaming abolition.
0.5 paise/minute incremental contribution from VAS and data revenues, led by strong
growth in pure-data revenues. We do build in a decline in RPM contribution of the VAS
component.
Key areas which could drive a positive surprise on RPM would be
Better-than-expected data revenues traction.
Higher-than-assumed increase in ‘pure-call’ realizations. We note that a good portion of
the 10% increase that we have assumed for FY2013E is a flow-through effect of the
hikes already announced.
Accelerated phase-out of tariff-discounting STVs from the market – there is a lot of
activity on this front in the market, even as headline tariff increases have received the
maximum press.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Telecom
India
Regulatory risks versus pricing power. Concerns about potential negative regulatory
developments on spectrum-related issues (pricing, refarming) and roaming charges have
resurfaced recently. Success in recent tariff hike experiments could aid the industry,
especially the incumbents in neutralizing the impact of regulatory developments
through further price hikes. Eventual outcome would depend on the competitive
response from challengers (relatively better-off on the regulatory front). We believe the
incumbents are in a sweet spot on pricing and remain positive on Bharti and Idea.
Revisiting potential regulatory headwinds
One-time excess spectrum charges and spectrum renewal charges. TRAI had made certain
recommendations on 2G spectrum pricing, which if accepted by the DoT, would be used to
determine (1) the one-time levy on operators holding more than 6.2 MHz of 2G spectrum, and
(2) spectrum fee on renewal for all operators. While noting that these are still just
recommendations and are subject to DoT’s acceptance, we estimate the total NPV hit (one-time
+ renewal) of Rs35/share for Bharti, Rs28/share for Idea, and Rs20/share for RCOM. We note
that our computations are based on TRAI’s February 2011 pricing recommendations. We see
both of these (excess spectrum charge and higher spectrum renewal charge) as near certainties;
however, the quantum could be lower than recommended by TRAI.
Spectrum refarming. TRAI had also recommended refarming of 900 MHz GSM spectrum;
refarming would involve taking back 900 MHz spectrum from operators holding such spectrum
(mostly incumbents) and issuing them similar quantity of 1,800 MHz GSM spectrum in lieu. This
has substantial capex and opex implications given the relatively inferior spectral characteristics
of 1,800 MHz spectrum. Assuming this recommendation is accepted and implemented, we
estimate an NPV hit of Rs32/share on Bharti, Rs21/share on Idea, and marginal for RCOM.
Partial/complete removal of roaming charges on home network. Recent press reports
suggest that the DoT is considering a change from the current 22-circle structure for telecom
licenses to a single pan-India license. This would mean an end of ‘outside home circle’ roaming
charges (on incoming as well as outgoing calls, data usage and outgoing SMS) as long as the
subscriber is on his service provider’s network. We believe that the move has merit as there are
very little incremental costs of access on roaming if the subscriber is in the home (same
operator’s) network. We note that roaming charges contributed 8.3% of GSM operators’ and
5% of CDMA operators’ revenues for the March 2011 quarter as per TRAI reports. Complete
abolition of roaming charges would have a negative valuation impact of Rs28/share on Bharti,
Rs12/share on Idea, and Rs7/share for RCOM (assuming implementation on April 1, 2012).
Further cut in termination rates. TRAI is in the middle of an interconnect regime review
process – a consultation paper has been floated and responses received from operators and
other industry bodies. We note that the last review of IUC charges by the TRAI in early CY2009
resulted in a 10 paise cut in termination charges to 20 paise from 30. We do note that a cut in
termination rates should theoretically be EBITDA neutral (despite being revenue-negative) for
large operators who have broadly equal termination revenues and costs. The trouble is that cuts
in termination charges typically result in off-net call rate cuts by smaller operators – this may not
be the case this time around given that smaller operators are looking at means to shore up their
financials. Nonetheless, a 5 paise cut in termination rates, if passed on, has a negative valuation
impact of Rs22/share on Bharti, Rs13/share on Idea, and Rs8/share on RCOM.
We summarize the potential regulatory headwinds and impact on Bharti, Idea and RCOM
under various probabilistic scenarios below (Exhibits 1-3). We note that the probabilities
should be looked at as a combination of event occurrence and quantum. For example, a
50% probability of one-time excess spectrum charges can be seen as a 100% chance of the
event happening at 50% of TRAI-recommended spectrum pricing levels. Our base-case
probability estimates for various events are highlighted as shaded cells in the Exhibits – we
note that our base case depicts our best guess of probability/quantum combination at this
point; our models and/or fair value target prices for these stocks do not build any impact.
Incumbents could respond to increased regulatory costs by raising tariffs further
We see a more-than-even probability of the incumbents attempting to recover the
increased costs of doing business (higher spectrum costs, potential spectrum
refarming, abolition of roaming charges, etc.) from the consumers by raising tariffs
further. Challengers’ response to such a move would be critical to the eventual outcome.
We note that challengers are in a relatively better position on the regulatory front – (1) most
of them do not have excess (>6.2 MHz GSM) spectrum and/or 900 MHz GSM spectrum, (2)
their licenses expire later than incumbents and hence PV of spectrum renewal charges is
lower as compared to incumbents, (3) roaming revenues as a % of total is lower than
incumbents, and (4) termination rate cuts make them more competitive in the market.
However, reeling under severe balance sheet stress and under pressure from their lenders
and strategic investors to improve financial performance, the challengers could continue
with their defensive stance, i.e. participate in the price hikes with the incumbents rather
than eyeing the same as a volume market share gain opportunity. We had discussed our
views on what’s driving the challengers’ defensive stance in detail in our August 29, 2011
‘The weak shall not inherit the earth’ note. A 1 paise/min higher-than-expected RPM
(assuming no impact on volumes) has a positive impact of Rs26/share on Bharti’s fair value
estimate and Rs16/share on Idea’s.
A closer look at the RPM math
Flow-through of headline tariff increases on RPM is not straightforward. There are several
components to the RPM equation. One, RPM definition divides total wireless revenues by the
total minutes carried on the network, both incoming and outgoing. Now, realization on
incoming minutes is fixed – zero for on-net and regulated Rs0.2/min for off-net. Hence,
changes to outgoing call rates have a lower impact than the headline change given that the
denominator of the RPM equation includes incoming minutes as well. Two, there are several
non-volume (voice) linked revenue streams like SMS, rentals, data, VAS etc. that do not get
impacted by headline call rate changes. We do note that operators have taken effective
price increases in SMS/rental components as well while data growth (3G led) is also RPM
accretive (increases the numerator of the RPM equation without changing the denominator).
We discuss the various components of RPM below.
Call charges (52% of revenues) – revenue realization to operators on outgoing (on-net
and off-net) and incoming (off-net) calls. Effective ‘pure call’ realization is different for
different types of calls (local, STD, ISD, on-net, off-net) and also depends on postpaid plan
structures and prepaid special tariff vouchers. These contributed to ~52% of GSM
revenues as per TRAI’s March 2011 data.
Rentals (19% of revenues) – this revenue stream comprises monthly postpaid rentals and
effective rental on prepaid connections. Effective rental on prepaid connection comes in
the form of first recharge coupons on new connections, validity recharges, special tariff
vouchers (fixed payment for lowering call rates on specific types of minutes for a specific
period), and administrative charges levied on talk-time recharges. Likely decline in gross
adds in the industry is negative for revenues from new connection FRCs. However,
operators have been increasing effective realization from STVs and administrative charges,
which should mitigate any negative impact. We also note that postpaid rentals and
prepaid STVs lower the ‘pure call’ realization on outgoing minutes by bundling free calls
and/or offering discounted tariffs.
Roaming (8% of revenues) – inter-circle roaming within India and in-roaming revenues
from international visitors to India. There could be potential downside pressure on
domestic roaming rates from competitive factors and/or regulatory intervention (as
discussed earlier in the note). We do note that a change in regulation would not take this
revenues stream down to zero. Roaming premium will go away on outgoing calls, though
the subscribers would still pay base rates. Incoming roaming revenues, of course, would
go down to zero. We also note that roaming charges would still remain applicable
if the subscriber moves out of the home network to some other operator’s
network – this could make incumbents with larger coverage more attractive for
roaming subs.
SMS/data/VAS/others (21% of revenues) – as discussed earlier, all these revenue segments
are non-volume-linked and hence are RPM accretive/dilutive if absolute growth in the
segment is higher/lower than voice traffic (volume) growth. We expect SMS and VAS
revenues to grow slower than voice volumes while pure-data revenues, led by 3G, should
grow faster driving RPM accretion on a net basis.
Exhibit 4 looks at a rough break-up Bharti’s FY2012/13E revenues/RPM on the above lines.
We note that this does not reflect the way we model but can be seen as a representation of
the workings behind our RPM forecasts. For example, the roughly 1.75 paise yoy increase in
RPM modeled in our numbers for FY2013E comprises
2 paise effective incremental RPM from call charges – this is a combination of tariff hikes
(we model an effective 10% increase in per minute pure-call realizations (which drive
<5% increase in RPM – the flow-through factor we mentioned earlier) across various
types of minutes as well as a modest change in composition of minutes towards higher
yield long distance (national and international) minutes.
An effective 0.6 paise/minute decline from the ‘rentals’ component. Even as some subcomponents
of ‘rentals’ are seeing an increase (changes in STV prices and/or validity,
reduction in talk-time on recharges), we model a decline to factor in the impact of sharp
decline in gross adds for the industry. This leads to a top line dilution as revenues from
first recharges go down; we do note that reduction in gross adds is accretive at the
EBITDA level given the high cost of subs acquisition.
Decline of 0.15 paise/minute on roaming and SMS components. We have not built in the
possibility of roaming abolition.
0.5 paise/minute incremental contribution from VAS and data revenues, led by strong
growth in pure-data revenues. We do build in a decline in RPM contribution of the VAS
component.
Key areas which could drive a positive surprise on RPM would be
Better-than-expected data revenues traction.
Higher-than-assumed increase in ‘pure-call’ realizations. We note that a good portion of
the 10% increase that we have assumed for FY2013E is a flow-through effect of the
hikes already announced.
Accelerated phase-out of tariff-discounting STVs from the market – there is a lot of
activity on this front in the market, even as headline tariff increases have received the
maximum press.
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