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Investment thesis: Back to profitable growth
Strong revenue growth, driven by tariff hikes and data
We expect Bharti and Idea to report 12-20% three-year revenue CAGR for their India wireless business,
driven by price increases, minutes of usage (MoU) growth and data usage growth. Revenue growth has
started to gain momentum after hitting a bottom in 2HFY10, with revenue growing 10% across circles in
1QFY12 (Exhibits 1-2), which was prior to tariff hikes or 3G data launch. Competitive intensity is declining
and incumbents have taken a lead in raising tariffs in their stronger circles (Exhibit 9). Top 5 players, which
account for >80% of industry revenue, have raised tariffs in most of their strong circles. While subscriber
net adds have peaked and have started to decline (Exhibit 21), we believe the market is far from saturation
as rural India, which accounts for 70% of the India’s population, is still underpenetrated at 35% (Exhibits
25-26). Increase in rural penetration and MoU will provide volume growth in the medium term, in our view.
Industry losing heavily; review of industry profitability indicates that tariff war is unsustainable
We have examined the financials of most of the listed and unlisted telco companies. Our analysis shows
that the industry ex-Bharti could be making losses of USD4b-5b per annum. New entrant UNINOR (not
listed) and MTS (not listed) have already put in USD2.0b-2.2b in terms of capex and EBITDA losses (Exhibits
34-37), but their losses are still higher than revenue. Unlisted companies (such as Aircel and Tata
Teleservices) and PSU operators (MTNL and BSNL) are making significant losses despite reasonable revenue
and subscriber market share. Leading private-sector operators like Idea and RCOM are operating at low
ROEs of 4-7%. Excluding Bharti, no operator is generating double-digit ROE. Many of the new entrants are
also facing litigation in the 2G scam and they may find it difficult to get new funding for their networks. The
established operators are very unlikely to initiate fresh tariff wars, as they have already seen significant
erosion of profitability due to margin pressure and increase in leverage due to the 3G spectrum cost
(Exhibits 14-15). New entrants did enter into tariff wars, but this has had made no impact on their revenue
market share (Exhibit 31).
Tariff hikes: Trigger, extent and impact
A look at the key tariff plans of leading operators for all circles reveals that most operators have taken
tariff hikes in their stronger circles where they have several advantages like strong subscriber base, high
revenue market share and network advantage due to the 900MHz spectrum (Exhibits 16-18). These circles
account for majority of incumbent’s revenue, and most subscribers are likely to be impacted as rates have
been hiked both for per-second and per-minute subscribers. Our analysis indicates that local outgoing onnet
calls typically account for 21% of volume and 33% of revenue, and we estimate the hike in this segment
will boost revenue per minute by about 6% as all subscribers move to the new rates (Exhibits 19-20). We do
not expect government intervention given the huge losses of the industry, especially the public sector
operators.
Data in India; muted start to 3G, but we continue to see strong long-term potential
Most 3G operators launched 3G services in India in 1H11, so it is still very early to assess success or failure
of 3G. However, our interaction with the industry experts suggests that initial take-up has been muted due
to low smartphone penetration, high tariffs, limited network reach, etc. But, we see strong potential for
data, and we expect 9-11% of an operator’s 2G subscribers to adopt 3G and contribute 3-5% to revenue by
FY14. We believe once the ingredients are in place India can catch up in data just like it has done in the
case of mobile, where India was five years behind China in terms of penetration in 2005 but has caught up
in a very short time. We believe 3G will see strong uptake once handset prices decline, network availability
and quality improves, and localised content availability improves. While Indian operators continue to
refrain from giving handset subsidy, they are working on improving the quality and affordability of 3G/2G
devices with offers like Reliance Tablet and Vodafone Facebook phone (Exhibits 46-47). Operators can
reduce device prices through economies of scale and are offering reverse subsidy in terms of discounted
tariffs, which reduces the overall cost of ownership of data services for subscribers.
Revenue growth, margin expansion and declining capex to lead to strong FCF generation
We forecast EBITDA margin expansion of 1.7-2.7% for Indian telecom operators we cover over the next two
years, compared to a decline of 2.2-7.5% reported in the past two years. We believe this will be supported
by an increase of 3-5% average revenue per minute (ARPM), compared to a 23-29% ARPM decline over the
last two years. Also, we believe 3G services will become EBITDA-margin-accretive with steady margins of
over 50% for operators such as Bharti as, cash cost for 3G is not very high if we exclude the spectrum cost.
While peak capex is clearly behind for the Indian operators, capex is likely to decline further as initial 3G
expansion cost is taken care of in FY12 and as MoU moderates.
Revenue growth driven by tariff increase and MoU growth
We expect Bharti and Idea to report 12-20% revenue CAGR over the next three years on their India wireless
business, driven by increases in prices and data usage. Revenue growth is gaining momentum with strong
10% revenue growth across circles in 1QFY12, which was prior to tariff hikes. The competitive intensity is
declining and incumbents have taken the lead in raising tariffs in their stronger circles. Top 5 players,
which account for >80% of industry revenue, have raised tariffs in their strong circles.
Most operators launched their 3G services in 1HCY11. While the initial take-up of 3G has been muted, we
are bullish on data services, which we believe will be a long-term revenue driver for Indian wireless telcos.
We expect 3G data to account for 3-5% of wireless revenue by FY14.
Tariff declines have offset strong volume growth; profitable volume growth ahead
In FY10 and FY11, Indian telcos reported strong growth in mobile subscribers and traffic volume. But, this
did not translate into revenue growth due to the steep decline in revenue per minute. The competitive
intensity is declining, thus we expect net additions to fall but MoU growth to continue. This, coupled with
an increase in revenue per minute, will boost voice revenue, in our view.
Per-second billing has had a significant impact on realisation and margins
Tata DoCoMo (not listed) introduced per-second billing plan in India in 2QFY10 and RCOM launched simply
Reliance in 3QFY10. Per-second billing was replicated by all leading operators, including Bharti, Idea and
Vodafone India (not listed), in 3QFY10. These plans caused a steep decline in ARPM with Bharti and Idea
reporting a 21-25% decline in revenue per minute over the four subsequent quarters (3QFY10-2QFY11). Post
2QFY11, we have seen ARPMs stabilising and revenue growth returning to the sector. We expect revenue
per minute to start increasing as operators start reversing the process of tariff decline through selective
tariff increase.
Stronger operators take the lead in raising tariffs
Incumbents have taken the lead in raising tariffs, especially on per-second rates. While Tata Teleservices
(not listed) and RCOM tweaked their tariffs for relatively small contributors like SMS and long-distance
calling rates, Bharti took the lead in raising the local on-net calling rate, which we estimate accounts for
one-third of its GSM wireless revenue. Other large operators Vodafone, Idea, RCOM as well as Tata have
also subsequently raised tariffs in several circles.
Revenue growth gaining momentum across circles; all circles reported 10%+ growth
Industry revenue growth has started to recover, with revenue increasing 13-18% y-y in 1QFY12 in A, B, C
and metro circles. Exhibit 1 indicates that revenue growth has rebounded. This is prior to any tariff hike
and excludes any significant contribution from the recently launched 3G services. Also, we have seen strong
revenue growth of 10%+ in 21 out of the 22 circles, including metros which have more than 100%
penetration. Aside from the boost from tariff hike, we expect future revenue growth to be driven by
subscriber adds in rural India and by an increase in data revenue in urban India.
Tariff increase: trigger, extent and impact
Our analysis of tariff hikes and discussions with operators indicate that GSM incumbents have raised tariffs
in their highest revenue-generating circles (Exhibit 9). Bharti has hiked tariff by 20% in three key categories,
including on-net local calls, per-minute rate and calls to fixed-line. Our analysis indicates that on-net local
calls account for 18% of MoU but 34% of wireless revenue (Exhibit 19).
Despite 10+ operators, on-net calls account for 52% of outgoing minutes
Despite the presence of more than 10 operators in most circles, on-net minutes account for over 50% of
traffic. On-net minutes as a percentage of total minutes had been on a decline since 2HFY10, when the
competitive intensity was at its peak. However, over the last one year, on-net minutes usage has stabilised
at 52%. We see this as another sign of declining competitive intensity. This also indicates that a hike in local
on-net tariff should have a significant impact on revenue.
Per-second and per-minute tariff raised; these plans cover most subscribers
Tariffs have been hiked 20% for per-second and per-minute subscribers, which we believe represent
majority of subscribers. We believe the tariff increase will lead to a 6% increase in ARPM over the next one
year.
Incumbents raise tariffs in strong circles; among challengers RCOM has raised tariff in most, Tata in some
GSM incumbents Bharti, Idea and Vodafone have raised rates in most of their strong circles. RCOM has also
raised rates for its GSM offering in most circles. Tata DoCoMo, which introduced per-second billing, has
also raised tariff in a few circles. The table below shows tariffs for the top 3 GSM operators for their persecond
billing plans and it indicates that tariffs have been raised to 1.2 paise per second for on-net calling
in most circles.
Triggers for tariff increase, reversal of tariff increase unlikely
Tariff hike is a step in the right direction, in our view, as industry net debt is at an all-time high and
profitability at a multi-year low (Exhibits 14 and 15). The competitive intensity is declining, as most new
entrants have made only token roll outs and are facing regulatory overhang and risk of license cancellation.
Uninor and MTS, the most aggressive of the new entrants, have invested close to USD2b in capex but are
making heavy losses (Exhibits 18-22). Industry has already utilised most cost levers and operates at
amongst the lowest cost structure in the world. We believe tariff hike is a rational move and not industry
cartelisation as industry profitability is low and leverage has increased significantly.
Regulatory sound bites indicate that the government is unlikely to intervene
While there have been concerns about government intervention on tariff hike, we believe the government is
unlikely to intervene given the poor profitability of the industry. The Minister of State for Communications
and IT in a written reply to the Rajya Sabha stated that “The operators have the flexibility to fix the tariff
for mobile services depending on the market conditions and other commercial considerations subject to
the regulatory principles of non-discrimination, compliance of interconnection usage charges and nonpredation”
New entrants no concern, incumbents can differentiate on data instead of plain-vanilla tariff cuts
Operators have realised the futility of tariff cuts to gain revenue market share as other operators can
replicate tariff plans. Despite steep tariff cuts, revenue market share in the past eight quarters has
remained largely unchanged. The exceptions have been operators (Idea, Vodafone) who have launched
services in new circles. Most new entrants are facing regulatory risk and funding issues, limiting their
ability to invest in networks and to indulge in tariff wars. Profitability of all operators has been under
pressure.
Observations from our analysis of tariff plans offered by key operators
We looked at some of the popular plans of incumbents for all circles and observe that on-net tariffs have
been raised to 1.2paise/second in several circles. Validity of special vouchers as well as their price differs
significantly across operators and for same operator across circles. Operators are also offering deferred
talk time to improve stickiness especially in rural circles. Per second billing as well as per minute billing
are the most popular plans and are available from GSM operators for most circles.
Most operators have raised tariffs in their stronger circles where they have competitive advantage:
Incumbents have initiated tariff hikes in their stronger circles. These are typically circles where the
operator has among the highest revenue market share, has 900Mhz spectrum and superior network
coverage, and the circles are among the largest contributors to total revenue. The operators also have 3G
spectrum in several of these circles, which should enable them to attract high-ARPU subscribers.
Per-second billing the most popular plan, per minute plan next: Per-second billing is the most popular
plan and all major operators are offering the same in all circles. Some of the plans with rates of less than
1paise/second come with higher cost voucher and are of short duration. Per-minute plan is also being
offered by operators in most of the circles.
Validity of the special recharge voucher is also an important parameter: While the tariff and the price of
the voucher are important, there is wide variance in the validity of special vouchers. This significantly
affects total additional one-time revenue, as well as determines when subscriber migrates to higher tariff
plan.
Deferred talk time to rural subscribers to improve stickiness: Incumbents are offering plans, especially in
the predominantly rural C circles, where subscribers are offered free talk time for three-to-nine months as
long as subscribers recharge a minimum amount. For example, Bharti is offering deferred talk time to new
subscribers in Kerala, Rajasthan, Himachal etc
Significant difference in cost of vouchers across operators and across circles for same the operator: There
is no uniformity in special vouchers or rate cutters across operators or for the same operator across circles.
Most special vouchers, especially high-value vouchers, compensate the subscriber in terms of free talk
time. While this assures the operator of a minimum receivable from subscriber, this is not additional onetime
revenue.
Quantifying the Impact of tariff hike and other observations on tariff plans
To quantify the impact of change in tariffs on realized revenue per minute, we have looked at industry mix
of minutes of use based on TRAI’s performance indicator report which indicates the contribution of different
category of minutes (incoming, outgoing, local, national, roaming etc) in terms of volume as well as
revenue.
Our conclusions are:
§ Local calls account for 70% of voice revenue, on-net roughly about 1/3rd of voice revenue.
§ While SMS and national tariffs have been raised by some operator, their impact is less significant.
§ As Tariff hikes percolate down to all subscribers, we estimate there could be an impact of INR0.02 (6%)
on ARPM.
§ We see ample scope for tariff tweaking, which could provide further upside to ARPM and to our
estimates
Data: Early days, but huge potential
Most 3G operators launched 3G services in India in 1H11, so it is still early days to assess the success or
failure of 3G. However, our interactions with industry participants, including operators, network vendors,
distributors and target subscribers, indicate that the initial pick-up of 3G has been below their expectation.
However, we believe there is strong potential for 3G in India. As evidenced by the strong increase in mobile
services, we believe India can catch up quickly in terms of adoption as the building blocks in terms of
handsets, service price, content and network availability are in place. We are already seeing large number
of 3G handsets available at below USD100 price points, and Idea has recently taken the lead in reducing 3G
service price.
Operators focusing on network quality, user experience and on monetising 3G networks
Operators are focusing on improving network quality and providing a good customer experience which they
believe is essential for sustained improvement in data revenue. Given the high spectrum cost and limited
spectrum availability, operators prefer a tiered pricing structure. Operators are clearly focused on
monetising the data and are focusing on servicing high number of low-usage subscribers than filling their
network with low-yield, high-usage subscribers via unlimited plans and/or data card subscribers. Our
analysis of 3G offers across operators and across service types indicates that while 3G services were
initially launched at a premium to EVDO data card offers, 3G prices is at par with EVDO (Exhibit 40) after
Idea’s recent price cut. In terms of coverage, Idea has mentioned that it currently covers a population of
95m through its 3G services (~8% of population) and intends to raise it to 250m-300m subscribers (20-25%
of population)
3G data prices being reduced, 2G prices being raised to reduce the arbitrage
GPRS plans have been at a significant discount to 3G data plans. 2GB on GPRS monthly was available at
INR98 compared to INR675 on 3G. While operators have made the GPRS offering more expensive at
INR98/1GB, Idea has taken the lead and reduced 3G price to INR450/1.2GB. Thus, the arbitrage between 2G
and 3G is narrowing, which is likely to induce GPRS subscribers to 3G. As subscribers adopt 3G services and
experiences better speeds, the usage is likely to increase, aiding 3G ARPU.
CDMA-based EVDO data card sales indicate strong latent demand for high-speed data
EVDO data cards are doing well in India. Our discussions with the industry participants suggest that there
are already more than 5m data card subscribers in India. This is significant growth in a short time, as there
are only 12m wireline broadband connections in India. CDMA operators are losing revenue market share on
voice and are shifting their capacity towards data. We observe that the only pure-play CDMA operator,
MTS, derives 29% of its revenue from data, which is the highest among all operators. MTS’s data card
subscriber base has doubled from 0.43m to 0.82m in the last two quarters. Vodafone, the second-largest
GSM operator in the country, recently tied up with MTS to offer CDMA-based EVDO cards to its subscribers
under its brand, netcruise. Also, in view of the 3G launch, EVDO data card prices have been reduced and are
now available at less than USD25.
Impact of 3G data on revenue
We expect 3G data to contribute 1.3% of revenue in FY12 and 2.1% in FY13 for Bharti. However, the
contribution in terms of incremental revenue will be much higher at 9%. Also, as data is a high EBITDA
margin business, we expect EBITDA margin to expand as contribution of data increases.
Revenue growth + margin expansion + reducing capex intensity = strong FCF
We are modelling in EBITDA margin increase of 1.7-2.7% for Idea, Bharti and RCOM over the next two years
(vs. 2.2-7.5% decline in the last two years), driven by 3-5% ARPM increase (vs. 23-29% decline over the last
two years). Also, we expect 3G services to be EBITDA-margin-accretive with steady margins of over 50% for
operators such as Bharti, as cash cost for 3G is not very high excluding spectrum cost. While peak capex is
clearly behind for the Indian operators, we expect capex intensity to decline further as initial 3G expansion
costs have been incurred in FY12 and minutes growth are set to moderate.
A steep decline in ARPM on launch of per-second billing, along with an increase in license fees, led to a 3-
4% decline in EBITDA margin for Indian telecom operators over 2QFY10-2QFY11. ARPM has been relatively
stable over the last three quarters and EBITDA margin has also stabilised. In addition, operators have
absorbed a significant portion of their 3G network cost.
Our analysis of Idea’s y-y change in EBITDA margin indicates that the biggest contributor to the margin
decline in FY10 was network cost, due to new launches and tariff declines. An increase in spectrum charges
impacted margins in FY11. However, network cost as a percentage of revenue has started to decline, driving
margin improvement in 1QFY12 (Exhibit 58).
Specifically, we see clear scope for reduction from the following cost heads:
§ Access charges: We expect EBITDA margin to increase as access charges as a percentage of revenue is
likely to decline, given the termination rate has been fixed at INR0.20/min and given the operator
originating the minute will retain the entire benefit of higher tariff.
§ Employee cost: Operators are restructuring their operations. They are reducing headcount, as well as
re-aligning their business. According to media reports, several leading operators, including Airtel, RCOM,
Tata Teleservices, are restructuring their operations in the current year.
§ SG&A cost – dealer commission and advertisement spend: Operators are working on reducing their
churn level and improving the quality of subscriber base. They have reduced dealer commissions on
recharges and also on sale of sim cards for most circles. The combination of lower commission rates
and lower gross adds should help reduce SG&A cost. Also, in view of the softness in overall economy, we
expect operators to get better deal from the television broadcasters, driving down advertisement
expenses.
§ 3G will be EBITDA-margin-accretive: We expect 3G services to become EBITDA-margin-accretive as the
largest operating cost for 3G is network cost in our view, and it is already being absorbed. 3G services
should provide margin upside as usage picks up. 3G has no significant incremental impact on other cost
heads like employee wages, access charges, and advertisement spend.
Low 3G capex due to late adoption, roaming tie-ups, co-location of sites and vendor competition
While there have been concerns about the 3G launch causing significant escalation in capex, Indian
operators have managed to reduce their capex consistently over the last few years. In FY12, capex guidance
indicates a capex-to-sales ratio of 17-20%, which we estimate will decline further in FY13 as operators
report strong revenue growth and minutes growth moderates.
3G spectrum in India is fragmented with over seven operators, but none of them have a pan-India 3G
spectrum. Operators have entered into roaming arrangements to provide pan-India 3G coverage. Roaming
arrangements will lead to better asset-sweating and optimal utilisation of capital. Bharti, Idea and
Vodafone between them cover all circles and have entered into 3G roaming arrangements among
themselves. Operators are still working out the 3G roaming agreements and have provided no details so far.
Focusing on restricting cost increase via rational expansion of 3G networks
Indian telecom operators are relying on their existing sites to expand their 3G coverage and are not leasing
fresh sites for 3G. This will enable wider deployment of 3G with limited capex. Our discussions with
industry participants and tower companies suggest that the cost of adding Node B in the existing site is
about one-fourth of the monthly cost per site. Assuming that roughly 20% of sites get converted into 3G, the
network cost increase would be about 5%.
Capex intensity should continue to decline
Indian telecom operators invested heavily during FY07-09, when capex-to-sales was 40-60%. Subsequently
capex intensity has declined sharply, excluding the spectrum payout in FY11. For FY12, Bharti guides to
domestic capex of about USD1.9b, Idea to INR40b and RCOM to INR15b, representing 17%, 8% and 21% of
our FY12 revenue estimate. This is despite the 3G launch in FY12. We expect a further decline in the capexto-
sales for Bharti and Idea.
MNP: Strengthens belief in the incumbents, subscribers moving from CDMA/new entrants to incumbents
While MNP has been a non–event, in line with our expectation (see our report MNP: no cause of concern,
dated 20 October 2010), it indicates the strength of the incumbents’ networks. There has been a clear move
away from CDMA, public-sector operators and new GSM entrants towards the incumbents. While the MNP
gains are not enough to impact the financial performance of incumbents, it has eased concerns that
incumbents could lose some of their high-value prepaid subscribers.
MNP was launched in India in November 2010, and 15.5m subscribers (1.8% of total) had ported until
August 2011. This compared to an annual churn rate of over 50% for most operators. More interestingly, in
contrast to concerns that the three GSM incumbents would lose their high-value post-paid subscribers,
they have been net recipients of subscribers through MNP.
According to press reports, as at 7 July, Idea led the MNP race with a port-in port-out ratio of 57 (57 lost
against 100 gained) followed by Vodafone (67), Airtel (75) and Aircel (87). CDMA operators were the biggest
losers, with RCOM and Tata Teleservices seeing the worst ratio of 1580 and 1,640 subscribers lost for 100
for 100 gained respectively. There is also a trend of subscribers moving away from new entrants to the
incumbents as RCOM’s GSM and datacom had a ratio higher than 1. Also, MNP has not lead to any pressure
on revenue per minute or revenue market share for the incumbents.
Sector valuation: Outperformance to continue
Although the share prices of Indian wireless telcos have increased in the past few months, we continue to
like the sector. We see significant room for upgrades to long-term estimates. We continue to assume
flattish revenue per minute beyond FY13, but we believe the risk is in the upside as we have been
conservative in our estimates. Over the next few quarters, we expect Indian telecom operators to report
strong improvement in profitability, driven by revenue increase and margin improvement. Voice revenue
growth will be driven by minutes growth and by improvement in revenue per minute.
We believe the worst of competitive intensity is behind us. New entrants have understood the futility of
tariff cuts and competitive intensity is unlikely to resurface. Most new entrants are also involved in
litigation, which will likely constrain their ability to raise funds. Bharti has taken the lead by raising prices
by a significant 20%, and initial indications suggest that most operators are likely to follow suit as Bharti is
a leader in cost structure.
We retain BUY on Bharti, Idea as well as RCOM and are raising TP for Bharti from INR440 to INR470, for Idea
from INR110 to INR120 and are cutting our TP on RCOM from INR200 to INR95
Risks to our thesis
Reversal of tariff increase and revival of competitive intensity
While we do not expect further tariff cuts from any of the large players given the highly leveraged balance
sheets, low industry profitability and resurgence of tariff war (note that tariff cuts in the past have not
enabled new entrants gain revenue market share) remains a risk to our thesis. There are still 10+ operators
in most circles and some of the new entrants have strong parent backing and could continue to invest in
the Indian market.
Higher-than-expected slowdown in minutes growth
While we are factoring in moderation of minutes growth due to the high base effect, a decline in net
additions and a tariff increase may result in a sharp slowdown in minutes growth. This is a risk to our
thesis as this could prompt operators to re-think their tariff strategies.
Lower-than-expected pick up of data services in India and increased competition in data
Indian telecom operators have paid significant amounts to acquire 3G spectrum. While these are early days
to assess success or failure of 3G in India, a failure on this front would be a risk to our investment view. We
assume 9-11% of an operator’s subscribers will adopt 3G services by FY14, contributing 4-5% to wireless
revenue. We expect operators to be rational in their 3G pricing, as there are only three 3G operators per
circle compared to 10+ 2G operators and also because of the high spectrum price they have paid. However,
irrational tariff war would be a risk. 3G operators could also face competition from the BWA operators,
especially Reliance Industries, which has a pan-India BWA spectrum and could look at deploying TD LTE.
Regulatory risks on spectrum renewal charges, spectrum re-farming
Regulatory decisions on spectrum could have a significant financial impact on the Indian telecom operators.
Three key decisions on spectrum will be one-time charges for excess spectrum over 6.2Mhz, spectrum
renewal charges, and 900Mhz spectrum re-farming as the license comes up for renewal. Our target prices
for Bharti, Idea and RCOM reflect charges for excess spectrum over 6.2Mhz and 50% of spectrum renewal
charges. 900Mhz spectrum is a significant advantage for the GSM incumbents and re-farming of the same
could have significant capex and network quality implications. Based on our discussions with industry
participants, TRAI’s recommendations on spectrum are unlikely to be implemented in their current form.
However, if the same does get implemented, it would be a risk to our thesis.
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Investment thesis: Back to profitable growth
Strong revenue growth, driven by tariff hikes and data
We expect Bharti and Idea to report 12-20% three-year revenue CAGR for their India wireless business,
driven by price increases, minutes of usage (MoU) growth and data usage growth. Revenue growth has
started to gain momentum after hitting a bottom in 2HFY10, with revenue growing 10% across circles in
1QFY12 (Exhibits 1-2), which was prior to tariff hikes or 3G data launch. Competitive intensity is declining
and incumbents have taken a lead in raising tariffs in their stronger circles (Exhibit 9). Top 5 players, which
account for >80% of industry revenue, have raised tariffs in most of their strong circles. While subscriber
net adds have peaked and have started to decline (Exhibit 21), we believe the market is far from saturation
as rural India, which accounts for 70% of the India’s population, is still underpenetrated at 35% (Exhibits
25-26). Increase in rural penetration and MoU will provide volume growth in the medium term, in our view.
Industry losing heavily; review of industry profitability indicates that tariff war is unsustainable
We have examined the financials of most of the listed and unlisted telco companies. Our analysis shows
that the industry ex-Bharti could be making losses of USD4b-5b per annum. New entrant UNINOR (not
listed) and MTS (not listed) have already put in USD2.0b-2.2b in terms of capex and EBITDA losses (Exhibits
34-37), but their losses are still higher than revenue. Unlisted companies (such as Aircel and Tata
Teleservices) and PSU operators (MTNL and BSNL) are making significant losses despite reasonable revenue
and subscriber market share. Leading private-sector operators like Idea and RCOM are operating at low
ROEs of 4-7%. Excluding Bharti, no operator is generating double-digit ROE. Many of the new entrants are
also facing litigation in the 2G scam and they may find it difficult to get new funding for their networks. The
established operators are very unlikely to initiate fresh tariff wars, as they have already seen significant
erosion of profitability due to margin pressure and increase in leverage due to the 3G spectrum cost
(Exhibits 14-15). New entrants did enter into tariff wars, but this has had made no impact on their revenue
market share (Exhibit 31).
Tariff hikes: Trigger, extent and impact
A look at the key tariff plans of leading operators for all circles reveals that most operators have taken
tariff hikes in their stronger circles where they have several advantages like strong subscriber base, high
revenue market share and network advantage due to the 900MHz spectrum (Exhibits 16-18). These circles
account for majority of incumbent’s revenue, and most subscribers are likely to be impacted as rates have
been hiked both for per-second and per-minute subscribers. Our analysis indicates that local outgoing onnet
calls typically account for 21% of volume and 33% of revenue, and we estimate the hike in this segment
will boost revenue per minute by about 6% as all subscribers move to the new rates (Exhibits 19-20). We do
not expect government intervention given the huge losses of the industry, especially the public sector
operators.
Data in India; muted start to 3G, but we continue to see strong long-term potential
Most 3G operators launched 3G services in India in 1H11, so it is still very early to assess success or failure
of 3G. However, our interaction with the industry experts suggests that initial take-up has been muted due
to low smartphone penetration, high tariffs, limited network reach, etc. But, we see strong potential for
data, and we expect 9-11% of an operator’s 2G subscribers to adopt 3G and contribute 3-5% to revenue by
FY14. We believe once the ingredients are in place India can catch up in data just like it has done in the
case of mobile, where India was five years behind China in terms of penetration in 2005 but has caught up
in a very short time. We believe 3G will see strong uptake once handset prices decline, network availability
and quality improves, and localised content availability improves. While Indian operators continue to
refrain from giving handset subsidy, they are working on improving the quality and affordability of 3G/2G
devices with offers like Reliance Tablet and Vodafone Facebook phone (Exhibits 46-47). Operators can
reduce device prices through economies of scale and are offering reverse subsidy in terms of discounted
tariffs, which reduces the overall cost of ownership of data services for subscribers.
Revenue growth, margin expansion and declining capex to lead to strong FCF generation
We forecast EBITDA margin expansion of 1.7-2.7% for Indian telecom operators we cover over the next two
years, compared to a decline of 2.2-7.5% reported in the past two years. We believe this will be supported
by an increase of 3-5% average revenue per minute (ARPM), compared to a 23-29% ARPM decline over the
last two years. Also, we believe 3G services will become EBITDA-margin-accretive with steady margins of
over 50% for operators such as Bharti as, cash cost for 3G is not very high if we exclude the spectrum cost.
While peak capex is clearly behind for the Indian operators, capex is likely to decline further as initial 3G
expansion cost is taken care of in FY12 and as MoU moderates.
Revenue growth driven by tariff increase and MoU growth
We expect Bharti and Idea to report 12-20% revenue CAGR over the next three years on their India wireless
business, driven by increases in prices and data usage. Revenue growth is gaining momentum with strong
10% revenue growth across circles in 1QFY12, which was prior to tariff hikes. The competitive intensity is
declining and incumbents have taken the lead in raising tariffs in their stronger circles. Top 5 players,
which account for >80% of industry revenue, have raised tariffs in their strong circles.
Most operators launched their 3G services in 1HCY11. While the initial take-up of 3G has been muted, we
are bullish on data services, which we believe will be a long-term revenue driver for Indian wireless telcos.
We expect 3G data to account for 3-5% of wireless revenue by FY14.
Tariff declines have offset strong volume growth; profitable volume growth ahead
In FY10 and FY11, Indian telcos reported strong growth in mobile subscribers and traffic volume. But, this
did not translate into revenue growth due to the steep decline in revenue per minute. The competitive
intensity is declining, thus we expect net additions to fall but MoU growth to continue. This, coupled with
an increase in revenue per minute, will boost voice revenue, in our view.
Per-second billing has had a significant impact on realisation and margins
Tata DoCoMo (not listed) introduced per-second billing plan in India in 2QFY10 and RCOM launched simply
Reliance in 3QFY10. Per-second billing was replicated by all leading operators, including Bharti, Idea and
Vodafone India (not listed), in 3QFY10. These plans caused a steep decline in ARPM with Bharti and Idea
reporting a 21-25% decline in revenue per minute over the four subsequent quarters (3QFY10-2QFY11). Post
2QFY11, we have seen ARPMs stabilising and revenue growth returning to the sector. We expect revenue
per minute to start increasing as operators start reversing the process of tariff decline through selective
tariff increase.
Stronger operators take the lead in raising tariffs
Incumbents have taken the lead in raising tariffs, especially on per-second rates. While Tata Teleservices
(not listed) and RCOM tweaked their tariffs for relatively small contributors like SMS and long-distance
calling rates, Bharti took the lead in raising the local on-net calling rate, which we estimate accounts for
one-third of its GSM wireless revenue. Other large operators Vodafone, Idea, RCOM as well as Tata have
also subsequently raised tariffs in several circles.
Revenue growth gaining momentum across circles; all circles reported 10%+ growth
Industry revenue growth has started to recover, with revenue increasing 13-18% y-y in 1QFY12 in A, B, C
and metro circles. Exhibit 1 indicates that revenue growth has rebounded. This is prior to any tariff hike
and excludes any significant contribution from the recently launched 3G services. Also, we have seen strong
revenue growth of 10%+ in 21 out of the 22 circles, including metros which have more than 100%
penetration. Aside from the boost from tariff hike, we expect future revenue growth to be driven by
subscriber adds in rural India and by an increase in data revenue in urban India.
Tariff increase: trigger, extent and impact
Our analysis of tariff hikes and discussions with operators indicate that GSM incumbents have raised tariffs
in their highest revenue-generating circles (Exhibit 9). Bharti has hiked tariff by 20% in three key categories,
including on-net local calls, per-minute rate and calls to fixed-line. Our analysis indicates that on-net local
calls account for 18% of MoU but 34% of wireless revenue (Exhibit 19).
Despite 10+ operators, on-net calls account for 52% of outgoing minutes
Despite the presence of more than 10 operators in most circles, on-net minutes account for over 50% of
traffic. On-net minutes as a percentage of total minutes had been on a decline since 2HFY10, when the
competitive intensity was at its peak. However, over the last one year, on-net minutes usage has stabilised
at 52%. We see this as another sign of declining competitive intensity. This also indicates that a hike in local
on-net tariff should have a significant impact on revenue.
Per-second and per-minute tariff raised; these plans cover most subscribers
Tariffs have been hiked 20% for per-second and per-minute subscribers, which we believe represent
majority of subscribers. We believe the tariff increase will lead to a 6% increase in ARPM over the next one
year.
Incumbents raise tariffs in strong circles; among challengers RCOM has raised tariff in most, Tata in some
GSM incumbents Bharti, Idea and Vodafone have raised rates in most of their strong circles. RCOM has also
raised rates for its GSM offering in most circles. Tata DoCoMo, which introduced per-second billing, has
also raised tariff in a few circles. The table below shows tariffs for the top 3 GSM operators for their persecond
billing plans and it indicates that tariffs have been raised to 1.2 paise per second for on-net calling
in most circles.
Triggers for tariff increase, reversal of tariff increase unlikely
Tariff hike is a step in the right direction, in our view, as industry net debt is at an all-time high and
profitability at a multi-year low (Exhibits 14 and 15). The competitive intensity is declining, as most new
entrants have made only token roll outs and are facing regulatory overhang and risk of license cancellation.
Uninor and MTS, the most aggressive of the new entrants, have invested close to USD2b in capex but are
making heavy losses (Exhibits 18-22). Industry has already utilised most cost levers and operates at
amongst the lowest cost structure in the world. We believe tariff hike is a rational move and not industry
cartelisation as industry profitability is low and leverage has increased significantly.
Regulatory sound bites indicate that the government is unlikely to intervene
While there have been concerns about government intervention on tariff hike, we believe the government is
unlikely to intervene given the poor profitability of the industry. The Minister of State for Communications
and IT in a written reply to the Rajya Sabha stated that “The operators have the flexibility to fix the tariff
for mobile services depending on the market conditions and other commercial considerations subject to
the regulatory principles of non-discrimination, compliance of interconnection usage charges and nonpredation”
New entrants no concern, incumbents can differentiate on data instead of plain-vanilla tariff cuts
Operators have realised the futility of tariff cuts to gain revenue market share as other operators can
replicate tariff plans. Despite steep tariff cuts, revenue market share in the past eight quarters has
remained largely unchanged. The exceptions have been operators (Idea, Vodafone) who have launched
services in new circles. Most new entrants are facing regulatory risk and funding issues, limiting their
ability to invest in networks and to indulge in tariff wars. Profitability of all operators has been under
pressure.
Observations from our analysis of tariff plans offered by key operators
We looked at some of the popular plans of incumbents for all circles and observe that on-net tariffs have
been raised to 1.2paise/second in several circles. Validity of special vouchers as well as their price differs
significantly across operators and for same operator across circles. Operators are also offering deferred
talk time to improve stickiness especially in rural circles. Per second billing as well as per minute billing
are the most popular plans and are available from GSM operators for most circles.
Most operators have raised tariffs in their stronger circles where they have competitive advantage:
Incumbents have initiated tariff hikes in their stronger circles. These are typically circles where the
operator has among the highest revenue market share, has 900Mhz spectrum and superior network
coverage, and the circles are among the largest contributors to total revenue. The operators also have 3G
spectrum in several of these circles, which should enable them to attract high-ARPU subscribers.
Per-second billing the most popular plan, per minute plan next: Per-second billing is the most popular
plan and all major operators are offering the same in all circles. Some of the plans with rates of less than
1paise/second come with higher cost voucher and are of short duration. Per-minute plan is also being
offered by operators in most of the circles.
Validity of the special recharge voucher is also an important parameter: While the tariff and the price of
the voucher are important, there is wide variance in the validity of special vouchers. This significantly
affects total additional one-time revenue, as well as determines when subscriber migrates to higher tariff
plan.
Deferred talk time to rural subscribers to improve stickiness: Incumbents are offering plans, especially in
the predominantly rural C circles, where subscribers are offered free talk time for three-to-nine months as
long as subscribers recharge a minimum amount. For example, Bharti is offering deferred talk time to new
subscribers in Kerala, Rajasthan, Himachal etc
Significant difference in cost of vouchers across operators and across circles for same the operator: There
is no uniformity in special vouchers or rate cutters across operators or for the same operator across circles.
Most special vouchers, especially high-value vouchers, compensate the subscriber in terms of free talk
time. While this assures the operator of a minimum receivable from subscriber, this is not additional onetime
revenue.
Quantifying the Impact of tariff hike and other observations on tariff plans
To quantify the impact of change in tariffs on realized revenue per minute, we have looked at industry mix
of minutes of use based on TRAI’s performance indicator report which indicates the contribution of different
category of minutes (incoming, outgoing, local, national, roaming etc) in terms of volume as well as
revenue.
Our conclusions are:
§ Local calls account for 70% of voice revenue, on-net roughly about 1/3rd of voice revenue.
§ While SMS and national tariffs have been raised by some operator, their impact is less significant.
§ As Tariff hikes percolate down to all subscribers, we estimate there could be an impact of INR0.02 (6%)
on ARPM.
§ We see ample scope for tariff tweaking, which could provide further upside to ARPM and to our
estimates
Data: Early days, but huge potential
Most 3G operators launched 3G services in India in 1H11, so it is still early days to assess the success or
failure of 3G. However, our interactions with industry participants, including operators, network vendors,
distributors and target subscribers, indicate that the initial pick-up of 3G has been below their expectation.
However, we believe there is strong potential for 3G in India. As evidenced by the strong increase in mobile
services, we believe India can catch up quickly in terms of adoption as the building blocks in terms of
handsets, service price, content and network availability are in place. We are already seeing large number
of 3G handsets available at below USD100 price points, and Idea has recently taken the lead in reducing 3G
service price.
Operators focusing on network quality, user experience and on monetising 3G networks
Operators are focusing on improving network quality and providing a good customer experience which they
believe is essential for sustained improvement in data revenue. Given the high spectrum cost and limited
spectrum availability, operators prefer a tiered pricing structure. Operators are clearly focused on
monetising the data and are focusing on servicing high number of low-usage subscribers than filling their
network with low-yield, high-usage subscribers via unlimited plans and/or data card subscribers. Our
analysis of 3G offers across operators and across service types indicates that while 3G services were
initially launched at a premium to EVDO data card offers, 3G prices is at par with EVDO (Exhibit 40) after
Idea’s recent price cut. In terms of coverage, Idea has mentioned that it currently covers a population of
95m through its 3G services (~8% of population) and intends to raise it to 250m-300m subscribers (20-25%
of population)
3G data prices being reduced, 2G prices being raised to reduce the arbitrage
GPRS plans have been at a significant discount to 3G data plans. 2GB on GPRS monthly was available at
INR98 compared to INR675 on 3G. While operators have made the GPRS offering more expensive at
INR98/1GB, Idea has taken the lead and reduced 3G price to INR450/1.2GB. Thus, the arbitrage between 2G
and 3G is narrowing, which is likely to induce GPRS subscribers to 3G. As subscribers adopt 3G services and
experiences better speeds, the usage is likely to increase, aiding 3G ARPU.
CDMA-based EVDO data card sales indicate strong latent demand for high-speed data
EVDO data cards are doing well in India. Our discussions with the industry participants suggest that there
are already more than 5m data card subscribers in India. This is significant growth in a short time, as there
are only 12m wireline broadband connections in India. CDMA operators are losing revenue market share on
voice and are shifting their capacity towards data. We observe that the only pure-play CDMA operator,
MTS, derives 29% of its revenue from data, which is the highest among all operators. MTS’s data card
subscriber base has doubled from 0.43m to 0.82m in the last two quarters. Vodafone, the second-largest
GSM operator in the country, recently tied up with MTS to offer CDMA-based EVDO cards to its subscribers
under its brand, netcruise. Also, in view of the 3G launch, EVDO data card prices have been reduced and are
now available at less than USD25.
Impact of 3G data on revenue
We expect 3G data to contribute 1.3% of revenue in FY12 and 2.1% in FY13 for Bharti. However, the
contribution in terms of incremental revenue will be much higher at 9%. Also, as data is a high EBITDA
margin business, we expect EBITDA margin to expand as contribution of data increases.
Revenue growth + margin expansion + reducing capex intensity = strong FCF
We are modelling in EBITDA margin increase of 1.7-2.7% for Idea, Bharti and RCOM over the next two years
(vs. 2.2-7.5% decline in the last two years), driven by 3-5% ARPM increase (vs. 23-29% decline over the last
two years). Also, we expect 3G services to be EBITDA-margin-accretive with steady margins of over 50% for
operators such as Bharti, as cash cost for 3G is not very high excluding spectrum cost. While peak capex is
clearly behind for the Indian operators, we expect capex intensity to decline further as initial 3G expansion
costs have been incurred in FY12 and minutes growth are set to moderate.
A steep decline in ARPM on launch of per-second billing, along with an increase in license fees, led to a 3-
4% decline in EBITDA margin for Indian telecom operators over 2QFY10-2QFY11. ARPM has been relatively
stable over the last three quarters and EBITDA margin has also stabilised. In addition, operators have
absorbed a significant portion of their 3G network cost.
Our analysis of Idea’s y-y change in EBITDA margin indicates that the biggest contributor to the margin
decline in FY10 was network cost, due to new launches and tariff declines. An increase in spectrum charges
impacted margins in FY11. However, network cost as a percentage of revenue has started to decline, driving
margin improvement in 1QFY12 (Exhibit 58).
Specifically, we see clear scope for reduction from the following cost heads:
§ Access charges: We expect EBITDA margin to increase as access charges as a percentage of revenue is
likely to decline, given the termination rate has been fixed at INR0.20/min and given the operator
originating the minute will retain the entire benefit of higher tariff.
§ Employee cost: Operators are restructuring their operations. They are reducing headcount, as well as
re-aligning their business. According to media reports, several leading operators, including Airtel, RCOM,
Tata Teleservices, are restructuring their operations in the current year.
§ SG&A cost – dealer commission and advertisement spend: Operators are working on reducing their
churn level and improving the quality of subscriber base. They have reduced dealer commissions on
recharges and also on sale of sim cards for most circles. The combination of lower commission rates
and lower gross adds should help reduce SG&A cost. Also, in view of the softness in overall economy, we
expect operators to get better deal from the television broadcasters, driving down advertisement
expenses.
§ 3G will be EBITDA-margin-accretive: We expect 3G services to become EBITDA-margin-accretive as the
largest operating cost for 3G is network cost in our view, and it is already being absorbed. 3G services
should provide margin upside as usage picks up. 3G has no significant incremental impact on other cost
heads like employee wages, access charges, and advertisement spend.
Low 3G capex due to late adoption, roaming tie-ups, co-location of sites and vendor competition
While there have been concerns about the 3G launch causing significant escalation in capex, Indian
operators have managed to reduce their capex consistently over the last few years. In FY12, capex guidance
indicates a capex-to-sales ratio of 17-20%, which we estimate will decline further in FY13 as operators
report strong revenue growth and minutes growth moderates.
3G spectrum in India is fragmented with over seven operators, but none of them have a pan-India 3G
spectrum. Operators have entered into roaming arrangements to provide pan-India 3G coverage. Roaming
arrangements will lead to better asset-sweating and optimal utilisation of capital. Bharti, Idea and
Vodafone between them cover all circles and have entered into 3G roaming arrangements among
themselves. Operators are still working out the 3G roaming agreements and have provided no details so far.
Focusing on restricting cost increase via rational expansion of 3G networks
Indian telecom operators are relying on their existing sites to expand their 3G coverage and are not leasing
fresh sites for 3G. This will enable wider deployment of 3G with limited capex. Our discussions with
industry participants and tower companies suggest that the cost of adding Node B in the existing site is
about one-fourth of the monthly cost per site. Assuming that roughly 20% of sites get converted into 3G, the
network cost increase would be about 5%.
Capex intensity should continue to decline
Indian telecom operators invested heavily during FY07-09, when capex-to-sales was 40-60%. Subsequently
capex intensity has declined sharply, excluding the spectrum payout in FY11. For FY12, Bharti guides to
domestic capex of about USD1.9b, Idea to INR40b and RCOM to INR15b, representing 17%, 8% and 21% of
our FY12 revenue estimate. This is despite the 3G launch in FY12. We expect a further decline in the capexto-
sales for Bharti and Idea.
MNP: Strengthens belief in the incumbents, subscribers moving from CDMA/new entrants to incumbents
While MNP has been a non–event, in line with our expectation (see our report MNP: no cause of concern,
dated 20 October 2010), it indicates the strength of the incumbents’ networks. There has been a clear move
away from CDMA, public-sector operators and new GSM entrants towards the incumbents. While the MNP
gains are not enough to impact the financial performance of incumbents, it has eased concerns that
incumbents could lose some of their high-value prepaid subscribers.
MNP was launched in India in November 2010, and 15.5m subscribers (1.8% of total) had ported until
August 2011. This compared to an annual churn rate of over 50% for most operators. More interestingly, in
contrast to concerns that the three GSM incumbents would lose their high-value post-paid subscribers,
they have been net recipients of subscribers through MNP.
According to press reports, as at 7 July, Idea led the MNP race with a port-in port-out ratio of 57 (57 lost
against 100 gained) followed by Vodafone (67), Airtel (75) and Aircel (87). CDMA operators were the biggest
losers, with RCOM and Tata Teleservices seeing the worst ratio of 1580 and 1,640 subscribers lost for 100
for 100 gained respectively. There is also a trend of subscribers moving away from new entrants to the
incumbents as RCOM’s GSM and datacom had a ratio higher than 1. Also, MNP has not lead to any pressure
on revenue per minute or revenue market share for the incumbents.
Sector valuation: Outperformance to continue
Although the share prices of Indian wireless telcos have increased in the past few months, we continue to
like the sector. We see significant room for upgrades to long-term estimates. We continue to assume
flattish revenue per minute beyond FY13, but we believe the risk is in the upside as we have been
conservative in our estimates. Over the next few quarters, we expect Indian telecom operators to report
strong improvement in profitability, driven by revenue increase and margin improvement. Voice revenue
growth will be driven by minutes growth and by improvement in revenue per minute.
We believe the worst of competitive intensity is behind us. New entrants have understood the futility of
tariff cuts and competitive intensity is unlikely to resurface. Most new entrants are also involved in
litigation, which will likely constrain their ability to raise funds. Bharti has taken the lead by raising prices
by a significant 20%, and initial indications suggest that most operators are likely to follow suit as Bharti is
a leader in cost structure.
We retain BUY on Bharti, Idea as well as RCOM and are raising TP for Bharti from INR440 to INR470, for Idea
from INR110 to INR120 and are cutting our TP on RCOM from INR200 to INR95
Risks to our thesis
Reversal of tariff increase and revival of competitive intensity
While we do not expect further tariff cuts from any of the large players given the highly leveraged balance
sheets, low industry profitability and resurgence of tariff war (note that tariff cuts in the past have not
enabled new entrants gain revenue market share) remains a risk to our thesis. There are still 10+ operators
in most circles and some of the new entrants have strong parent backing and could continue to invest in
the Indian market.
Higher-than-expected slowdown in minutes growth
While we are factoring in moderation of minutes growth due to the high base effect, a decline in net
additions and a tariff increase may result in a sharp slowdown in minutes growth. This is a risk to our
thesis as this could prompt operators to re-think their tariff strategies.
Lower-than-expected pick up of data services in India and increased competition in data
Indian telecom operators have paid significant amounts to acquire 3G spectrum. While these are early days
to assess success or failure of 3G in India, a failure on this front would be a risk to our investment view. We
assume 9-11% of an operator’s subscribers will adopt 3G services by FY14, contributing 4-5% to wireless
revenue. We expect operators to be rational in their 3G pricing, as there are only three 3G operators per
circle compared to 10+ 2G operators and also because of the high spectrum price they have paid. However,
irrational tariff war would be a risk. 3G operators could also face competition from the BWA operators,
especially Reliance Industries, which has a pan-India BWA spectrum and could look at deploying TD LTE.
Regulatory risks on spectrum renewal charges, spectrum re-farming
Regulatory decisions on spectrum could have a significant financial impact on the Indian telecom operators.
Three key decisions on spectrum will be one-time charges for excess spectrum over 6.2Mhz, spectrum
renewal charges, and 900Mhz spectrum re-farming as the license comes up for renewal. Our target prices
for Bharti, Idea and RCOM reflect charges for excess spectrum over 6.2Mhz and 50% of spectrum renewal
charges. 900Mhz spectrum is a significant advantage for the GSM incumbents and re-farming of the same
could have significant capex and network quality implications. Based on our discussions with industry
participants, TRAI’s recommendations on spectrum are unlikely to be implemented in their current form.
However, if the same does get implemented, it would be a risk to our thesis.
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