Telecom - SC verdict: Unexpected boost to consolidation; sector update :: Edelweiss

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The Supreme Court of India has ordered the government to cancel 122 2G licenses issued in 2008, issue new licenses and conduct the spectrum auction based on recommendations by TRAI within four months. This mainly impacts new operators as well as Idea. However, this would also bring about much awaited consolidation and tighter operational discipline in the industry. We believe Bharti and Vodafone will be the biggest beneficiaries. This might lead to earnings upgrades on the Street. We maintain Buy on Bharti and Idea, but continue to prefer Bharti.

Supreme Court cancels 122 2G licenses

The Supreme Court ordered cancellation of 122 2G licenses issued in January 2008, terming the process of allotment on first-come-first-served basis as ‘totally arbitrary and unconstitutional’. The Telecom Minister, in a press conference, indicated that the DoT would implement the court’s order and cancel licenses and withdraw the allotted spectrum. The Supreme Court also directed TRAI to make recommendations on allocation of 2G licenses and spectrum allotment. It has ordered the government to complete the entire process within four months.         

What is likely to happen next?

As the government would cancel all 122 licenses, interested operators can apply for a new license and participate in the auction to be conducted within four months for spectrum. Idea derives about 4% of revenues (10% from Karnataka and Punjab) from seven circles where its license has been cancelled. Thus, we expect Idea to apply for a license and bid for spectrum in the auction. In our view, Idea would require to make an investment of about ~INR10bn for the spectrum. We also expect Telenor to apply for a new license and make further investment in bidding for spectrum. This, we believe, would bring in operational discipline in the industry.

We expect a reduction in freebies and promotional offers from Idea and Uninor which are the most aggressive on the ground in terms of subscriber additions. This would lead to possible surge in RPMs. We also expect subscriber acquisition cost to shrink due to a reduction in distributor margins as the chase for marginal customers reduces. With the cancellation of licenses, excess supply of spectrum would lead to cheaper prices. Overall, we expect margins, cash flows and ROCE to improve in the industry. 

Outlook and valuations: Prefer Bharti

Our recent interaction with industry players indicated that collaboration between operators had increased and operational discipline was in the offing. With the cancellation of licenses, we believe, there is better visibility on this discipline. In our earlier note (Risk-reward favourable, dated December 14, 2011), we had indicated that an increase of 1% in tariff improves DCF of Bharti by INR3 per share and INR2 per share for Idea. A reduction of 10% in spectrum price would add INR4 per share to Bharti and INR3 per share to Idea. But Idea could see an incremental cash outflow of ~INR10bn (30% higher capex) hence, we prefer Bharti.