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Why the World's Looking at Indian Telecom?

Co-Founder & Head of Business, Transfin.
Jun 7, 2020 5:03 AM 8 min read
Editorial

While COVID-19 has painted a morose economic outlook across the country, Indian telecommunication companies (“telcos”) have largely been immune. Not only has data consumption shown an uptick, telco services have also been critical during the pandemic for a wide-ranging set of reasons. Their ubiquitous and utilitarian status has never had a stronger endorsement!

The Indian telco sector is now essentially a three-player market (Jio, Airtel and Vodafone Idea) characterised by lofty consumer demand, fierce competition and regulatory complexity.

Add the recent investment activity from marquee investors such as Silver Lake Partners, KKR, Facebook coupled with the grapevine of potential interest from Abu Dhabi Investment Authority, Microsoft and Google, the sector truly finds itself in the midst of an interesting period, one warranting almost elevated levels of intrigue.

With telecom making flashy news on a regular basis, we will try to touch over the key themes in the sector with a snapshot of how things stack up.

 

 

Points to Know about Telecom Industry

Before going there, it is perhaps prudent to list down some basic industry operational terms ("Key Performance Indicators" or KPIs) that show up in almost any news piece that one might read on the topic.

Total Subscribers

This is probably the most intuitive of all telecom metrics and it is something one would probably associate with almost all service companies. It represents the sum of all paying subscribers. The entire market share discussion revolves around this number. As per last reported numbers, the current mobile segment (also called the wireless segment) consists of Jio with 387.5m subscribers, Airtel with 283.7m and Vodafone-Idea with 304m constituting the three biggest players.

Why the World's Looking at Indian Telecom?
Number of Mobile Subscribers of Airtel, Jio and Vodafone-Idea.

Average Revenue Per User in India (ARPU)

ARPU is the most closely watched metric and has taken enhanced relevance in recent times due to heavy tariff discounting that the industry has witnessed (courtesy Jio, of course!). ARPU indicates how much revenue a company can generate from an individual customer. It is calculated by dividing the revenue by the average number of customers in the period and is usually expressed on a monthly basis.

Since the focus currently in the India market is skewed towards mobile (wireless) services, most of the discussion you hear is around mobile ARPUs. For example, Airtel recently reported roughly ₹1,31,222m ($1.7bn) in Mobile Services revenue with an average customer base of 283m for the quarterly period ending March 31st 2020. The resulting Mobile ARPU is ₹463 for the quarter or a third of it i.e. ₹154 per month – their most quoted number. Another way to think about ARPU is as a proxy for the average tariff. Increasing tariffs will lift ARPU. However, price increases have an opposite impact on subscriber progression, so it is a delicately managed metric.

Gross Subscriber Adds

This is the total number of new subscribers added by the carrier in a given period of time. It acts as an important proxy to unearth subscriber acquisition trends.

Churn

Number of subscribers that terminate or discontinue their service with their carrier. This is typically expressed in percentage terms. A common view in the industry is that one telco's churn might show up in a competitor telco's "Gross Subscriber Add" as mobile services are increasingly becoming ubiquitous and a must-have utility. It acts as a proxy to understand how good a company is at retaining its customers.

Net Subscriber Adds

Total number of new subscribers added by the carrier minus customers that terminated the service with the carrier. Should be fairly intuitive that Net Subscriber Adds = Gross Subscriber Adds – Churn!

Now that some basic telco terms are behind us, let’s explore some topical themes in the sector.

 

The Eternal Quest to Increase ARPU

Jio entered the market in September 2016 as a textbook “new entrant” and drove meaningful disruption across the industry, with “ARPU re-rating” as perhaps the biggest consequence. Jio’s pursuit towards lifting Total Subscribers meant a robust initial push towards Gross Subscriber Adds. Price-cutting and discounting emerged as the optimum central strategy to achieve this. This had industry-wide ramifications as it somewhat coerced competitors to drop their tariffs to remain competitive. This naturally led to a decline in industry ARPU across the board. This till now remains as the single biggest challenge in the industry: How to mean-revert and grow back the ARPU to more sustainable levels? After all, at the end of the day, ARPU has to make economic sense.

See this interesting commentary from Gopal Vittal (Airtel India & South Asia MD & CEO) during the Q3/FY20 earnings call:

“...think in the end...we need to see an ARPU of ₹300...and I think that is when we will earn a reasonable return on capital on the overall business. I think even with this round of tariff increases, today our ARPU is about ₹135. While ARPUs will go up in the next quarter because of the tariff increases but that is just not good enough, I mean at ₹200, we will barely be head above water in terms of return on capital.”

Why the World's Looking at Indian Telecom?
How ARPU has changed over time in the telecom industry.

Since then, Airtel has seen a sharp 14% upswing in ARPU and currently sits at an industry-leading ₹154. This is still at a premium to Jio and Vodafone-Idea, who are at ₹130.6 and ₹109 respectively as per their most recent reporting. 

The biggest challenge for telcos is to find ways of raising prices to become more financially robust while preventing a spike in Churn.

Why the World's Looking at Indian Telecom?
The big question for telcos is how to raise ARPU without causing a spike in Churn.

 

All About AGR

The AGR See-Saw

For a wireless carrier to operate, it needs two fundamental things – License (issued by the Government) and Spectrum (radio waves that are required for communication, again auctioned by Government). Both are fairly expensive cost items and to avoid pressuring telecom operators with steep upfront or one-time payments, the Government decided to collect License Fee (LF) and Spectrum Usage Charge (SUC) via a revenue sharing arrangement in 1999. The Central Government took a conscious decision to spend money from this towards improving connectivity in remote and uncovered areas like rural, tribal and hilly regions. What it translated into was that telcos would share 8% of “revenues” as LF and 3-5% of “revenues” as SUC. This “revenue” had a special meaning and was called Adjusted Gross Revenue or AGR.

It is the very definition of this AGR that eventually became contentious. AGR’s definition included revenues from all telecom and non-telecom service with the following three deductions or “adjustments”:

  1. Service Tax and Sales Tax provisions that were anyway paid to the Government,
  2. Roaming revenues that were actually passed on to other telecom operators and
  3. iii) Ad-hoc charges such as switching costs (if any).

The telcos however argue that the adjustment should also exclude revenues from non-telecom services. Telecom operators often recognise revenues from renting of assets, non-recurring gains on sale of assets, income from financial investments, foreign exchange gain and other ad-hoc revenues. Why pay a % of revenue (say from foreign exchange fluctuations) which have no bearing on licence or spectrum?

This disagreement in “adjustments” resulted in fair bit of see-sawing between the Department of Telecommunications, Telecom Disputes Settlement and Appellate Tribunal (TDSAT) and the telcos.

Why the World's Looking at Indian Telecom?What complicated this further was that the definition of AGR being questioned was not purely on a forward-looking basis, but the Supreme Court ruling asked the telcos to pay dues for the past years plus accumulated interest. This resulted in an estimated c. ₹1.48Lcr ($19.8bn) windfall for the government with LF constituting ₹92,600cr ($12.4bn) and SUF constituting ₹55,100cr ($7.4bn). This is an ongoing issue as the definition of AGR and the exact amount owed is still being debated and challenged.

Capital First

The AGR issue has surely put some Balance Sheet pressure on Airtel and Vodafone Idea. Jio came out the rather unscathed due to a relatively smaller lifeline. However, all three have been running on some sort of deleveraging mandates. In the last month or so, Jio has raised ₹67,194cr ($9bn) in equity from Facebook, Silver Lake, Vista Equity Partners and General Atlantic in addition to a ₹53,125cr ($7bn) rights issue within its larger deleveraging exercise. Airtel has raised over $11bn in equity capital over the past five years and there appears to be more in the pipeline. Vodafone-Idea was rumoured to have caught the interest of Google and has done its own capital raising via a ₹25,000cr ($3.3bn) rights issue last year and contemplating selling stake in Indus Towers of which it owns 11.15%, among other asset sales.

Service Second

So why are Indian telcos on a capital-raising spree? It is clear that ARPU uptick is undeniably a central strategic move for all telcos towards becoming financially optimum. But to raise ARPUs without massive churn, there needs to be a parallel uptick in the overall quality of service. Data speed and coverage are important attributes that need to be in place to justify tariff hikes. And that needs capital! Investments in 4G and 5G infrastructure along with acquiring relevant and enough spectrum are all significant cash outflow considerations that are not only good to have but a must-have. These investments almost take the shape of prerequisites in times when competition is potent and there is no way to justify tariff hikes without a corresponding uptick in speed, coverage and overall quality of the service.

It is quite simple - if ARPU needs to go up, telcos need to invest more, and despite being cheaper, issuing more debt is not really a prudent alternative at this juncture!

Given the tremendous growth runway in the Indian market, it is hardly surprising that that international investment community is not shy of betting on it – a positive sign for the entire ecosystem!

FIN.

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