The Indian telecom market is in real danger of going into the state of a duopoly, and the government is trying hard to prevent such an outcome. Why? It is bad for the consumers, as it will restrict his/her choices and make the players complacent. But it will be interesting to know why we got ourselves into this state. Did we have choices to prevent such an outcome, or it is natural for markets such as telecom? In this article, I plan to discuss this in detail.
Spectrum Prices
Telecom companies need to spend a large proportion of their earnings (on a yearly basis) to buy spectrum, which is used for generating services. These services translate into revenues, which in turn generate cash flows, and a large proportion of it is reinvested into buying additional assets, and this cycle continues perpetually. The basic problem of the Indian Telecom sector is that the prices of most of such assets (especially spectrum) are regulated by the government. On top of this, the government charges a license fee which is a large percentage of the operator’s top line.
Till recently (until the last auctions) the prices of airwaves were on the path of a rising trajectory. Both TRAI & DoT used the so-called “market discovered price” to value spectrum instead of doing a “ground-up valuation”. And this resulted in a huge problem, as the prices discovered in the auctions had no correlation with the valuation of airwaves. The reason-the “market discovered price” emerged from a demand and supply mismatch, but the valuation is just an aggregation of the PV of the projected cash flows generated by an operator using the airwaves.
The closest analogy is the price of a stock trading in exchange. At certain times, the price can shoot up to unreasonable levels, even though its valuation estimated based on projected earnings can be very low. If a long-term investor is forced to pay up for stock at a price that is discovered as a result of a demand and supply mismatch, then his hope of generating any profits in the future is close to zero. Take the example of Zomato, on 26th June 2022, Aswad Damodaran estimated an intrinsic valuation for Zomato as Rs 35.32 per share but it was trading at Rs 54 in the open market. In fact, even at the time of the IPO, the value estimated by Damodaran was never more than Rs 42 per share, but the value went as high as Rs 155 — all driven by a demand-supply mismatch.
Similarly, in India, spectrum prices in the initial rounds of auction touched unrealistic levels- all due to a demand-supply mismatch driven by the strong urge for the players to stay in business. But instead of recalibrating the prices, the regulator used these “market discovered” prices as a benchmark for setting reserve prices for the future auctions — as a result it drove the weaker players out of the market and it became even difficult to sustain just three.
From the above figure, one can clearly see that VI (including Vodafone & Idea individually), which is now struggling to survive in the market, has spent a total of $ 25.77 billion on acquiring airwaves to date — a number that is close to the market leaders (Note Bharti’s actually tally includes the other players it acquired later which are listed in the above table).
Spectrum Quality
Though all the big three players have paid almost similar values for acquiring airwaves however their quality of spectrum is not at par. The figure below draws a comparison.
The airwaves of the three players are shown in the chart as wedding cakes, with each layer indicating a specific band, whose thickness maps to the quantum (the average spectrum in a specific band) and its length indicating its reach (not to scale). One can clearly see, that RJIO’s spectrum strength is in high and low frequencies, followed by Bharti in mid and high, and VI only in mid frequencies.
AGR Dispute
The final nail in the coffin was the AGR judgment. On 1st Sept 2020, SC delivered a judgment in the historic AGR case, which had rattled the telecom sector for the past two decades. What was strange though — the SC settled the DoT’s provisional demand as the Final Demand which the operators had claimed to be laced with serious accounting errors. The other problem was that a large proportion (75% or more) of the DoT’s Demand was just interest and penalties. This was perceived as unfair, given the fact, the operators earlier had won in multiple jurisdictions — TDSAT and other lower courts. Even the TRAI was sympathetic to the views of the operators and sided with them on many past occasions on the “definition of revenue” — the base for calculating license fees.
The industry (except RJIO, being a new entrant had no past encumbrances) got totally shattered, with an overall impact of a staggering Rupees One Lakh Sixty-Nine Thousand Crores (22.8 billion USD). Of the three players, VI’s position became even weaker due to the sudden additional liability of Rs 60 K Cr!
Possible Solution
Current Initiatives
The government wants the telecom space to stay competitive, and hence is now trying hard to prevent a situation of bankruptcy. As part of this initiative, a package was announced recently that gave all the players (including VI) some breathing space in terms of payments of their dues to the GOI. This is especially important for VI, as 76% of its overall liability is only to the government. Also as a part of this package, GOI had offered VI an option to allow the conversion of its accumulated interests (as a result of the deferment of payment of dues for 4 years) into shares (that the GOI can hold in VI). This value is more than Rs 16 K Cr. If the conversion was to happen today the GOI will end up holding approximately 60% of the company.
Future Initiatives
The GOI is proposing a new Telecom Act, which will replace the earlier Act of 1885. The provisions proposed in the draft bill (2022) will empower the DoT to take drastic actions to prevent the market from becoming a duopoly. These actions include — a) Deferment of payment to DoT of license fees and spectrum annual installments; b) Conversion of such dues by DoT into shares of the licensed entity; c) Write-off such amounts or part thereof; d) Relief from payment of such amounts or part thereof.
However, the solutions proposed in the bill may not be enough. Why? In order to stay competitive, VI needs to spend on Capex (Spectrum and Equipment). Any cash flow the company is able to generate will first have to be spent on meeting DoT’s obligations. Hence, if the company is unable to pay DoT, then it will also not be able to spend on Capex and Equipment — the result will be a loss of customers and market competitiveness. Now, if the DoT proactively decides to give concessions only to VI, then the same might will look arbitrary, as the provisions will not be tested by the market like when the bankruptcy code is invoked. And if the DoT made the subsidies secular then it will tantamount to compensating companies that don’t need such measures and will also not be financially prudent.
Therefore, the only way it might work is to allow a sick telecom company to restructure itself by allowing its spectrum to be treated as an asset at par with any other assets, and DoT should treat itself as a lender at par with any other lender at the time of restructuring.
Conclusion
The implications of the loss of competitiveness in the Indian telecom sector will be severe. It will be damaging for the consumers, as their choices will get compromised and innovation will take a hit. Hence, the GOI needs to act now, and arm itself with rules (like treating spectrum as assets) so that the debt can get restructured within the bounds of constitutional legality and with transparency. But, If GOI owns a majority stake in VI (the direction where it looks like it is heading), then the powers of the GOI to help VI will increase significantly. However, the catch is in such a situation it might have to take VI under its control, which will then get virtually transformed into a PSU.
(Views expressed are my own and do not reflect that of my employer)
PS: Find the list of other relevant articles in the embedded link.
