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Consolidation Call: Market correction expected following M&A policy notification

August 21, 2013
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The Indian telecom market has benefited from years of competition, which has led to rock-bottom tariffs and strong network coverage across the country. But the downside of hyper competition is now becoming visible as the balance sheets of most telecom service providers have been strained due to low ARPUs and high leverage.

The future of some of these players will depend on their ability to absorb the competitive pressures created by the expansion of 3G and 4G services by select companies, which have acquired licences and achieved economies of scale. Companies that do not have licences to introduce new services such as 4G will struggle to sustain operations by catering to low-end subscribers, while those with small-scale operations may not be able to achieve the cost efficiencies that large players have.

These factors have led to a situation where industry consolidation has become inevitable not only in the services market but also across the telecom value chain. In the telecom service space, operators will pursue consolidation in order to improve their cost efficiency through scale, to achieve synergies and gain access to critical assets such as spectrum. Industry players including handset manufacturers, telecom equipment providers and infrastructure providers are also likely to be a part of the consolidation phase. Handset vendors such as Nokia and BlackBerry are not performing as well as players like Samsung and Apple. In the telecom tower space, it has become difficult for small companies like Tower Vision to sustain their business amidst growing energy costs and competition for tenancies.

Often criticised for being overcrowded and hypercompetitive, the Indian telecom market is finally showing strong signs of consolidation. According to media reports over the past few months, the sector is gearing up for some major multi-million dollar merger and acquisition (M&A) deals in the near future.

A major push towards consolidation in the telecom sector came in the form of the cancellation of 122 2G licences by the Supreme Court in February 2012. Though “achieving consolidation” was not on the agenda when the court delivered its landmark verdict, the move has set the tone for consolidation. The decision has forced several companies involved in the 2G controversy to streamline their operations. Further, incumbent operators are seeking opportunities to acquire or merge with regional players to obtain spectrum and improve profitability by serving a larger user base. As a result, the telecom market size is likely to be rationalised in the coming years.

Guidelines awaited

The telecom sector currently has 13 mobile service providers with some of them expected to opt for consolidation as soon as the final guidelines are in place. Although a key objective of the National Telecom Policy, 2012 (NTP 2012) was “formulating a liberalised M&A policy with necessary thresholds, while ensuring adequate competition”, the government is yet to finalise these guidelines.

In November 2011, the Telecom Regulatory Authority of India (TRAI) had recommended certain revisions to the existing M&A rules to encourage consolidation in the sector. These include:

The resultant entity cannot have over 60 per cent revenue market share in any given circle.

Deals wherein the collective market share of entities upon merger is up to 35 per cent would be automatically approved.

Deals wherein the collective market share of entities upon merger is 35-60 per cent would require TRAI’s approval.

Spectrum held by the resultant entity should not be more than 25 per cent of the total spectrum in a given service area.

These recommendations are awaiting approval from the Department of Telecommunications (DoT). Delays in finalising the M&A policy have compelled several operators to put their plans for collaboration or buy-out on the back burner. Recently, Africa’s MTN Group, which has been planning to collaborate with Reliance Communications (RCOM) in India, has put talks on hold until specific M&A rules are released by the government. MTN was expecting to pick up 20-25 per cent stake in RCOM for $1.2 billion.

In this context, the announcement by the Ministry of Communications and IT to finalise M&A guidelines by end-July 2013 is a positive development.

Besides, the cabinet’s approval to allow 100 per cent foreign direct investment (FDI) in the sector will open up opportunities for global players to enter the Indian market.

These two policies will facilitate consolidation in the industry, which currently has a huge debt burden. Currently, the industry’s total debt stands at Rs 1.8 trillion-Rs 2 trillion, which is likely to increase as the government takes a final decision on spectrum refarming and the one-time fee for holding excess airwaves.

Ongoing consolidation

While policy uncertainty has prevented service providers from merging operations, the market has in fact consolidated around a few players at the circle level. The circle-wise subscriber figures for April 2013 highlight that despite the presence of 10-13 players, over 50 per cent of the market share is held by only the top three players. In circles such as Assam, the Northeast and Jammu & Kashmir, the top three players account for over 70 per cent of the total subscribers. This trend, wherein a handful of players dominate a circle, has gained momentum after the cancellation of 2G licences. The move has resulted in some players exiting the sector and others reducing their footprint by exiting circles in which they had subscale operations. The government has undertaken two rounds of auctions to reallocate the spectrum vacated following the licence cancellation, but the high cost has discouraged new operators from acquiring pan-Indian spectrum. This has resulted in an increase in the collective market share of the top three players in circles that witnessed operator exits. For instance, five operators have exited the Punjab circle, which has strengthened the market position of the top three players in the circle as their collective market share increased from around 52 per cent in April 2011 to about 59 per cent in April 2013.

Besides licence cancellation, another reason for operators downsizing operations in the past few months has been their poor operational and financial performance. For instance, Aircel has shut down operations in five circles while Tata Teleservices Limited (TTSL) has exited three circles, despite having access to spectrum in these service areas. Such companies that own idle spectrum in select circles will become a key target for acquisition. The incumbents, which are currently facing a spectrum crunch on a pan-Indian basis, may acquire these players to improve service provision.

A move towards consolidation is also visible in subsectors such as telecom infrastructure. It is only rational for the ancillary segments to undertake restructuring because it would be challenging for 10-12 tower companies to survive in an industry once the service market size has reduced to five-six players.

Indus Towers, the largest tower company in India and globally, houses the tower assets of Bharti Airtel, Idea Cellular and Vodafone India – the three leading operators in India that together account for over 65 per cent of the industry’s revenues. While the entry of new players in 2008 led to the emergence of several new tower companies, most of these have a small tower base and have been under severe financial pressure following the 2G licence cancellation. Most of their key clients have either exited the sector or have scaled down operations, resulting in revenue loss. Moreover, the response to 3G/4G services, which were expected to drive the next round of growth in the tower space, has been below expectations with operators investing cautiously in these networks.

In this scenario, several tower M&A deals could be in the offing. Recently, the American Tower Corporation (ATC) India made a bid to acquire Tower Vision’s 8,000 towers, which would increase its tower base in India to 18,000. The deal, however, has been put on hold due to a disagreement over asset valuation. Tower Vision is demanding a value of Rs 400,000 per tower, while ATC is offering Rs 300,000-Rs 350,000 per tower. This agreement would be the first deal in the telecom tower space in almost three years and will pave the way for small players with poor finances to consolidate.

Meanwhile, the recent announcement by Bharti Airtel to collaborate with Idea Cellular and Vodafone India to form a joint venture for sharing their fibre network is another move towards market consolidation.

Possible moves

In the long term, as the Indian telecom industry matures, it is expected to witness healthy competition with five to six players per circle. Global experience shows that industry size is an important determinant for the survival of telecom operators and mature markets can support only three to five players. However, given the size of the Indian market, it may easily be able to accommodate six players.

Therefore, several M&A permutations and combinations are expected to emerge across the telecom value chain once the issue of policy uncertainty is addressed. Some of these are as follows:

Big regional players acquiring ailing incumbents: Scaling up of networks for a pan-Indian presence would be the key driver for such deals. Several such transactions are in the pipeline and the industry can witness significant action on this front once the M&A guidelines get finalised. Operators such as Sistema Shyam TeleServices Limited (SSTL) and Telenor whose licences were cancelled, are expected to acquire players like Aircel and TTSL to establish a pan-Indian presence.

 

Incumbents acquiring small players: Globally, an operator is on an average allotted 17-20 MHz of spectrum. In India, a maximum of 10 MHz 2G spectrum is allocated to an operator and that too only in a few circles. Incumbents that are running out of spectrum capacity would want to acquire smaller/regional players. However, these deals are not expected in the near term given the poor financial state of the incumbents.

Small players merging operations: Synergies in business operations are likely to drive such deals. However, instead of a complete merger, operators may combine certain businesses such as infrastructure.

Foreign telecom majors partnering with local players: The Indian telecom market continues to offer significant growth opportunities. The multiple-SIM phenomenon has inflated subscriber figures to high levels whereas the fact is that a large part of the population still has limited connectivity. Relaxation of FDI norms would encourage the entry of global majors in the Indian telecom sector. Operators facing challenges in meeting their debt obligations are likely to offer stake to international players.

Conclusion

The Indian telecom space is ready for an overhaul, and notification of the M&A policy will set the ball rolling for consolidation in the industry.

The sector will witness market correction, leading to the exit of non-serious players and the entry of new foreign players. The majority of the consolidation is likely to take place in the telecom services market while ancillary segments such as tower infrastructure and value-added services will witness some level of restructuring.

 
 
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