where I examined the recommendations of TRAI and showed my readers how it was impossible to achieve a fragmentation of the industry without resorting to unfair means. My column predated the breakout of the 2G Scam, which has hogged headlines for the last few months. It might be useful to read that article, to understand how the industry will evolve now.
Declaimer: This article written was originally in October 2010, and some of the data points may be outdated.
The TRAI Recommendations
The TRAI Recommendations: It is now clear that they will be watered down, one by one. In May 2010, TRAI suggested that telcos pay market rates (based on 3G auction prices) for the 2G spectrum at the time of license renewal. At these prices, the license renewal would have cost the big telcos Rs.20,000 cr each; the new proposals floated by TRAI have already brought the bill down to half that amount. While this itself is a relief, it remains unfair and the telcos will protest it.
The unfairness comes from the assumption that a price discovered in times of artificial scarcity (and post the 2G Scam, we know why), should be used to benchmark license renewal fees and spectrum allocation in an environment that is now far easier.
While the proposal for making spectrum tradeable is progressive, what they will find, after implementing the guideline, is that prices of spectrum will drop steeply, because on the selling side will be the numerous scam-tainted cos who have no customers, and on the buy side, is a set of very limited buyers with very limited purchasing power. The artificial scarcity of spectrum will have gone, and I won’t be surprised if prices even collapse. Remember, 3G spectral efficiency is 2.7X time 2G, so the spectrum needed for the same traffic will have dropped substantially. Already, one co seems to have realized that, because they have approached the Supreme Court with an offer to return the spectrum and the licenses if they can get back the Licence Fee they paid to the DoT. And the deafening silence of the DoT on this request seems to indicate that they know this to be true.
The proposal to cap spectrum seems to have been given a quiet burial. In any case, it would not have stood up to scrutiny in the courts and is so blatantly seen as punishing the successful telcos, that it would have created a public backlash.
As an aside, for those who are interested, it brings out the unfairness of the scam for the leading telcos. You fight a battle for the brand/customer and win fairly, based on superior customer service/ experience, etc. Then an artificial scarcity of your most important raw material (spectrum) is created, and that now-rare commodity is siphoned away to johnny-come-lately, who are seeking a free ride into an industry that has already been opened up, and where latent customer demand is now unhooked. Shockingly, they discover that it takes much more than free spectrum to win the customer, and after entry, they find that the rest of the battle for the customer’s pocket is still way beyond their means. They bleed white and chastened, they are happy to be given euthanasia. I like the burglar, who picks the lock of the tijori/ Treasury, only to find that he has mistakenly stumbled into a snake pit…
That leaves MNP, which came with a bang and went out with a whimper. The limited data coming from MNP shows that the big telcos have superior networks, so there is no ‘hoarding’ of the spectrum. The same cos that are behind on rollout obligations, are scam-tainted, have hoarded unnecessary spectrum, and have kicked off the irrational pricing, are the biggest losers in MNP. The verification of subscriber bases has shown these cos to be fudging numbers to corner the spectrum again. If all this spectrum is taken over and released to those networks that have subscribers, network quality will increase dramatically.
That leaves only one more renegade proposal, which could hit this beleaguered industry. TRAI wants every MHz above 6.2 MHz to be priced at Rs.1769.75 cr. This is to put the more giant telcos at a cost disadvantage, simply because they have more customers and therefore, need more spectrum. This too, does not clear the test of fairness, and may not see the light of day.
The Investment Hypothesis:
The Investment Hypothesis: After the collapse of Nazism, Germany has been defensive about its history for the last 60 years. That is human nature; the most diehard savers just now are no longer in Japan, but in the US and maybe, Greece. The cleanest, most careful policy that you will now see from this Govt, will be in the Telecom sector, trust me!
If this is obvious to us, then we can move on to my next point. We will no longer see the hoarding of spectrum anymore. Further, we will not see any policy from the Govt that pushes up the cost base of the entire industry, reducing it to a backdoor tax collection machine for the Govt. There will be some respect for the impregnably low tariffs achieved by this industry, and the fact that such a cost base fuels many other service and consumption industries.
Now let us look at the competitive scenario. To repeat, MNP has come and gone, and the results have been predictable. The 3G launches have not seen aggressive behavior from anyone, nor are there any big expectations. Most big players will quietly use 3G to improve spectral efficiency and absorb the license costs within their existing profit streams. This is particularly true of Bharti, which will lead the price discounting, as it pays down the 3G and Zain debt. It is the only co that has been paying down debt, about $0.5 bn since my last update.
The PSU telcos have too many problems of their own, with branding and service quality. They were never qualified for leadership, anyway. The battle was between Bharti, Vodafone, Reliance and Idea. Reliance is now known to be facing Balance Sheet stress and is caught in a debt trap, operating above the acceptable Debt: EBITDA ratio with big chunks of debt maturing by the end of FY2012. It will have to place equity, which looks difficult, given that it has FCCBs that are not going to be converted. Even if it places Equity, it will be hugely dilutive, making it an unattractive investment even at these valuations.
Bharti Again: Quietly, its EBITDA run rate has gone back to its pre-Zain days. While the stock has stayed virtually at the same place, it has not suffered the washout that has plagued the broader market in the last 2 months. That is because there was very little expectation built into the price, given the overhang of the Zain valuations, the question marks over the turnaround + revenue/ profit growth at Zain, and the overhang of regulatory imposts embedded in the TRAI proposals.
One by one, these concerns have been dealt with. Zain is back to revenue growth, the tariff wars have abated, EBIDTA is back at Rs.20,000 cr per annum (this time on a revenue base of ~Rs.60,000 cr), and the co’s Free Cashflows of Rs.10,000 cr are being used to pay down debt. While Reliance has Debt: Revenue = 1.5, with lower margins and much lesser Free Cashflow (Debt: FCF= 15 years), Bharti’s debt is at 1-time Revenue, and 5 years’ Free Cashflow. In about 2 years, the debt would have got very comfortable. At 6 times EBITDA, the stock is among the cheapest Telecom stocks in the world, with an attractive positioning in the best growth markets of the world. It is perhaps the most competitive telco in the world, with its ‘minutes factory’ model, and is available at the valuations of a cyclical sugar/ textile co, which typically has Free Cashflow:: EBIDTA = 20% against 50-60% in case of Telecom.
Using Warren Buffet’s principle, Bharti, therefore, is valued at about 60% of its Fair Value over 3 years, i.e. a Margin of Safety of 40%. Believe it or not, it falls into Charlie Munger’s set: if you buy a stock with a sufficient Margin of Safety, the best time to sell it is …..never!!!
Using the Rule of 72, at a 20% growth rate, Free cash flow is doubling every 3 years. Remember, most of the Capex is over, and now the improvements in Network quality, tower population, solar panels for towers, etc. have to be funded. Can you now imagine RCom being able to support all that?
In the next 2 years, we will see this industry consolidate, either by the fading away of some major players (the PSU telcos are prime candidates) or by their restructuring/ merger with other firms.
Is the Joker in the pack? Mukesh Ambani’s Reliance Industries could consolidate the industry, given what it already has (BWA) and an opportunistic acquisition or two, maybe even RCom.
With the end of the regulatory overhang and the New Telecom Policy, one can expect that the end of the uncertainty over the Telecom sector will act as a trigger for a re-rating. You may not have to wait for the fundamentals to play out; just a clearing of the horizon may be enough.