The Govt used to try and hold up stock markets by getting the UTI and LIC to buy shares to stem the panic. Next thing you know, the US-64 was brought down to its knees. Then, during the Lehman crisis, the US Govt tried a ban on short-selling. You would have thought that regulators learn from each other, but no, the Germans tried the same thing recently when they tried a ban on short-selling any European currencies/bonds; and brought the house down.
Declaimer: This article written was originally in November 2010, and some of the data points may be outdated.
The US actually went so far as to break up AT&T into the 5 Baby Bells; as far as I know, AT&T is still among the largest 25 cos in the world. Which makes the following story doubly queer….
What are they TRAI-ing to do?
Is TRAI trying to hammer down some self-fangled notions about anti-competitive market structures, or is this a real regulation? Who benefits? It would be very easy to insinuate that they are victims of some devious corporate warfare game, devised by some Strategy Head who does not understand The Art of War (Sun Tzu).
The simple principle recounted in the seminal 3000-year book: in any battle, the DIFFERENTIAL over the crowd is the most important factor deciding the probability of victory, NOT the absolute power. So if there are 100 players with 10 ounces of strength each, then the 101st player with 12 ounces of strength is very valuable; but if there are 10 players with 100 ounces of strength each, then the 11th player with 120 ounces is NOT very valuable. Think about it…..the differential has to be disproportionate to the DISTRIBUTION of strength, not the ABSOLUTE level of strength.
If the short message that we get from the TRAI suggestions, is that ‘they are going after Big Telecom’, then they are doing an expectedly ham-handed job of it. Remember the playing field in Telecom just now: there are 2 giant pan-India brands (Bharti/ Vodafone) together accounting for 57% market share, 1 down-market pan-India brand (Reliance), and 3 regional brands (Aircel/ Idea/ Tata, who will probably be bought out) + 2 dying public sector cos. Plus there are sundry others, who are irrelevant and need to be put out of their misery.
Now let us take the TRAI proposals:
Wants to charge for an extra spectrum and make it sharable/ tradeable.
This is in favor of the biggest players, Bharti/ Vodafone, because they are most likely to have spectrum shortages, especially as they mop up market shares in a post-consolidation marketplace. The one-time charges for past allocations will probably be seen as unfair by the Courts; even if they are not, the total hit is a small part of the cashflows being generated by these players. Except to have a short-term effect on stock prices, they will not do any long-term damage to the cos, because they will be a little blip (2 months in the case of Bharti) in the EBIDTA streams of the co.
Mobile No Portability to be accelerated.
This will be the shocker. When we look back on this, it will be obvious, but we will kick ourselves for not having seen it before. MNP is expected to hit Big Telecom because the cheaper plans of the upstarts will motivate the high-spenders to switch.
But look at actual reality. My (Bharti) phone bills have already dropped 84% over the last 2 years; do I really care about the rest of the 16%? How sensitive am I, to save the rest of the money? Now I will look to maximize Network quality AND brand sheen. And in the Bharti 98100 customer set (the most valuable part of Bharti’s post-paid spenders, as any telemarketer will tell you), WHO would want to switch to the Reliance network, for example? The trade-off will be between Network Quality (on which Bharti/ Vodafone will increasingly differentiate themselves from the rest of the breed, with their DIFFERENTIAL cashflows) and brand sheen, which the Bharti/ Vodafone combination has already built.
The ‘Quality’ Argument
Do a dipstick survey to see if I am making sense. Ask your gardener/ plumber which phone he uses, and whether he would want to keep his no. You will find that the valuable nos are in the 98100/ 98110 series, which are the high-spenders. My phone bills, for example, are 32 times the Indian ARPU of Rs.220, so I must be the kind of customer the telcos are fighting for. Find anybody who spends more than Rs.2000 per month; he is very likely to be from Bharti/ Vodafone and very unlikely to change. But with falling ARPUs, it is very likely that Reliance will lose its price-and-value-sensitive customers, who will find that the Network Quality-at-a-particular-price is a far better value proposition than the poor Network quality + low-end brand at-the-cheapest price that Reliance offers.
The short point:
MNP will be won by the brand wars, as Network Quality becomes a hygiene factor, with little to choose between the top 3 players.
Wants to link 2G spectrum to 3G prices.
Will probably not clear the scrutiny of the courts. As the battle shifts to 3G now, most of the real additional spending will be on data and non-voice products, where Bharti has already reached 17% of total revenues, and Vodafone is at 11%. As this goes to 50%, voice-only players will be squeezed out of the market altogether.
Wants to cap the total spectrum.
This is back to the Licensing Raj, and reeks of desperation. If we have any justice left in the country, this will not stick, and we already have a pre-emptive approach made to the TDSAT, where I think this issue will get decided. You might as well cap the market share that a firm is entitled to, under anti-competition norms.
The other things that the market is saying:
Big Telecom has overpaid for 3G.
Sure, it would have helped if they had got it cheaper, but this is not a setback relative to each other, i.e. all the players have paid similar amounts, especially for the all-India spread that they have captured. Even if they have paid 50% extra, it is only 4 months EBIDTA for Bharti, and a very significant platform for future consolidation has been obtained. So if there is an overpayment, the premium per unit of EBIDTA flows is lowest in the case of Big Telecom.
Bharti vs Reliance: Comfort as a Strategy
Remember, only Bharti is going to comfortably raise the cash, Reliance is already heavily over-borrowed. That is a big differentiator; we saw the ease with which Bharti was able to raise the Zain war chest. With post-Zain EBIDTA and revenues of $13 bn, and similar Debt: EBIDTA profiles (i.e. 3-4 times), Bharti is now 3.5 times the size of Reliance. If it is able to maintain its ROCE with no further setbacks, its yearly EBIDTA will equal the entire capital stock in Reliance.
What does that say for its differential ability to invest in Network Quality, Rural Distribution, solar panels for its cell sites, more towers, and the entire product infrastructure around 3G, besides Digital TV?
With stretched Balance Sheets all around, Bharti is the only one with enough free Cashflow to make a go of it. The returns on the incremental Capex will increase, because of the oldest rule of Investment: in an atmosphere of ‘investment famine’, where Mr. Market has turned away from a sector, product profitability will rise to the point where it will be viable to get the growth debt-funded. That is, the higher the Risk Premium + the higher cost of debt to an out-of-favor sector, will be serviced by higher product prices/ profitability. If you are looking for examples, the Jute industry is a good one.
Counting your Chickens
The market is valuing Bharti at a point where NOTHING is any more expected from it, i.e. at 11 times Forward earnings in an industry where subscriber growth is still coming in at 35%, even the smallest amount of ‘traction’ (i.e. link between customer/ volume growth and revenue growth) will allow Bharti to beat market estimates.
What we know well is that when profits are in short supply, investments are well scrutinized and the money spent carefully. The money goes into places where the demand-supply mismatch is maximum; I expect the biggest investments to be made in towers, rural distribution and brand building, and the building of non-voice applications targeted at the rural markets. This will give Bharti a near-monopoly in the vast rural hinterland, with a very secure, high-cost barrier that will secure its cashflows.
To get a good fix on what will decide the fate of this bruising battle, take a look at the field, stakeholder-by-stakeholder:
- Equity Investors: have valued Bharti at 11 times forward earnings, as compared to 6 for Reliance. The idea is valued at 19 for its M & potential and it’s regional/ niche positioning, but Mr. Market does expect Bharti to outperform.
- Bankers: smarter in general than the typical, marginal retail investor, who is driving stock prices just now. Have taken a long-term view on Bharti, but they don’t seem to treat Reliance the same way. Idea and Vodafone are their other favored clients.
- Employees: one look at the website, is enough.
- Customers: Here it gets a little dangerous. Brand sheen can be created with good advertising, as Vodafone has shown spectacularly. This is the big hope for Reliance; if they can reposition their brand with some good advertising, then I will stand corrected. But I don’t think advertising alone can do it; you will also need a better customer experience, especially in Network usage.
- Suppliers: The differentiators have been created by the Bharti outsourcing model. If somebody can beat them at their own game, watch this lot carefully. But with Bharti scaling this ability up in other geographies like Africa, I would expect this broader reach to enhance their competitiveness rather than reduce it.
- Govt: this really is the joker in the pack. As the government’s most effective backdoor Rural Taxation mechanism, I would have expected the Govt to support consolidation in the Telecom sector. Moreover, as the most likely world-beater coming out of India, with the potential to touch the lives of the entire planet, I would think that it would be India’s most remembered brand. Sigh….!!! On the one hand, you have China using its diplomatic muscle to speak up for Huawei, while on the other, you have a campaign to systematically weaken the Telecom revolution and those who made it happen.
In Favor of Reliance
Probably the biggest indicator that there is some substance to what I am saying, is this new development between the Ambani brothers, where RCom is rumored to be at the center of the rapprochement between them. The elder Ambani has always been excited about the Telecom business and had nursed RCom in its early days.
If RCom needs cash, this is the only place where it can get it, i.e. from friends and relatives. And this would then need to be evaluated afresh because the RIL clout would bring in 2 strengths, that RCom has not had until now:
- The ability to use the enormous cashflows of RIL to buy its way back into the race.
- The ability to ensure a friendly ‘regulatory environment’, the first indications of which can already be seen. A combined Ambani onslaught into the Telecom space, would not be something to laugh at, but they would be starting with a handicap. It would take RCom nearly Rs.15,000 cr just to draw level with Bharti, starting from their 11% revenue share, and their low-end subscriber base (~17% share). Still, it would necessitate a re-evaluation of the situation, because that would create 3 distinct aspirants for market leadership, and divide the steady-state leadership market share into a 30:20:20 matrix, as opposed to a 40:25:10 matrix just now. The 3rd player is an open seat just now. It has usually gone to an innovation leader or niche dominator, which looks more like Idea/ Tata just now. The Art of War tells us that an ex-price warrior (like RCom) usually retires from the race, outstretched because he tries to do too much (i.e. takes on the market leader) with too thin a resource base.
- RIL has not proved itself at winning marketing wars, but is certainly a past master at winning in highly regulated environments, besides having Project and fund-raising skills. Could this turn out to be RIL’s Waterloo? I am sure they will be spending some time thinking about that. The corporate battlefields of the world are peppered with companies that do not know their limitations. The battle for Indian Telecom is now in the international arena, and the brand wars will have to be won in countries where the playing fields may not be fixed.
And what do trends say?
Let us look at some industry trends to understand what is happening. Crisil has estimated that $60 bn will be needed to set up 3G infrastructure. So far, we have had about the same investment ($50-60 bn) invested into 2G, including the Tower business. This has created a market leader like Bharti, earning $3.5 bn in a consolidating market. Industry EBITDA, net of cash losses, would be about $6-7 bn.
For the rest of the investment to make sense, a facile assumption would be that entrenched players have an advantage, and their EBIDTA will double to justify the incoming investment. But the distribution of this EBIDTA growth would be disproportionate; as we can see from the calculation above, Bharti has a 22% subscriber share, 32% revenue share, and nearly 50% share of EBIDTA. We can speculate that its share of Free Cashflow would be running at 70-80%, making it the most likely contender to dominate the 3G space, and then squeeze out the voice players in the 2G space, especially the discount warriors.
Irrationally Rational Investments
I have tried to build a case above, based on the rules of Corporate Strategy. But the joker in the pact would be an ‘irrational’ investment by RIL, to give another lease of life to RCom. That would muddy the waters quite a bit; it would be a bigger setback to Reliance perhaps, than to Bharti, but only time will show that.
For the time being, it means that the steady-state target 3G shares will be divided among 3 players, with some regional satraps, who will anyway want to be bought out.
The industry revenue could double, maybe triple from the current $30 bn. The breakeven point would be a doubling of revenue, but any increase beyond that will be built by the player who builds applications on top of the core telecom revenue (like the Music Download business that sits on the voice business of Bharti).
So think education services in the villages, e-degrees and ‘laptop schools’, price and availability information in the villages, and you have ‘traction’. Suddenly, the rural network will become viable, cutting into transport and freight costs, and making possible things that were not feasible earlier. The co that thinks non-Telecom applications will be the one to get ahead.
The real joker in the pack, (and unseen threat to Reliance) would be a take-off by Zain, followed by a determined Vodafone, using its massive cashflows from other markets, to slug it out in India. The outsider here will be RIL, which has cash, but little knowledge of either technology, marketing, or application development.
As stock prices go, the industry unattractiveness of Telecom will be gone in a little while, and all boats will soon rise with the tide. There will be some hiccups along the way, like the Vodafone tax case could be a potential setback to Vodafone, while some unknowns from Zain would be a setback to Bharti.
But it will be interesting times for sure, in Indian Telecom….