Telecom companies’ return ratios have taken a beating after their audacious bids for third-generation (3G) telecom spectrum in 2010. Hardly anyone is expecting a repeat when they bid in the 2G auction, slated for this November. Still, even bids at the government-decided reserve price will hit return ratios further.
The government has set the reserve price for the 2G spectrum auction at Rs.2,800 crore per megahertz, about 23% lower than the price recommended by the Telecom Regulatory Authority of India (Trai). Most analysts agree that the price is still too high, especially keeping in mind the high debt position of the industry. Kotak Institutional Equities has put out an insightful report titled How much is the wireless spectrum really worth?, in which it says that incumbents would do well to exercise their option not to bid in the forthcoming auction.
Kotak’s analysts Rohit Chordia and Shyam M. say that the only scenarios where bidding at close to the reserve price will make sense are as follows—firms settle for a shareholder value-destructive return expectation, such as a 10% pre-tax return on capital employed (RoCE), while still estimating industry revenue to grow to 2.3 times current levels, operating margin to double from current levels, and asset turn ratios to improve. If one were to build in a half-decent return expectation such as a 15% pre-tax RoCE, revenue will have to grow to 2.7 times the current levels, operating margin to 2.3 times and asset turn to double.
The report adds, “As a stretched aside, turning realistic about our assumptions, the current industry scenario (revenue of Rs.1.5 trillion, OPM of 17%, net fixed assets turn of 0.6 times) throws a negative Rs.1.6 trillion value for spectrum to generate 10% RoCE. In essence, this industry needs some sort of viability gap funding (like certain infra projects do) or at least free spectrum (like the erstwhile coal block allocations in India) to generate even a positive RoCE in the current structure.”
But like they did with the 3G auction, if individual companies decide to bid aggressively, expecting that they will be able to garner a disproportionately higher share of revenue and profit from a particular circle vis-à-vis their spectrum payout, it will be hugely value destructive for the sector. Needless to say, banks that decide to fund these bids will also be taking a big risk.
Of course, one will know only when the auctions actually take place. Another unknown factor is whether the prices discovered in the November auction will be set as a base for spectrum renewals of incumbents, which will start happening from the end of 2014.
Based on the current available details, the government’s recent decisions are clearly negative for the sector. While its decision to allow companies to make staggered payments will provide some relief, the government is likely to keep the net present value of its inflow intact by mandating a high discounting rate. As a result, from a net present value perspective, telecom companies will not gain. Besides, while Trai had suggested a cut in spectrum usage charges, the government has retained the current charges.