IUC cut: An aggressive Reliance Jio a big worry for Airtel, Idea2 min read . Updated: 20 Sep 2017, 08:29 AM IST
The IUC cut will result in massive savings for Reliance Jio, giving it room to launch competitive tariff plans to counter Airtel, Vodafone and Idea Cellular
Mumbai: The Telecom Regulatory Authority of India (Trai) has cut interconnection usage charges (IUC) levied by telecom firms by 57%, adding that termination rates will be abolished in early 2020. While a cut in IUC was widely anticipated, the announced cuts are ahead of what the Street had expected.
This is a big win for Reliance Jio Infocomm Ltd. Analysts at Kotak Institutional Equities estimate Jio’s net spend on account of IUC to be in the region of Rs7,000-7,500 crore annually. Large incumbents such as Bharti Airtel Ltd, obviously, stand to lose a large chunk of this revenue stream, which contributes about 14-18% of their operating profits.
But the far bigger worry for incumbents is the secondary impact of the IUC cut. This depends on what Jio plans to do with the massive savings. Analysts at JM Financial Institutional Securities wrote in a note to clients, “Jio may use the lower mobile termination rate to introduce unlimited voice calling at the Rs100 price point (vs Rs153 currently), to gain subscriber market share more rapidly."
This will prove to be a double whammy of sorts for the incumbents. A cut in IUC essentially means that they now need to recover a greater share of their costs from their own customers. But leave alone being able to raise tariffs, they would most likely be forced to drop tariffs. As such, the IUC cut will have a cascading impact on the revenues of incumbents.
Based on data submitted by Bharti Airtel Ltd and Idea Cellular Ltd to the regulator, net income from IUC amounted to between 14% and 18% of their wireless businesses’s operating profit. As a result, the operating profit of their wireless businesses could decline by 8% and 10% respectively.
According to analysts at Kotak Institutional Equities, net income from IUC contributed 11% and 16.3% respectively to the operating profit of these companies, which suggests a slightly lower impact.
Besides, it’s important to note that Bharti Airtel has some buffer thanks to its non-wireless businesses, which means the impact on its consolidated profit will be even lower.
Airtel and Idea shares have fallen by 9-10% from their highs in late August, which, according to an analyst at a multinational brokerage, more than adequately captures the negative impact of the IUC cut. Of course, it’s too early to gauge the extent of the secondary impact owing to Jio’s pricing aggression; but it’s safe to assume that this impact will be greater.
Meanwhile, shares of Reliance Industries Ltd, Jio’s parent, have risen over 9% since end-August, which also seems to capture the immediate upside from IUC.
As such, the company’s shares might not react sharply to the news when trading resumes on Wednesday; although, investors should note that the event is a significant milestone for the industry, as it points to a far higher regulatory risk for incumbents than was earlier anticipated.
Mark to Market writers do not have positions in the companies they discuss.