Singapore: Contrary to the popular perception that the entry of Reliance Jio Infocomm Ltd (R-Jio) may hurt the growth prospects of incumbent telecom operators, the new entity will expand the size of the market significantly, and this, in turn, will benefit the likes of Bharti Airtel Ltd and Idea Cellular Ltd, says Suresh Mahadevan, managing director and head of Asian telecom and media research at UBS AG. In an email interview, Mahadevan said the incumbents will gain from increased demand for data, which will boost revenues, margins and returns.
How do you see the entry of R-Jio? How disruptive will it be for Airtel and Idea? And what should the incumbents do to compete and maintain current growth rates?
The launch of R-Jio is likely to accelerate mobile data growth by offering affordable 4G handsets and data prices. Also, India currently lacks fixed-line broadband options anywhere but in the large cities. Therefore, for mass-market subscribers, the first data/internet experience is likely to be on a smartphone over a mobile network. Once data adoption accelerates, we are likely to see a network effect. Airtel and Idea have invested substantially to beef up their 3G and 4G coverage and, thus, they are likely to be the key beneficiaries of this growth. Our forecast is that Airtel and Idea data revenue would grow at 24% and 39%, respectively, for FY17—leading to a mobile revenue growth of 7% and 13%, respectively, in FY17.
Mobile data affordability is increasing due to the steady decline in data prices, the launch of 4G services at 3G prices, and the substantial reduction in prices of LTE (long-term evolution) or 4G devices. Also, mobile data usage is increasing due to high price elasticity, an increase in smartphone shipments and the launch of LTE networks.
We believe the market views the launch of R-Jio as a major threat to incumbents, one in which incumbents are likely to lose out materially. However, in our view, the market is missing the bigger picture, which is rapid growth in data consumption—accelerated by the launch of R-Jio—and the incumbents benefitting significantly. Affordability coupled with improved speeds, following network expansion by operators; favourable demographics; a lack of fixed-line broadband options, particularly in smaller cities, and latent demand from current non-smartphone users—about 68% of mobile users—is likely to lead to a surge in mobile data usage. We estimate the mobile data market will grow from ₹ 264 billion ( ₹ 26,400 crore) in FY15 to ₹ 2,133 billion ( ₹ 2.133 trillion) by FY26—representing a CAGR (compound annual growth rate) of around 21%. Due to the significant growth in the data market size, even if we assign an optimistic 17% revenue market share to R-Jio and a conservative 24% revenue market share for Airtel and 14% revenue market share to Idea, in FY26, Airtel’s and Idea’s data revenue would grow at a 19% CAGR to ₹ 520 billion ( ₹ 52,000 crore) and ₹ 307 billion ( ₹ 30,700 crore), respectively.
There is a possibility that R-Jio might launch ‘all-you-can-eat’ unlimited data and voice plans. However, we expect such plans to be priced higher than the current ARPUs (average revenues per user), given that Indian ARPUs are among the lowest in the world—the average Indian ARPU is less than $3. Even if R-Jio launches such promotional offers at lower pricing, they would be difficult to maintain, given Reliance’s already high investment in R-Jio. Airtel’s and Idea’s mobile data usage increased 5-6x over the past 12 quarters, during which data prices fell by more than 20%. Data usage—although increasing at a substantial rate in India due to the reduction in data prices and growth in data subscriber base—still remains very low when compared with that in other geographies.
Smartphone shipments increased at a rapid rate over the past two calendar years—at a CAGR of more than 50% through 2013-15. We expect this trend to act as a catalyst for further data growth. I believe Airtel and Idea have significant first-mover advantage in the 4G space and will emerge as key beneficiaries of a surge in data usage.
We expect data revenues to grow at CAGRs of 34% and 41% over FY15-18E for Airtel and Idea, respectively. We expect the strong growth in mobile data business to drive operating leverage as the incremental operating costs are substantially lower. While R-Jio is likely to put pressure on data tariffs, the higher volumes as a result of Indian mobile users’ high elasticity will ensure earnings before interest, taxes, depreciation and amortization (Ebitda) margins trend up.
Voice pricing has been stable for the past two quarters, which has also played an important role in lifting margins. We forecast that mobile Ebitda margins for Airtel and Idea will steadily trend higher as data usage improves.
Historically, the benefits of operating leverage have accrued to both Airtel and Idea—mobile revenue CAGRs of 9% and 18%, respectively, over FY12-15 resulted in Ebitda CAGRs of 12% and 29% over the same period, despite a 13-15% decline in data prices.
How do you view the coming spectrum auctions?
I believe both Airtel and Idea may not participate in the 700MHz spectrum auctions because the pricing is extremely high in our view, and the supporting ecosystem is at a nascent stage. Both of these telcos have strong spectrum holdings, particularly Airtel.
Airtel has increased its 4G spectrum bank by acquiring Videocon’s and Aircel’s 1800MHz and 2300MHz spectrums in six and eight circles, respectively, raising its 4G coverage from 15 circles to 22 circles. All major telcos with significant 3G and 4G commitments have high financial leverage, and we believe that capacity utilization remains low in 3G and 4G. The reserve price for the 700MHz spectrum is, at ₹ 114.8 billion ( ₹ 11,480 crore) per MHz, four times the price of the 1800MHz frequency, which we believe is expensive. The 5MHz pan-India block would cost ₹ 574 billion ( ₹ 57,400 crore) which is, respectively, about 2.5x and about 5.0x Airtel’s and Idea’s mobile Ebitda for FY16E.
All of the major Indian telcos have high financial commitments relating, variously, to spectrum payments, including potential upfront payments in the 2016 auctions—other than 700MHz. All telcos also have high financial commitment towards continued 3G/4G LTE infrastructure expansion and they are all confronted with higher opex to support enlarged infrastructure and increased competitive intensity.
Airtel and Idea’s current net debt to Ebitda is 2.5x and 2.9x, respectively, which we believe acts as another limiting factor to bid for overpriced spectrums. The supporting ecosystem for LTE 700MHz is currently at a nascent stage with about 16% of LTE devices supporting the band and this can deter operators from committing substantial capital expenditure to it. Besides, both Airtel and Idea have strong spectrum holdings—Airtel has recently expanded its 4G coverage to all of India, and currently operates 4G services in 15 circles and 428 towns.
Idea is well positioned in its leadership circles—it has 4G spectrum in six out of its eight key circles—totally it has 4G spectrum in 10 circles. It has 3G+4G coverage at 87% of revenue base. We believe the market is pricing in potential bidding for 700MHz by Bharti and Idea in October 2016, which would negatively impact their cash flows. However, after its Videocon and Aircel deals, Airtel has enough spectrum and in unlikely to bid in the coming auctions. We expect only selective bidding from Idea for bands other than 700MHz, with the intent to fill some spectrum gaps.
How do you see the space panning out?
While we believe the R-Jio launch has the potential to disrupt mobile data tariffs, we think there is a high likelihood that the entry of R-Jio will also expand the size of the market significantly, which could benefit Bharti Airtel and Idea Cellular. If data demand accelerates, we could see positive delta to revenues, margins and returns, which could lead to a re-rating for Airtel and Idea. Bharti Infratel also benefits in a data-boom scenario as the firm is well positioned as the tower provider of choice to market leaders. We believe the entry of R-Jio could see some weaker participants such as R-Com, Aircel, Tata DoCoMo and Telenor fail. We believe India’s telcos have a tremendous opportunity in data: data revenue has already grown 5-6x over the past 12 quarters for Airtel and Idea. We expect this trend to accelerate with the launch of R-Jio. We believe both Airtel and Idea are well positioned to benefit from this potential data boom. Infratel offers a low beta option on potential strong growth in India’s data market.
So you are therefore of the view that there won’t be a repeat of 2003 when Reliance Infocomm (later to become Reliance Communications Ltd, or R-Com) was launched?
R-Com’s launch in 2003 resulted in cheap handsets which was unheard of. Airtel and Hutch reacted to R-Com’s promotional pricing and reduced tariffs in H1 CY03 (first half of calendar year 2003). Voice revenue per minute declined significantly from 150 paise in Q3FY04 to 70 paise by 3QFY07.The mobile market subscriber base in India grew from 11 million in December 2002 to 234 million in December 2007. Airtel’s mobile revenues grew from ₹ 14 billion ( ₹ 1,400 crore) in FY03 to ₹ 215 billion ( ₹ 21,500 crore) in FY08. Ebitda margins expanded from 19.5% to 39.8% during the same period... There was also a surge in capital investment made by operators as they expanded coverage in order to monetize increasing voice consumption. During FY03 to FY08, Airtel’s gross annual investment on the mobile business rose from ₹ 8 billion ( ₹ 800 crore) to ₹ 107 billion ( ₹ 10,700 crore). Airtel’s share price rose 42x from December 2002 to December 2007.
The parallels are all there now as RJio will launch by December 2016.
As of December 2015, only 22.5% of Airtel’s and 24.1% of Idea’s mobile subscribers used data services. With the launch of R-Jio likely to drive affordability, we expect these numbers to improve significantly. We forecast 42% of Airtel’s mobile subscribers and 47% of Idea’s mobile subscribers will use mobile data services by December 2020.
We expect data pricing to decline significantly—for both Airtel and Idea we forecast data yields will decline 15%, 14% and 13% during the FY17, FY18 and FY19, respectively. For Airtel, data volume is likely to grow at a 42% CAGR, from 506 petabytes (PB) to 2,032PB, during the period FY16 to FY20. For Idea, we forecast data volume will grow at an over 50% CAGR, from 305PB to 1,563PB, during the period FY16 to FY20. We forecast mobile Ebitda margins will improve for both Airtel and Idea from FY16 to FY20.
We forecast Airtel’s mobile Ebitda margin will expand 320 basis points, from 38.8% in FY16 to 42% in FY20; and we forecast Idea’s mobile Ebitda margin will expand 250 bps, from 32.5% in FY16 to 35% in FY20. Once R-Jio has been launched, we expect Airtel and Idea to re-rate as investors will focus on the rapid growth of data usage rather than on the disruptive impact on the market leaders of the launch of R-Jio.
Paradoxically, while Airtel and Idea benefit from a delayed R-Jio launch, the market has de-rated the share prices of both Airtel and Idea, giving, in our view, long-term fundamental investors an excellent opportunity to own these names.