Graphic: Ajay Negi/Mint
Graphic: Ajay Negi/Mint

Vodafone sees sluggish growth, thanks to Reliance Jio

At 6.38 billion, Vodafone's impairment charge this time around looks fairly high, at more than double the previous one

Vodafone Group Plc said it was hit by an impairment charge of €6.38 billion ($6.86 billion) with respect to its investment in India. After accounting for a deferred tax asset, the net impairment charge was lower at €5 billion. A little over six years ago, it had written down goodwill and other intangible assets by £2.3 billion ($3.33 billion).

On both occasions, the company cited an increase in competitive pressure, leading to a reassessment of profit growth projections, which led to large write-downs in the carrying value of Vodafone’s India assets. It’s worthwhile noting here that Vodafone had paid a hefty premium while acquiring the India operations in 2007, and it isn’t surprising that the bloated value of intangible assets have to be periodically written down.

Even so, Vodafone’s impairment charge this time around looks fairly high, at more than double the previous one. Note that so far this year, market capitalizations of Bharti Airtel Ltd and Idea Cellular Ltd have fallen by around $2 billion and $3.8 billion, respectively, reflecting the large value erosion in the sector. As such, the large write-down only underscores the troubles the sector is facing.

Six years ago, when the previous impairment charge was taken by Vodafone, it had assumed Ebitda (earnings before interest, taxes, depreciation, and amortization) growth of 17.5% on an average in the five years till March 2015. Interestingly, organic profit growth ranged 15-20% during this period, although it fell sharply to 4.1% in fiscal year 2015-16.

With the entry of Reliance Jio Infocomm Ltd, sluggish growth rates are expected to continue. The growth assumptions for the current impairment testing assume Ebitda growth of 7.8% on an average in the next five years.

“A new entrant has recently launched free trial services for an extended time period and commercial price plans that were at a significant discount to prevailing market pricing, resulting in competitive responses from other operators. This has created a high degree of uncertainty over a range of commercial planning assumptions including future pricing, profitability and market structure," the company said in a statement. This is perhaps the first official acknowledgment that Reliance Jio’s launch has been hugely value destructive.

Strangely enough, despite the diminishing returns from the sector, large companies are increasing capital expenditure to retain market share. As a result, return ratios are falling from already low levels.

The only silver lining, from an investors’ perspective, is that share prices of Indian telcos have already fallen sharply in recent months, and seem to be pricing in a fairly bad future.