Vodafone Group Plc’s Rs47,700 crore ($7.2 billion) equity infusion in its Indian unit is massive. For perspective, with those funds it can purchase all of Idea Cellular Ltd and Reliance Communications Ltd’s equity shares (at current valuations), and still be left with nearly a billion dollars.
It’s a clear message to Reliance Jio Infocomm Ltd—incumbents have deep pockets, too. For investors, though, the takeaway is that a bloody war in the sector is increasingly probable.
Consider the timing of Vodafone’s announcement. In about a week’s time, Indian telecom service providers will start bidding in the largest ever auction for spectrum in the country.
Vodafone said in a statement, “The equity infusion will enable Vodafone India to continue its investments in spectrum and expansion of networks across various technology layers."
In the previous two auctions, i.e. 2014 and 2015, companies ended up spending Rs1.7 trillion in acquiring renewal as well as fresh spectrum. On the one hand, much of this has been financed through debt, leading to high leverage in the sector. But worse still, revenue and profit growth haven’t kept pace with these accelerated investments, and return ratios of these companies have suffered. Importantly, growth in data revenue has slowed.
The silver living in the 2016 auction is that unlike the previous ones, incumbents needn’t worry about renewal spectrum. Besides, thanks to Bharti Airtel Ltd’s aggressive spectrum purchases from small companies such as Aircel Ltd, it is sitting on a fairly comfortable position, especially as far as its broadband spectrum holdings go.
Yet, while these factors should ideally result in rational bidding for the spectrum, it isn’t something that can be taken for granted. “Rationality has not been the hallmark of the Indian wireless sector for the past many years, and hence, how much ever we would like to call out a rational outcome for the 2016 auctions, we would stay shy of doing so," analysts at Kotak Institutional Equities said in a recent note to clients.
Irrational behaviour, in their book, would include bids for the ultra-expensive 700 megahertz (MHz) spectrum, especially in the metros and other large markets; or bids that are 1.5 times or more higher than the reserve price in any non-700MHz spectrum. With Vodafone flexing its financial muscle just ahead of an auction, it’s fair to say that fears of irrational bidding aren’t totally unfounded
Of course, this is not to say that this worst-case scenario will necessarily play out. Vodafone may well choose to be judicious and buy only the spectrum necessary to plug the gaps in its portfolio. According to analysts at JM Financial Institutional Securities Ltd, the average broadband spectrum holding of Vodafone India on a per circle basis is just 5MHz, far lower than Bharti and Jio’s holding of 22MHz each.
Vodafone is clearly underinvested as far as spectrum assets go for servicing growing data needs. Also, to compete with Jio, investing in 4G services is key and the company can be expected to fill the gaps in its spectrum portfolio, at the least, in the coming auctions. According to analysts at Bernstein Research, Vodafone would need to spend about Rs17,500 crore on spectrum for a pan-India 4G presence.
With the large equity infusion Vodafone has received, it is clear that its parent company wants to take whatever steps are necessary to retain its customers, especially those that generate high Arpu (average revenue per user). Of course, what this means consequently is that the fight to gain market share will get tougher for Jio, which can result in a further downward revision of prices.
So whether Vodafone and other companies bid irrationally in the forthcoming auction or not, return ratios of the sector look set to fall in any case. The law of diminishing returns appears to be at work in the sector.