Trai’s call: enough of competition, now it is time for consolidation

Trai’s call: enough of competition, now it is time for consolidation

Investors in Indian telecom stocks are aware of the large regulatory risks associated with these investments. But recommendations of the Telecom Regulatory Authority of India (Trai) on spectrum auction and pricing show the sector’s regulator, along with the government, has the capacity to surprise even the most cautious investor.

Trai’s latest move is a huge policy flip-flop. In 2008, by pricing spectrum cheap, the government had encouraged unbridled competition. In 2012, by recommending a near 10-fold increase in spectrum prices, Trai is effectively calling for consolidation in the industry. In short, Trai is recommending an extreme shift in policy, from one that encourages competition to one that encourages an oligopolistic situation.

Sanjay Chawla, Singapore-based telecom analyst at JM Financial Institutional Securities Pvt. Ltd, says that if Trai’s suggestions are implemented by the government, only the top two-three private sector companies will be able to survive.

Most telecom firms are already loaded with debt due to the high bids they made for the third-generation (3G) spectrum. Needless to say, the few companies that will survive will eventually enjoy pricing power. But the road till there will be painful, which is what telecom stocks are factoring in.

“Trai’s recommendations sound progressive on paper, but do not take into the account the practicalities of (a) the financial health of the sector, and (b) the stage of evolution of the Indian telecom market," says a report by Kotak Institutional Equities.

And there seems to be hardly any business case for new firms such as Uninor, if they have to shell out 18,000 crore to operate on a pan-India basis. It’s quite likely that the auctions will fail if the government sticks to the high reserve prices recommended by Trai.

Be that as it may, it’s worrying that policymakers for the telecom industry are even thinking of such huge policy flip-flops. Investors have no choice but to price in a higher amount of regulatory risk to the sector. “We anticipate a definite move from a low-pricing, high-volume model to a higher-pricing, lower-volume model soon," says the Kotak report. No one would have even dreamt of such a large shift in the industry’s business model.

If the government sticks to these recommendations, Chawla estimates a 50 per share hit on the valuation of both Bharti and Idea, vis-à-vis JM Financial’s target stock prices of 420 and 125, respectively. This is after adjusting for the benefit of lower spectrum usage fees, after the payment of auction-based spectrum prices, but excludes any benefit from an increase in pricing power driven by the exit of weaker players.

In value terms, this works out to a hit of 19,000 crore and 16,500 crore for Bharti and Idea, respectively. Needless to say, the relative hit on Idea is much more. It’s little wonder Idea’s shares declined nearly 5% on Tuesday, while Bharti’s shares fell by less than 2%.

Also See | Warning Bells (PDF)

Graphic by Yogesh Kumar/Mint