The Indian Telecom sector has been under pressure for the last 8 years because of rising competitive and capex intensity. During this period the contribution of telecom services to GDP has declined from 2% of GDP in FY09 to just 1.2% in FY17. The return ratios for the telecom players has also consistently declined during the period and all the telecom companies do not manage to earn their cost of capital because of continuous investments in spectrum purchases. While competitive intensity has changed with entry and exit of players, the capex intensity has consistently risen because of spectrum auctions. The industry at this juncture is at its weakest because of the high degree of financial leverage and margins impacted by rising competition from new player Reliance Jio. In the current state, the industry has insurmountable challenges which are leading to huge wave of industry consolidation.
Industry structure is a key determinant for profitability
In the pre 2008 era, the Indian telecom industry was one of the most lucrative markets marked by high growth rates and reasonably concentrated market. Spectrum was not auctioned but given on subscriber-linked criteria. The system was not perfect and it could be gamed by telecom operators. This led to flurry of new entrants in 2009 which led to significant crash in tariffs and sharp decline of telcos profitability. After the crash in tariffs (which never recovered), the rising capex for spectrum led to increase in financial stress which has limited the incumbent telcos ability to invest. Thus with the entry of Reliance Jio, industry consolidation to augment capacities is the only viable solution. The industry in totality has over capacity and the only way the demand versus supply will match in the future is through industry consolidation.
Where do we go from here?
The industry is now composed of three sets of players:
1) Established incumbents like Bharti, Vodafone and Idea Cellular which have executed well in the past and have strong brands. Vodafone merger with Idea will solve the capacity constraints of both the players
2) Weaker players like Telenor, MTS, RCOM, BSNL, MTNL and Aircel which are exiting or are consolidating for survival. Even after consolidation, the operators ability to invest will pose a challenge
3) Reliance Jio which has defined the technological and strategic landscape.
In future, the industry will see slower investments and more consolidation. With so much supply in the market, revenue will grow with usage albeit with a lag. We expect 11 per cent revenue CAGR over the next 5 years but most of the growth will be back ended post industry consolidation. The weaker players will have to exit but their debt presents a structural problem for an exit. In this regard, the government might need to step in to improve the industry profitability to ease the exit of players and solve the structural debt issue. The government has many levers to improve the industry profitability which include reducing service tax to spectrum usage charges. All or any of these measures can improve the industry profitability significantly.
Finally, little help from regulator
The Indian telecom industry is at a critical juncture and faster improvement in profitability will be crucial for long-term health of the sector. Industry consolidation is critical but government interventions to improve industry profitability will help the sector immensely. The Indian telecom sector has immense potential for growth but realising the potential is in the hands of government and regulator.