News of sector consolidation has created a positive sentiment and hopes of decreasing competitive intensity. We believe that R Jio will continue to be a significant threat to sector profitability, especially for incumbents, on both ARPU compression and subscriber churn. We maintain our ratings on Airtel (Hold) and Idea (Underperform). The fear of tenancy loss due to consolidation at Infratel, ignores the mitigants and an overall stable business model, upgrade to Buy.
Competitive intensity not going down actually, only perceivably
Analysis of the competitive intensity in the market using Herfindahl-Hirschman index (HHI) underlines this difference between perception and reality. HHI plotted on revenue market share shows reducing competition intensity but does not capture the impact of R Jio entry as yet. The same HHI plotted on subscriber market share indicates increasing competition. We believe that even if competitive intensity would perceivably seem lesser with consolidation, it will still not be good news for incumbents.
Will still be a five-player market at best
Over the longer term, even if consolidation were to happen, Indian telecom will still be a five-player market—three large (Airtel, Idea-Vodafone, R Jio), one smaller (R Com combine) and one fringe (BSNL-MTNL). The three equally strong competitors would be equally bad as fragmented competition (as at present) for incumbents. R Jio’s aggressive stance (target of 50% market share) would make market dynamics even worse in the interim before some kind of a steady state is reached, which is still a while away, in our view.
ARPU compression to sustain, revenue and subscriber churn exacerbate problems for the incumbents
Our analysis of the industry ARPU pyramid shows that top 15% of customers account for 44% of industry revenues, a segment that could see a significant ARPU compression given R Jio’s plans and incumbents’ response. Subscriber and revenue share churn would further exacerbate the problems for incumbents. A 1 ppt decline in subscriber market share is a 3-5% impact on revenues across incumbents. Both these factors have started reflecting in slowdown of revenue growth across industry and especially for the incumbents.
Risk/reward favourable for Infratel, upgrade to Buy
The stock has corrected due to potential cell site redundancies from consolidation. Our worst case analysis suggests 15% impact on tenancies and a similar impact on earnings. At the same time, there are mitigants i.e. penalties for tenancy cancellations in an otherwise stable business with good contract visibility, not adequately factored in. In addition, consolidation could accelerate the sale of towers owned by Idea, a positive for the residual cash and capital structure of the company. We tweak our estimates and price target, upgrade to Buy. Dividend yield is >4%.
Maintain view on operators
The run-up in share prices for both Airtel and Idea prices in the consolidation gains, more so for Idea. Airtel stands to benefit more gaining both in market share and spectrum which Idea-Vodafone merged entity would need to give up due to M&A caps being hit. In addition, the merger integration over a longer term could also provide opportunities to further gain share. We change our valuation methodology for Airtel to SOTP, maintain Hold and continue to prefer it over Idea. For Idea, the best case of merger synergies is already priced into the stock now with challenges around integration not completely factored in, maintain Underperform.
Consolidation—boon or bane?
Telecom stocks have seen a significant run-up since the announcement of Idea-Vodafone merger, with consolidation being perceived implying a reduction in competitive intensity. While this might be true intuitively, three large players along with one smaller player and one fringe player would keep the competitive dynamics fairly severe, especially in context of stock expectations. This is especially negative for the two listed incumbents under consideration— Bharti Airtel and Idea.We continue to see risks on both realisation and ARPU for the incumbents with competitive intensity unlikely to fructify the merger synergies for Idea, nor change growth and return dynamics for Airtel.
*We change our valuation methodology for Bharti Airtel to SOTP to arrive at a 12M PT of R380 (from R330); maintain Hold.
*We maintain Underperform rating on Idea with a PT of R90.
*Bharti Infratel has seen a steep correction that under emphasises the steady cash flows and the margin of safety that the business offers; we upgrade to a Buy with PT of R360.
Competitive intensity unlikely to fall with consolidation
To understand the level of competition, we plot the HHI for the Indian telecom industry through the years. If we plot HHI through the years for revenue share in the industry we see that competitive intensity has eased since the licence cancellations in 2012 although it still remains a competitive market place. We also note that the impact of R Jio has not truly started reflecting in the revenue numbers just yet given the free nature of the offer at launch for six months.