Regulatory and policy risks
Historically, regulatory and policy risks have played a crucial role in the credit risk of the players in the Indian telecom industry. Several instances demonstrate this: the introduction of unlimited competition in the cellular and basic services, the opening up of international long distance services two years earlier than expected, and changes in the access deficit charge (ADC) and interconnect usage charges (IUC), are cases in point.
In the past, regulatory actions affected the long-term profitability of the operators and resulted in a heightened perception of event risks. This constrained the ability of the players to access the capital markets. However, the regulatory scenario in the country has changed dramatically since 1999 with the introduction of the New Telecom Policy.
Since then a number of issues have been resolved. These issues include: switching over to revenue sharing, streamlining of revenue sharing, introduction of the third and the fourth GSM operator, resolving of issues related to limited mobility, and introduction of the universal access license. There is increased clarity today on the direction of regulation and policy. This has lowered the risk on the industry as a whole. However, there continue to be areas that still remain unresolved. These are listed below:
Carrier access code (CAC)
In July 2002, the Telecom Regulatory Authority of India (TRAI) directed access service providers to implement carrier selection within 6 and 18 months, for domestic and international long distance calls respectively. Even after the passage of three years, there has been no implementation of CAC. In the new scenario, however, the risk of CAC to the revenues of the integrated players is minimal. This is because, in the absence of standalone national long distance (NLD) players, the incentive for subscribers to shift carriers has diminished. Some access players already have offerings with no long distance costs for calls within certain networks.
At the end of FY2004-05 integrated players accounted for 75% of the total subscribers (fixed and mobile). Moreover, quality of service is not currently a differentiator among the various NLD operators. Hence, the impact of implementation of CAC is negligible in terms of loss of revenues, although some impact is expected in terms of increased marketing costs as players seek to minimise churn of traffic.
Number portability, once introduced, would increase the retention cost of subscribers. The operators would need to differentiate their service offerings to retain their customer base. Further, quality of service would become increasingly important. Thus, the operating costs of companies would increase without any corresponding benefit to the topline. Companies that are not in a position to offer the latest services or upgrade the quality of their networks may experience increased net churn.
The above aspects are factors already identified by the regulator for introduction; however, regulatory risk from unforeseen events continues. The government is working on the New Telecom Policy 2005, which among other things, seeks to introduce a One India Call Rate for local and domestic long distance traffic. The introduction of such a scheme, in the absence of an increase in local call rates, could have a detrimental impact on the profitability of players. This would be especially true for the non-integrated stand-alone access players.
Further, the government aims to achieve 250 million subscribers by 2007 from the current level of 100 million subscribers. This may directly affect the fortunes of the operators, if the government tries to force down subscription costs to achieve the targeted rollout, either through direct tariff regulation or by cutting tariffs through BSNL and MTNL. The improving profitability of the operators, by attracting regulatory scrutiny, has heightened this risk. With more standalone players going for integrated networks, the introduction of the universal licensing regime with a steady reduction in entry fee could increase the risk of competition for existing integrated operators. The introduction of network unbundling and resellers, though currently ruled out, could also increase the levels of competition over the long term.
Competition in the Indian telecommunications industry is concentrated in the mobile segment, where there are up to six operators in some circles. Despite intense competition, the rapid growth of the market has allowed these players to expand their subscriber bases even as they lose market share. This has, however, come at the expense of average realisations, with the ARPUs steadily declining to Rs 391 in 2004-05 from Rs 1,319 in 1999-00. The operating profitability of these companies has improved due to the benefit of increased scales, and declining regulatory costs. However, they still trail the high operating margins of some of the operators in the Asia Pacific like China Mobile.
The profitability of the mobile service operators is expected to increase further, despite a steady decline in average revenues per unit (ARPUs) and expansion into B and C category circles as well as rural areas. This improvement is expected to be driven by a decline in capital expenditure (capex) per subscriber, continued benefits from the improved scale of operations, and an expected decline in regulatory charges.
However, competitive risks continue, with price remaining a key driver of subscriber growth. Going forward, operators could bundle handsets along with airtime, as is the practice in developed markets. This will increase the credit exposures for these companies. The success of the bundled offering would depend on their ability to leverage the scale in procurement while maintaining adequate controls to minimise credit loss.
Further, consolidation is expected: players with financial strength will try to achieve economies of scale through the inorganic route. Currently, there are 11 mobile operators. Consolidation is expected to reduce this number to around five players with pockets deep enough to sustain integrated networks and operations. Competitive pressures would still remain high, since the number of operators per circle would remain higher than that in the other countries in the Asia Pacific region. Further, while the final FDI guidelines have not been issued, entry of strong international telecom players with deep pockets could increase the competitive pressures in the local market.
It is estimated that the telecom services industry will require investments of about Rs 1,00,000 crore over the next five years, to achieve a total subscriber base of 283 million connections by 2010. Of this, around Rs 60,000-65,000 crore is expected to be in mobile services, Rs 15,000-17,500 crore in fixed wireless, Rs 6000-7000 crore in wireline, and the remaining in other services. Given the improving profitability of the industry, a significant proportion of the above, is expected to be generated through internal accruals.
With increased consolidation and higher visibility of the sector, the operators' ability to tap the domestic and international capital markets has improved considerably. The players have also demonstrated their ability to tap vendors for capital through structures that link repayment to the rollout of the network. Operators are increasingly looking at tapping the equity markets which would increase their financial flexibility as well as reduce the fixed element of capital servicing
Though the investment climate has improved significantly, the operators' growth plans are expected to result in negative free cash flows over the short to medium term. Hence, in a scenario of committed capex and lower than expected demand, declining ARPU's and fixed capital charges could impair the financial health of the operators. This risk is mitigated to some extent by the improving cash accruals of the players, lending comfort against increasing debt levels.
The launch of 3G services will require large expenditures. The availability and pricing of spectrum for 3G services are yet uncertain and have a direct impact on the future profitability of these players. The regulator has suggested an entry fee waiver, to reduce the cost of service. While one of the operators has suggested an entry fee, the Ministry of Finance has suggested an auction route. Any fee structure that implies a large fixed element could have a significant impact on the credit profile of the companies. Given the need to provide differentiated service offerings, in an auction scenario, mobile operators may bid high to obtain 3G spectrum and remain competitive. This could have a severe impact on their credit profiles, as the European experience shows. Further, in the event of slow off-take of services, the operator would not be able to recover the fixed costs from the price-sensitive consumers. Additionally, rolling out the 3G network would also involve significant capex. However, players are expected to exercise discretion and undertake incremental rollout to service areas that have the requisite demand and affordability.
Some integrated operators are contemplating rolling out wireline-based broadband services in their respective circles. To increase the mass appeal and make the product successful, the players would have to lower the connection costs to the consumer, thereby extending the payback period. Though the benefit of scale economies would continue to apply, competition from the existing incumbent players through DSL as well as from the mobile operators through 3G, could lead to lower than anticipated returns. The risk is compounded by the requirement to rollout capacities in anticipation of wireline demand.
Though the risks in the telecommunications industry remain, they have reduced considerably from earlier levels. Increased clarity on the regulatory and competition fronts has enabled the operators to plan their rollouts more prudently.
Additionally, the improving financial health of the players has also mitigated the impact of residual risks. The ability of the players to access the financial markets to fund their investment requirements at competitive rates has also improved significantly.
Hence, given the present configuration of risk drivers, it is expected that the Indian telecommunications industry as a whole will continue to show an improving credit profile.