BMI View: Vodafone has received government approval for its plan to buy its minority partners' shares in Vodafone India for a consideration of US$1.6bn. Given the need for sector consolidation in the Indian telecoms market, BMI outlines the three important considerations for prospective investors as well as our outlook regarding the impact of the upcoming elections on the wider telecoms sector.
Overcrowded Telecoms Sector In Need Of Consolidation
| Mounting Telecoms Debt |
The Indian telecoms industry is overcrowded with 15 players, although the top five account for more than 75% of market share. Due to intense price competition, operators face huge downward top line pressures and falling profit margins. This saddles smaller local players - which are not large enough to offset fixed capital expenditure - with huge debt. The end result is mounting industry debts which can only be unwound by a combination of foreign equity investment and industry wide consolidation. The Cellular Operators Association of India (COAI), which represents GSM mobile operators that together service nearly 700mn of the country's 865mn mobile subscriptions, has argued that the regulatory costs - which include service taxes, licence fees, graded spectrum usage charges and revised spectrum variable prices - account for nearly 40% of the customer tariff. This caused EBITDA margins for the industry to fall to 15% in 2012, compared to the 36.5% average in the same period for Asian telecoms sector.
Since the Indian government raised the foreign direct investment (FDI) limit from 74% to 100% in July 2013, foreign investors have moved to shore up their investments. In August 2013, SingTel increased its holding in Bharti Airtel, India's largest mobile phone operator, to 32.34% by buying an additional 3.62% stake for SGD383.6mn (US$301mn). Vodafone's equity injection to buy out its minority shareholders, as announced in December 2013, represents a huge vote of confidence and capital inflow into a sector that is sorely in need of revitalisation. Given the importance of sector consolidation and heightened foreign interest accompanying the change in the FDI limit, BMI highlights three important considerations that would shape the equity buyout trends in the Indian telecoms sector.
Key Indian Telecoms M&A Deals, 2010-2013
| Year || Target || Acquirer || % Shares Acquired || Indicative Enterprise Value (US$mn) |
| 2014 || Vodafone India || Vodafone Group || 35.62 || 1,640 |
| 2013 || Bharti Airtel Ltd || Qatar Foundation QSC || 4.76 || 37,147 |
| 2012 || S Tel Pvt Ltd || SkyCity Foundation Pvt Ltd || 42.70 || 409 |
| 2012 || Vodafone India Ltd || Piramal Healthcare Ltd || 5.50 || 11,249 |
| 2011 || Vodafone Essar Ltd || Piramal Healthcare Ltd || 5.00 || 11,475 |
| 2011 || Hutchison Essar Ltd || Vodafone Group PLC || 22.00 || 10,061 |
| 2010 || SSTL || Russia || 17.00 || 3,000 |
| 2010 || Unitech Wireless Ltd || Telenor ASA || 11.10 || 1,664 |
| Source: Thomson One Banker |
Consideration 1: Slowly Improving Regulatory Environment
| Investors Losing Confidence |
|Indian Telecoms Market Timeline, 2003-2012|
The Indian telecoms market has been the victim of a fluid regulatory environment in recent years. Telecoms-related FDI inflows contracted sharply in 2010 after peaking in 2009; this was a direct result of the controversial review of the 2G spectrum licensing process, which was deemed to have been improperly executed and saw several international players including Batelco, Etisalat DB and S Tel have their hard-fought licences revoked. In 2012, foreign investor confidence reached rock bottom when the Indian Finance Ministry decided to retrospectively tax Vodafone's Indian acquisitions, a ruling which prompted the UK based operator challenge the Indian government in the international courts.
BMI believes the raising of the FDI cap in the telecoms sector marks the start of much-needed improvement to the regulatory environment; nevertheless, we caution that this will be a slow process. From an investor perspective, the increase in the FDI limit is expected to give foreign-based operators such as Vodafone, Telenor and Sistema the option to establish their wholly owned subsidiaries in India to compete with local operators like Airtel and Reliance. Furthermore, the move will help to revitalise the telecoms industry and provide much needed capital in the indicative range of US$10-15bn. Indian investors - Bharti Group in Airtel, Aditya Birla Group in Idea, Tatas in TataTele, Shyam in MTS, Piramal and Vodafone, Reliance in Reliance Infocomm, and Reddys in Aircel - will now be in a better position to sell part or all of their businesses to foreign investors should it become necessary.
From a broader perspective, the Indian government appears keen to shake off its battered international image to attract FDI, following a similar approval to allow British retail giant Tesco to expand into the retail market in partnership with the Tata Group. In BMI's view, this represents a more positive business environment for foreign investors.
Consideration 2: M&A Guidelines Affecting Acquisition Valuation
Long-awaited clarifications to telecoms merger and acquisition (M&A) regulations were delivered by the empowered group of ministers (EGoM) in December 2013, giving further impetus for consolidation in the Indian telecoms sector. The latest M&A guidelines appear to favour consolidation by incumbent operators like Bharti Airtel and Vodafone in the context of new guidelines relating to spectrum pricing. Under the new spectrum pricing recommendation, three scenarios could surface:
An incumbent operator acquires another incumbent operator. In this scenario, because the incumbent acquirer has obtained its 4.4MHz GSM spectrum or 2.5MHz CDMA spectrum at administrative prices as part of its licence agreement, it will not have to pay for those frequencies owned by the target entity. However, the acquirer will have to pay the market price to the Indian government for any additional frequencies the target entity has bought through auctions.
A new operator, which has already bought frequencies through auctions, decides to acquire an incumbent player. In this scenario, the acquirer will have to pay market price for any spectrum owned by the target company.
An incumbent operator buys a new operator. In this scenario, the acquirer will not have to pay anything for the frequencies it inherits through the acquisition.
The difference in spectrum pricing treatment can be traced back to the original licensing process which granted incumbents like Bharti and Vodafone frequencies bundled with licences at administrative prices. BMI believes that the recommendation, if ratified, could dampen M&A activity as it raises acquisition costs. Since spectrum consolidation is the biggest driver for big companies looking to acquire smaller ones, the additional cost involved would make it easier and cheaper for prospective acquirers to bid for new spectrum through auctions rather than endure heightened regulatory scrutiny engendered by the new M&A laws. Possibly, the only firms to benefit are incumbents like Bharti and Vodafone.
That said, the market share limit - revised from 35% to 50% (in terms of subscription figure and revenue) - would increase the leeway operators have to undertake consolidation. Had the government maintained the market share ceiling at 35%, the possible merged entities would have exceeded the market share ceiling in most cases. For instance, the combined market share of Bharti Airtel and Vodafone exceeds 35% in 21 circles by revenues and in 19 circles by subscriber base.
Key Indian Telecoms M&A Guidelines
| || Key Empowered Group of Ministers Decision |
| Market Share of Merged Entity || Up to 50% allowed (in terms of subscriber base and/or Adjusted Gross Revenue) in any telecoms circle; if exceeding 50%, merged entity has a year to lower it to the 50% permitted limit. |
| Lock In Period || 51% promoter's equity lock-in for five years; three-year lock-in for owner's equity to be abolished (applicable for acquisition not merger). |
| Spectrum || Maximum spectrum of the merged entity should not exceed 25% of the total spectrum allocated in the particular telecoms circle; excess spectrum will be returned to the Indian government. |
| Spectrum Price || If an acquired firm has received spectrum at an administrative price, its acquirer will have to pay the government the differential of the administrative price and the market price of the spectrum. If an incumbent operator acquires another incumbent operator, the acquirer will not have to pay for the spectrum obtained as part of its licence agreement. |
| Equity Holdings || No single entity can hold equity of 10% or more in more than one licensee company in the same service area. |
| Source: EGoM. M&A guidelines still subject to further approval. |
Consideration 3: Impact For Telecoms With Upcoming India Election
The upcoming election in April-May 2014 for the Lok Sabha (lower house) poses key downside risks to BMI's core view of an improved business environment for the telecoms sector. We believe most companies will continue to sit on the sidelines in the run-up to the election as operating conditions remain difficult and political uncertainty weighs on the economic outlook. Moreover, the lack of policy clarity from both the ruling Indian National Congress (INC) and opposition Bharatiya Janata Party (BJP) have also weighed on businesses' willingness to invest and spend.
BMI's country risk team has predicted a core scenario of the BJP winning the lower house election. A pro-business BJP electoral win would inject a massive confidence boost to foreign investors. Under the BJP, the FDI limit for telecoms is likely to remain unchanged. However, any new inflow of foreign investment is unlikely to go into green field projects as the Indian telecoms sector is already facing stagnation with approximately 900mn mobile subscriptions in the market currently. We believe most of the consolidation would come from bigger operators buying out smaller entities.
If the INC - the ruling party - retains its majority in the lower house, we would not expect to see a change to the ongoing liberalisation of the telecoms sector. However, the arrival of new players into the Indian market would also be unlikely in the near term following the 2G controversy which took place during the tenure of former minister Andimuthu Raja, as well as the frequent policy changes in the telecoms sector under the INC's jurisdiction.
Overall, the improved regulatory outlook in India's telecoms market, coupled with a finalisation of the M&A guidelines, should provide a modest boost to investor confidence in the much battered sector. The current weak Indian Rupee climate would strengthen the case for cheap valuations for an India-based company. Nonetheless, the overly-complex spectrum pricing policy and the political uncertainty surrounding the upcoming Lok Sabha election should keep most investors on the sidelines until a new ruling party is formed.