Industry report: Telecom · launch of Reliance Jio (RJio) operations, which is characterized by...

Industry report: Telecom - subdued return on investments : a key concern for the industry

12th March, 2019

Table of contents Outlook ……………………………………………………………………………………..….…. Industry profile ………………………………………………………………………………… Three major players ………………………………………………………………….……… Telecom subscription: Robust growth over the last decade ……………… Internet subscribers: Witnessing a fast paced growth ……………………… Industry gross revenue ……………………………………………………………..……… SWOT analysis ……………………………………………………………………………..…… Sectors in telecom industry …………………………………………………..……….… Telecom spectrum: Basics ……………………………………………………….…..…… Spectrum allocation structure ………………………………………………………..… History of telecom since 1994 ……………………………………………………..…… National digital communication policy, 2018: Roadmap to 2022 …….… Revenue-cost model of telecom operators ………………………………….…… Burdensome spectrum costs ……………………………………………………….…… A look on TRAI recommendation on 5G Spectrum ……………………….…… Industry transformation: After Jio ………………………………………………….… Tower sector ……………………………………………………………………………….…… Rural India: New opportunity …………………………………………………………… Internet of Things (IoT): A game changer for telecom industry? ……..… Key challenge for 5G implementation …………………………………………….… Key takeaways …………………………………………………………………………………..

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19

21 23 24

25

26

27

30

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35 36

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Sector outlook

Muted subscribers growth • Total telecom subscriber growth was modest at 2% CAGR over Dec. 16-18 to

reach 1.2bn by 31st Dec. 2018 - translating into a pan-India tele-density of 91.5%. Rural subscriber base increased by 6.5% CAGR over the same period, while urban subscriber base declined by 1.2% CAGR. Urban and rural tele-density stood at 160% and 59.5%, respectively, by Dec. 2018.

• Going forward, overall subscriber growth would remain muted or it could slightly decline with the consolidation in the subscriber base through the implementation of minimum recharge plans initiated by the incumbents.

Anticipating stability in ARPU • Mobile operators average revenue per unit (ARPU) is on decline since the

launch of Reliance Jio (RJio) operations, which is characterized by aggressive pricing strategy so as to acquire large chunk of subscriber market share. However, in last quarter the incumbents arrested the falling ARPU and reported flat ARPU on sequential basis. This was mainly due to the elimination of low ARPU or only incoming call customers through minimum recharge plan. This can be considered as an initial signs of stability in ARPU, however further improvement could be driven by competition.

• Off late, the incumbents have shifted their focus from market share retention to return on capital, which can be accretive for ARPU. On the contrary, we believe that RJio with its profitable operations and group financing capabilities would continue to keep its pricing level attractive till it attains a significant subscriber and revenue market share. Thus the sector would continue to struggle for at least next 6-9 months for attaining a serviceable ARPU levels.

Industry gross revenue to rise gradually • Historically, telecom industry gross revenue growth was in-line with

subscriber base growth. However, post the entry of RJio, gross revenue declined from USD 40.3bn in FY16 to USD 39.5bn in FY18 and USD 16.6bn in H1 FY19. The fall in revenue was despite the growth in the overall subscriber base and can be attributed to RJio’s dirt cheap pricing of mobile services. Historically, too the industry gross revenue was in declining trend with respect to the GDP. It has declined from 2.5% of GDP in FY10 to 1.5% in FY18. For FY19E, we are estimating a gross revenue of USD 34.8bn (1.24% of the GDP), a decline of 12% over FY18.

• Gross revenue is likely to recover from losses sustained in past two years to cross USD 40bn in FY21 and USD 45bn in FY22. The reason behind this increase can be attributed to the possible increase in ARPU along with increase in 4G subscriber base.

Improving ARPU to aid in margin expansion • In FY18, the sector witnessed pressure on the profitability, primarily due the

emergence of RJio. In FY18, Airtel reported around 7ppts contraction in EBITDA margin, while VIL reported a 6ppts contraction. In current fiscal too, these incumbents faced pressure on the profitability with Airtel and VIL reporting 8ppts and 10ppts Y-o-Y contraction in the margin, respectively.

• However, with initial signal of ARPU expansion and incumbents focus on return on capital, we are anticipating a modest expansion in the margin on sequential basis. Additionally, with further pricing stability in the sector in mid-term, we are expecting a relatively better profitability in the subsequent years. Operators with higher share of 4G subscribers, are likely to gain more from the revival in the industry profitability.

Elevated debt levels • Coming to industry debt level, operators interest burden have increased to

more than double after FY15 due to high spectrum prices set by government. With high interest costs along with decline in realizations, many private telecom operators either left the industry or merged with others. The companies who survived were left with high leveraged balance sheet. Although, the government in Mar. 2018 enhanced the number of annual installments for spectrum payment from 10 to 16 years, the financial position of the telcos continue to be in stress.

• Moreover, with continued nature of capital expenditures on improving network infrastructure without any significant improvement in the realization, the industry debt is likely to remain at elevated levels, unless certain measure are taken to deleverage it.

Debt reduction plans • The aggregate net debt of Airtel, VIL and RJio at the end of current fiscal is

estimated to be more than Rs. 3tn, implying net leverage of over 7x for the sector. Telcos are planning various deleveraging initiative like equity infusion or asset monetization in the near term.

1,207 1,191 1,206 1,169 1,191

0

500

1000

1500

Sep 17 Dec 17 Mar 18 Jun 18 Sep 18

Total mobile subscribers base (mn)

Airtel VIL RJio

TTM EBITDA (Rs. bn) 259 37 135

Net Debt (Rs. bn) 1,033 1,066 1,121

Net Debt / EBITDA (x) 4.0 28.8 8.3

Our top pick (Rs. bn) FY17 FY18 FY19E FY20E FY21E

Bharti Airtel Ltd. (CMP: 334; TP: 390) Net Sales 954.7 836.9 818.7 875.2 944.6

EBITDA 352.0 300.4 258.4 291.3 346.8

PAT 38.0 11.0 (10.7) (14.2) 3.7

EPS (Rs.) 9.5 2.7 (2.7) (3.6) 0.9

EBITDA Margin (%) 36.9% 35.9% 31.6% 33.3% 36.7%

PAT Margin (%) 4.0% 1.3% -1.3% -1.6% 0.4%

RoE (%) 5.1% 1.4% -1.4% -2.0% 0.5%

RoCE (%) 9.2% 6.4% 2.7% 3.6% 5.3%

P/E (x) 36.8 145.1 (124.2) (93.7) 358.7

P/B (x) 1.9 2.0 1.8 1.9 1.9

EV/EBITDA (x) 6.7 8.1 8.8 8.2 7.2

Source: Choice Broking

280.1

77.1

75.3

0 100 200 300

RJio

Airtel

VIL

4G subscribers (mn)

39.1

38.8

41.7

40.3

40.9

39.5

34.8

38.6

42

.8

47

.5

0.0

10.0

20.0

30.0

40.0

50.0Telecom gross revenue (USDbn)

80

110

140

170

Sept 17 Dec 17 Mar 18 Jun 18 Sept 18 Dec 18

ARPU (Rs.)

Airtel RJio Idea

• For instance, Airtel is planning to raise as much as Rs. 320bn through equity and bond sales, which would mainly be utilized to pare its debt. Additionally, it is planning to monetized assets to buid its 4G war chest. While, RJio’s parent company i.e. Reliance Industries Ltd. (RIL) is looking to spin off its telecom infrastructure business in an effort to reduce debt and overall liabilities. Brookfield Asset Management, one of the world’s top infrastructure and private equity investor is in early talks to buy a controlling stake in RIL’s telecom tower & fibre assets valuing it over USD 15bn (Rs. 1.1tn). Similarly, on the lines of Indus Tower, Airtel and VIL are also looking to form a JV company, which will house their fiber assets. The intention behind this move would be asset sharing and possible monetization in future to pare debt. Considering the above moves, we are cautiously optimistic on the deleveraging exercise of the telcos.

High 5G spectrum prices, a knife on wound • There is a huge debate going on globally with the rollout of the next

generation mobility technology i.e. 5G. US has taken the lead by rolling out 5G services in certain areas, China and South Korea would be the next to test and rollout the 5G services. According to the Mckinsey, globally 5G rollout would take until 2022. In India, the government is planning to auction 5G spectrum in this calendar year, but the incumbents are reluctant to participate citing high spectrum cost. Despite acknowledging the high leverage position in the industry, the industry regulator has set an exorbitant high price for 5G spectrum, which is around 6.9x the price discovered in the South Korea auction.

• As far as the rollout of 5G services is concerned, it is likely to be delayed until there is required infrastructure, networking equipment and mobility devices. The much talked about use of 5G is IoT, which is a long term play and its mass application depends upon the pricing. Initial rollout of 5G service would be an enhanced version of 4G, and will be characterized by high speed. We are not anticipating any significant jump in the industry revenue from 5G in the initial couple of years, while the future growth would depend on its mass adaptability.

What we expect from government • We are of the opinion that government should wait for the improvement in

the leverage position of the telcos and defer the spectrum auction by a year. However, if they plan to do this fiscal, then it should be at a rational pricing level with enough availability of the spectrum. Otherwise, the operators would end up paying high price in the scarcity of spectrum. As of FY18 end, spectrum liabilities formed around an average of 70% of the long term debt of the top three players. Thus a higher 5G spectrum price would add to the existing liabilities thereby further deteriorating the financial position of the companies.

Conclusion • Considering the above points, we expect positive changes in the industry

due to its inclination towards recovery - which can be characterized by the operators focus on returns (viz. increasing ARPU) as well as their plans to pare debt (viz. asset monetization, asset sharing, fund raising, etc.). With these strategies, operators would be in a position to strengthen their countrywide 4G networks along with margins expansion. However, profits are contingent to the operators whose focus is on both ARPU expansion and maintaining the market share. On spectrum liabilities, without government support (i.e. lower spectrum prices and other levies) the operators especially the incumbents may not come out of the debt trap.

• In growth terms, we are positive on RJio (as its affordable plans with value added services would continue to attract new subscribers), neutral on Airtel (with its highest proclaimed 4G speed, it may retain 4G subscribers but due to less affordable plans it may not add much subscribers) and negative on VIL (less aggressive in maintaining subscriber base). In margin terms, we have a stable view on RJio, neutral on Airtel (maintained 4G subscribers along with focus on high ARPU and debt reduction), negative on VIL (although the company is realizing its synergy benefits & has plans to pare its debt, we are not confident on its margins until company make any tough plans to increase its 4G base).

• Profitability of the RJio cannot be compared with other players, as it is following a different account principle on depreciation as compared to its incumbents. Also, its business model is largely focused on aggressive marketing offers, which is not sustainable in long run. On de-leveraging front, RJio can only accomplish this by bringing in strategic investors for its mobility and or its associated passive infrastructure business. No strategic investor would enter this hyper competitive low margin business, unless there is an action plan from RJio to de-leverage its balance sheet.

Considering the above observations, we assign a “Neutral” view on Airtel, while “Negative” view on VIL.


544.7

351.9

569.4

83.6%

57.4%

68.3%

0%

50%

100%

0

200

400

600

Airtel RJio VIL

Long term borrowings as on FY18 (Rs. bn)

Sprectrum liabilites as percent of long termborrowings (%)

5G spectrum price comparison

South Korea

UK Ireland Spain

Auction completion date

1-Jun-18 1-Apr-18 1-May-17 1-Jul-18

Operator SKT O2 UK Three

Ireland Vodafone

Spain

Spectrum band 3.5GHz 3.4GHz 3.5 /

3.7GHz 3.6 /

3.8GHz

Spectrum purchased (MHz)

100 50 100 90

Spectrum purchase cost (USD mn)

1,100.0 447.5 17.2 231.7

Price per MHz (USD)

11.0 9.0 0.2 2.6

Price per MHz (Rs. mn)

715.0 581.8 11.2 167.3

Proposed 5G spectrum price in India (Rs. mn)

4,920.0 4,920.0 4,920.0 4,920.0

India price as a multiple of others (x)

6.9 8.5 440.1 29.4

Subscriber market share

CY Airtel Vodafone Idea RJio

2015 23.8% 18.7% 16.6%

2016 23.4% 17.8% 16.5% 6.3%

2017 24.7% 17.9% 16.5% 13.5%

2018 (till Sept.) 29.2% 36.5% 21.2%

Revenue market share

CY Airtel Vodafone Idea RJio

2015 31.6% 18.9% 23.0%

2016 33.1% 23.5% 18.7%

2017 28.0% 20.7% 17.3% 19.7%

2018 30.0% 31.4% 29.7%

Industry profile

• The Indian telecom industry is second largest in the world after China in terms of number of subscribers. • Domestic telecom sector has witnessed a substantial increase in the number of subscribers in the last decade. At the end

of Dec. 2018, the overall telecom subscriber base has reached 1,197.9mn with an average increase of 1.25% Q-o-Q since Apr. 2015. India’s overall tele-density was 91.5% in Dec. 2018. However, rural tele-density was only 59.5% as compared to urban tele-density of 160%.

Particulars Wireless Wireline Total

Total telephone subscribers (mn) 1,176.0 21.9 1,197.9

Urban 647.5 18.8 666.3

Rural 528.5 3.1 531.6

Overall tele-density (%) 89.8 1.7 91.5

Urban (%) 155.5 4.5 160.0

Rural (%) 59.2 0.4 59.5

Broadband subscribers (mn) 500.4 18.2 518.6

Source: TRAI data as on 31th Dec., 2018

55.6%

44.4%

Urban & rural share in telecom subscription (Dec. 18)

Urban

Rural

98.2%

1.8%

Wireless & wireline share in telecom subscription (Dec. 18)

Wireless

Wireline

29.2%

36.5%

21.2%

10.5%

2.7%

Airtel

Vodafone Idea

Reliance Jio

BSNL

Others

Telecom operators subscriber market share (Sept. 18)

55.0%

21.4%

20.8%

2.3% 0.6%

Reliance Jio

Vodafone Idea

Bharti Airtel

BSNL

Others

Telecom operators market share in wireless broadband (Sept. 18)

Source: TRAI, Choice Broking

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• The sector has witnessed exponential growth in last decade on account of affordable tariffs & mobility device, wider availability of network, leading to expanded subscriber base in 3G & 4G segments.

• India ranked second in world after China in terms of number of internet users with over 462mn users as of Jan. 2018. According to Google, India is adding nearly 10mn active internet users every month - which is the highest rate of addition to the internet community in the world. The availability of low-cost smartphones, tablets and customer friendly data tariffs is driving internet penetration across urban, semi urban and even rural areas.

Internet broadband subscribers Per 100 population

Total internet subscribers 42.9%

Urban internet subscribers 88.3%

Rural internet subscribers 21.8%

• Indian smartphone users in India surpassed 400mn mark in Jun. 2018 and is likely to cross the 500mn mark in the next four years, a report by industry body IAMAI. However, still more than 75% of the cell phone users rely on feature phones that work on a 2G or 3G platform.

• Mobile industry contributed 6.5% to India’s GDP while providing direct and indirect employment to 4mn people in 2015. The industry has also been one of the fastest-growing sectors in the country with a 7.3% CAGR over the last decade. An ICRIER study recently pointed out that a 10% increase in the rate of growth of Internet subscribers will result in a 2.4% increase in the GDP rate.

Three major players Vodafone Idea Bharti Airtel Reliance Jio

Mobile subscriber base

Q3 FY19

387mn 284.2mn 280.1mn

Visitor location register 93.3% 98.7% 83.6%

Average voice consumption per user per month 580min 726min 794min

Data subscribers 146.3mn 107.5mn 280.1mn

4G subscribers 75.3mn 77.1mn 280.1mn

Average data consumption per user per month 6.2GB 10.5GB 10.8GB

ARPU Rs. 89 Rs. 104 Rs. 130

Revenue

TTM

Rs. 314,548mn Rs. 806,560mn Rs. 361,360mn

EBITDA margin 11.8% 32.1% 37.3%

PAT margin -34% 0.5% 7.3%



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Peer comparison

Company Name Face

Value (Rs.)

CMP (Rs.)

MCAP (Rs. bn)

EV (Rs. bn)

Stock Return (%) Subscriber base (mn)

TTM Total Operating Revenue (Rs. bn)

TTM EBITDA (Rs. bn)

TTM PAT

(Rs. bn)

TTM EBITDA Margin

(%)

TTM PAT

Margin (%)

1 M 3 M 6 M 1 Y

Bharti Airtel Ltd. 5 334 1,334 2,367 6.6% 15.0% -12.2% -17.0% 403.7 807 259 4 32.1% 0.5% Vodafone Idea Ltd. 10 34 298 1,364 10.2% -0.3% -26.1% -56.7% 387.0 315 37 (107) 11.8% -34.0% Reliance Jio Infocomm Ltd. "*" 1,428 280.1 361 135 26 37.3% 7.3% Bharti Infratel Ltd. 10 319 590 536 -1.1% 26.6% 17.7% -4.4% 68 31 25 46.1% 36.5%

Company Name EPS (Rs.)

BVPS (Rs.)

DPS (Rs.)

Debt Equity Ratio

Net Debt / EBITDA

(x)

Fixed Asset Turnover

Ratio RoE (%) RoCE (%)

P / E (x)

P / B (x)

EV / Sales (x)

EV / EBITDA

(x)

MCAP / Sales (x)

Earnings Yield (%)

Bharti Airtel Ltd. 1.0 191.1 2.5 1.5 4.0 0.5 0.5% 2.6% 346.3 1.7 2.9 9.1 1.7 0.3% Vodafone Idea Ltd. (12.2) 79.6 0.0 1.7 28.8 0.2 -15.4% -4.0% (2.8) 0.4 4.3 36.8 0.9 -35.8% Reliance Jio Infocomm Ltd. "*" 0.6 22.9 0.0 1.4 10.6 0.2 2.6% 5.4% 0.0 0.0 4.0 10.6 0.0 Bharti Infratel Ltd. 13.5 81.2 14.0 0.0 (1.7) 1.2 16.6% 13.0% 23.7 3.9 7.9 17.1 8.6 4.2%

Source: Choice Broking; Note: “*” is an unlisted company

Bharti Airtel Ltd.

Bharti Airtel Ltd. (Airtel) is a leading global telecommunications company with operations in 16 countries across Asia and Africa. Headquartered in New Delhi, the company ranks amongst the top three mobile service providers globally in terms of subscribers. In India, Airtel’s product offerings include 2G, 3G and 4G wireless services, mobile commerce, fixed line services, high speed home broadband, DTH, enterprise services including national & international long distance services to carriers. In the rest of the geographies, it offers 2G, 3G & 4G wireless services and mobile commerce. It had over 403.7mn customers across its operations at the end of Dec. 2018. Its domestic mobile subscriber base stands at 284.2mn in Dec. 2018 from 347.5mn in last quarter, a decline of 18% Q-o-Q. The company faced a churn of more than 48mn non-paying subscribers in quarter ending Dec. 2018, after it started charging Rs. 35 as a minimum amount from user for staying active on the network. The numbers are likely to drop further as the company suspended the network service (outgoing calls) to people with low balance. On account of this strategy, Airtel’s ARPU has increased to Rs. 104 from Rs. 100 in last quarter. ARPU is further likely to improve in coming months, as the company shifted its focus on return on capital from market share. This move will also allow the telco to reserve its infrastructure and resources for better-paying customers.

25

9.5

26

3.7

26

9.7

27

7.5

28

4.5

28

6.0

29

4.0

30

8.1

34

8.5

34

7.5

28

4.2

0

50

100

150

200

250

300

350

400

Jun16

Sept16

Dec16

Mar17

Jun17

Sept17

Dec17

Mar18

Jun18

Sept18

Dec18

Mobile subscribers (mn)

196 188 172

158 154 145 123 116 105 101 104

0

50

100

150

200

250

Jun16

Sept16

Dec16

Mar17

Jun17

Sept17

Dec17

Mar18

Jun18

Sept18

Dec18

ARPU (Rs.)

Standalone (Rs. mn) FY16 FY17 FY18

Revenue from operations 603,003 622,763 536,630

EBITDA 240,549 262,193 188,822

Reported PAT 77,803 (99,256) 792

Total debt 421,569 568,899 625,361

Margin ratios

EBITDA margin 39.9% 42.1% 35.2%

EBIT margin 22.9% -5.2% 9.8%

PAT margin 12.9% -15.9% 0.2%

Financial stability ratios

Total debt to equity 0.4x 0.6x 0.6x

Current ratio 0.4x 0.5x 0.5x

Interest coverage ratio 3.9x -0.6x 0.9x

Net Debt to EBITDA (consolidated) 2.6x 2.8x 3.0x

Performance ratios

RoE 8.2% -9.4% 0.1%

RoCE 10.7% -2.0% 3.2%

Upcoming strategies: • Airtel is planning to raise as much as Rs. 320bn through equity and bonds sales, which would to mainly utilized to pare its

debt. Additionally, it is planning to monetized assets to buid its 4G war chest. • Potential IPO of its African entity in 2019 • Airtel and VIL are looking to form a JV company, which will house their fiber assets These strategies will help company to bolster its countrywide 4G networks to counter RJio & will ease pressure on its leverage.

7



Reliance Jio Reliance Jio Infocomm Ltd. (RJio) is engaged in providing telecommunication, broadband services, and digital services in India. It provides 4G long-term evolution (LTE) service network. The company also provides end-to-end digital solutions for businesses, institutions and households; and seamlessly bridging the rural-urban divide. It offers plans, applications, devices, jio-tunes, jio-auto pay. In applications, it offers myjio, jiochat, jiotv, jio cinema, jiomusic, jiomag, jio xpress news, jio cloud, jio 4g voice, jio money, jio security, jio newspaper, jio net. The company also sells mobile handset under the brand name of Jiophone, and wireless broadband device under the brand name of Jiofi. Founded in 2007, RJio operates as a subsidiary of Reliance Industries Ltd. (RIL). The Mukesh Ambani-led operator continued to expand market share by adding new customers and is poised to dislodge Airtel from the No. 2 spot. RJio’s mobile subscriber base stands at 280.1mn by the end of Dec. 2018 from 225.3mn in last quarter, an increase of 11% Q-o-Q. As the company focused on market share acquisition, its ARPU fell for the fifth straight quarter to Rs. 130. However, it is quite high as compared to its rivals.

72

.2

10

8.7

12

3.4

13

8.6

16

0.1

18

6.6

21

5.3

25

2.3

28

0.0

0

50

100

150

200

250

300

Sept16

Dec16

Mar17

Jun17

Sept17

Dec17

Mar18

Jun18

Sept18

Dec18

Mobile subscribers (mn)

156 154

137 135 132 130

115120125130135140145150155160

Sept 17 Dec 17 Mar 18 Jun 18 Sept 18 Dec 18

ARPU (Rs.)

Standalone (Rs. mn) FY18

Revenue from operations 201,540

EBITDA 68,010

Reported PAT 7,230

Total debt 484,550

Margin ratios

EBITDA margin 33.8%

EBIT margin 16%

PAT margin 3.6%

Financial stability ratios

Total debt To equity 0.6x

Current ratio 0.2x

Interest coverage ratio 1.5x

Net Debt to EBITDA 7x

Performance ratios

RoE 0.9%

RoCE 2.3%

Upcoming strategies: • RIL, parent company of RJio, plans to spin off its telecoms infrastructure business in an effort to reduce debt and overall

liabilities. Brookfield Asset Management, one of the world’s top infrastructure and private equity investor is in early talks to buy controlling shares in RJio’s telecom tower & fibre assets valuing it over USD 15bn (Rs. 1.1 lakh crore).

• The company had announced in Oct. 2018, a Rs. 52.3bn deal to acquire majority stake in Den Networks Ltd. and Hathway Cable & Datacom Ltd. to expand in the broadband and direct-to-home service industry. This acquisition will give RJio access to 24mn existing cable connected homes of these companies across 750 cities, thereby covering around half of its target to connect 50mn homes across 1,100 Indian cities.

8



Vodafone Idea Ltd.

Vodafone Idea Ltd. (VIL) is an Aditya Birla Group and Vodafone Group partnership. It is India’s leading telecom service provider. The company provides pan-India voice and data services across 2G, 3G and 4G platform. VIL’s mobile subscriber base stands at 387mn in Dec. 2018 from 435.2mn in last quarter, a decline of 12.4% Q-o-Q. After the company started charging a minimum amount from user for staying active on the network, it de-activated 35mn subscribers during the quarter ending Dec. 2018. On account of this strategy, its ARPU has increased to Rs. 89 from 88 in last quarter & would likely to improve further in coming months. However, the increase in ARPU is not sufficient to contribute to its high leverage ratio until company improve its 4G customer base.

176 171 158

142 141 132 114 105 100

88 89

0

50

100

150

200

Jun16

Sept16

Dec16

Mar17

Jun17

Sept17

Dec17

Mar18

Jun18

Sept18

Dec18

ARPU (Rs.)

Consolidated (Rs. mn) FY16 FY17 FY18

Revenue from operations 359,494.1 355,757.4 282,789.4

EBITDA 118,877.0 105,964.7 65,406.0

PAT 23,064.5 (8,215.2) (44,905.1)

Total Debt 375496.2 516,714.78 569,624.94

Margin Ratios

EBITDA Margin 33.8% 29.3% 21.6%

EBIT Margin 16.4% 7.5% -8.3%

PAT Margin 7.4% -2.4% -17.2%

Financial Stability Ratios

Total Debt to Equity 1.7 2.3 2.3

Current Ratio 0.3 0.4 0.8

Interest Coverage Ratio 3.3 0.7 -0.5

Net Debt to EBITDA 3.1 4.9 8.7

Performance Ratios

ROE 11.4% -3.5% -19.4%

ROCE 10.4% 3.7% -2.9%

Upcoming strategies: • VIL board in Jan. 2019, approved a plan to raise Rs. 250bn via rights issue to bolster its balance sheet and meet future

capex needs to boost 4G coverage in an effort to catch up with rival telcos. • Airtel and VIL are looking to form a JV company, which will house their fiber assets.

9

37

9.7

39

5.3

40

4.6

40

8.4

39

7.8

40

9.2

43

4.1

44

3.6

43

5.2

38

7.0

340

360

380

400

420

440

460

Sept16

Dec16

Mar17

Jun17

Sept17

Dec17

Mar18

Jun18

Sept18

Dec18

Subscriber base (mn)



Telecom subscription: Robust growth over the last decade

• Wireless subscribers formed 98.2% of the total subscribers. It increased by 19% CAGR from 165.1mn in FY07 to 1,170mn in FY18.

• Due to this fast paced growth, wireless tele-density increased over 5x from 18.2% in FY07 to 92.8% in FY18. In current fiscal till Dec. 2018, wireless subscription stood at 1,176mn with wireless tele-density reached 89.8%.

55.1%

44.9%

Wireless subscription

Urban Rural

26

1.1

39

1.8

58

4.3

81

1.6

91

9.2

86

7.8

90

4.5

96

9.9

1,0

33

.6

1,1

70

.2

1,1

83

.4

1,1

76

.0

0102030405060708090100

0

200

400

600

800

1000

1200

1400

Wireless Subscription (in mn) Tele-density

Wireless subscription & tele-density

10

Internet subscribers: witnessing a fast paced growth

• As on 30th Sept. 2018, total internet subscribers in India stood at 560mn, of which wireless subscribers stood at 538.8mn occupying 96% of total internet market.

• Total broadband subscription increased at a 59.5% CAGR over FY08-FY18 to 412.6mn subscribers in FY18. For the current fiscal till Dec. 2018, broadband subscribers stood at 518.5mn.

3.9 6.2 8.8 11.9 13.8 15.1 60.8

99.2 149.8

276.5

412.6

518.5

0

100

200

300

400

500

600

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19*

Broadband subscribers



Forecast:

• According to CISCO’s Visual Networking Index, the number of internet subscribers in the country is expected to double by 2021 to 829mn. Also there would be 2bn networked devices in 2021 in India, up from 1.4bn in 2016.

• The overall IP traffic is expected to grow four-fold over 2016-21 - a 30% CAGR to reach at 6.5 exabytes of data per month in 2021, up from 1.7 exabytes per month in 2016.

• Video will continue to dominate IP traffic and overall internet traffic growth - representing 76% of all internet traffic in 2021, up from 57% in 2016.

Technology wise breakup of 560mn internet subscribers (Sept. 2018)

388.0

75.0 74.9

0.8 0.1 0

50100150200250300350400450

Wireless internet subscribers (mn)

12.2

3.3 3.2

1.4 1.1 0.1

0

2

4

6

8

10

12

14

DSL Ethernet/LAN

Dial up CableModem

Fibre LeasedLine

Wired internet subscribers (mn)

11


Gross revenue: Industry

• Indian telecom gross revenue increased from USD 32.1bn in FY08 to USD 39.5bn (Rs. 2.5 lakh crore) in FY18. • Gross revenue for the first half of FY19 stands at US D 16.6bn (Rs. 1.2 lakh crore).

32.1 33.0 33.3

37.6 41.7

39.1 38.8 41.7 40.3 40.9 39.5

16.6

0

5

10

15

20

25

30

35

40

45

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19*

Telecom sector gross revenue (USD bn)

Past analysis • Telecom revenue growth has flattened from FY12. Growth from FY12-16 followed a sideward trend on account of decline in telecom

subscribers, reaching to its original level in FY15. • Historically, telecom industry gross revenue growth was in-line with subscriber base growth. However, post the entry of RJio, gross

revenue declined from USD 40.3bn in FY16 to USD 39.5bn in FY18 and USD 16.6bn in H1 FY19. The fall in revenue was despite the growth in the overall subscriber base and can be attributed to RJio’s dirt cheap pricing of mobility services.

91

9.2

86

7.8

90

4.5

96

9.9

1,0

33

.6

1,1

70

.2

1,1

83

.4

1,1

93

.7

0

200

400

600

800

1000

1200

1400

FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19*

Telecom subscriber base (mn)

12

Source: Choice Broking Note: “*” FY19 data till Sept. 2018

Source: Choice Broking Note: “*” FY19 data till Sept. 2018

Gross revenue forecast

• Gross revenue of USD 39.5bn in FY18 accounted for 1.5% of total GDP. • Telecom gross revenue to GDP ratio is declining at a CAGR of 5.5% i.e. from 2.5% in FY10 to 1.5% in FY18 due to slow/flattened growth

in gross revenue as compared to increasing growth in country’s overall GDP in past decade. • From FY17-19, we can see the disproportionate decline in this ratio i.e. from 1.9% to 1.5%, however we expect this ratio to increase

and reach 1.4% levels till FY22.

• Gross revenue is expected to reach USD 47.5bn in FY22 based on above calculated ratio of 1.4% & projected GDP estimate of USD 3.5tn.

Source: Choice Broking & Statista

13


33

.3

37

.6

41

.7

39

.1

38

.8

41

.7

40

.3

40

.9

39

.5

34

.8

38

.6

42

.8

47

.5

13

23

.9

16

56

.6

18

23

.1

18

27

.6

18

56

.7

20

39

.1

21

02

.4

22

74

.2

25

97

.5

27

90

.7

30

07

.0

32

39

.8

34

90

.2

0

500

1000

1500

2000

2500

3000

3500

4000

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19EFY20EFY21EFY22E

Telecom Gross Revenue GDP

2.5% 2.3% 2.3%

2.1% 2.1% 2.0% 1.9% 1.8%

1.5% 1.2% 1.3% 1.3% 1.4%

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22

Telecom gross revenue to GDP (%)

SWOT Analysis

STRENGTH

Strong demand

Increasing data usage

Strong telecom infrastructure

New policy aims $100 billion worth

investments telecom industry

WEAKNESS

Cut-throat competition

High debt levels

OPPORTUNITY

Untapped rural market

Increasing internet users

New stream of revenue with IoT

THREAT

Zero interconnection charges w.e.f Jan 1, 2020

would impact revenue of incumbents

14

Sectors in telecom

Telecom industry is divided into two sectors:

Telecommunication industry

Telecommunication equipment sector

Telecommunication service sector

Wired services

Cable & program distribution

Internet services

Re-sellers

Other broadband services

• Telecommunication equipment sector: The equipment sector comprises of companies that manufacture products that are used by both end users & input to other telecom companies. Customers use these products to access telecom services & telecom companies use these products to create & maintain infrastructure & deliver services. It includes mobile towers, mobile equipment, etc. among others.

• Telecommunication service sector: The services sector can be divided into following categories:

Wireless services: As on Dec. 2018, the wireless market accounted to 98.2% of the total subscriber base. It comprises of entities operating and maintaining switching and transmission facilities to provide direct communications via airwaves. Wired services: Consists of companies that operates and maintains switching and transmission facilities to provide direct communications through landlines, microwave or a combination of landlines and satellite link-ups. Internet services: This sub-sector consists of internet service providers (ISPs), which offers wired, wireless & broadband internet services. ISPs offer broadband internet connections to consumer and corporate channels. India is the second largest country in terms of internet subscribers with 512.3mn internet subscribers, as of Jun. 2018. India became the world’s fastest-growing market for mobile applications in the first quarter of 2018 and remained the world’s fastest growing market for Google Play downloads in the second and third quarter of 2018. Cable and program distribution: Establishments in this sub-sector provide television and other services on a subscription or fee basis. Distributors of television services transmit programming through fiber optic or coaxial cables. Direct broadcasting satellite operators constitute a growing segment of the pay television industry. Re-sellers: They lease transmission facilities such as telephone lines or space on a satellite from existing telecommunication networks & resell the services to other customers. Other broadband services: These includes services such as internet protocol television, voice over internet protocol, and internet protocol virtual private network.

15


Telecom spectrum: Basics Energy travels in the form of waves known as electromagnetic waves. These waves differ from each other in terms of frequencies. This whole range of frequencies is called the spectrum. They are divided into bands based on frequencies. Radio waves have frequency range between 3 KHz to 300 GHz. In telecommunication like TV, radio and GPRS, radio waves of different frequencies are used. Note: Lower frequency waves travels more, requires less power & least affected by any object which come under its interface due to longer wavelength as compared to high frequency. However, high frequencies waves have low latencies as compared to low frequencies.

16

What is 2G, 3G, 4G? All these numbers refer to the generation of the technology being used for communication. The oldest of these is obviously 2G, while 4G is still evolving. These technologies were developed to take advantage of different bands, and this means that you can't just use a technology on any band at will. Bands might be roads, but only specific types of vehicles can travel on them. That's why your phone needs a modem that can operate on multiple frequencies, so that it can connect to all the bands, and transmit your voice, messages, and data. Our cell phone uses radio waves to communicate. When you send information, your cell phone converts that information (along with your subscriber identity) into electric signals & radio antenna in your phone convert these electric signals into radio waves. Radio waves carry information depending upon the level of frequency and travel in air to reach nearest cell tower & such information handovers through base station controller (BSC), mobile switching centre (MSC) to reach destination.

Basic telecom architecture: In GSM network, when you make a call via mobile station (user equipment like mobile phone, fixed line phone + SIM = mobile station), it is transferred to the nearest mobile tower known as base transceiver stations (BTS). BTS encrypts such information & handover it to BSC, which controls multiple BTSs & is responsible for allocation of radio channels, frequency administration & handover information to another BTS (if both BTSs are controlled by the same BSC) otherwise handover to MSC. When we’re on the road or travelling somewhere, the BSC and the intelligence of the cellphone keeps tracks of and allows our phones to switch from one cell tower to the next during conversation. As the user moves towards a cell tower, it picks the strongest signal and releases the cell tower from which the signal has become weaker. The released channel from that cell tower will then become available to another user. MSC is considered as heart of GSM architecture as it makes the connection between mobile users within the network. It controls multiple BSCs & is also connected with other MSCs. MSC also administers handovers to neighboring BSC. Three components are connected to MSC namely HLR, VLR & AUC. When you travel to different city, MSC connects you to network of that area without any interruption. This is done with the help of visitor location register (VLR) as it contains temporary information relating to subscriber’s location when the subscriber visits location other than its home network. Home location register (HLR) is a central database that contains details of each mobile phone subscriber that is authorized to use the GSM core network. The HLRs store details of every SIM card issued by the service provider. HLR also manages the mobility of subscribers by means of updating their position in administrative areas with the help of VLR. It sends the subscriber data to a VLR. Authentication center (AUC) authenticates your sim card before connecting to network (Eg. when you power on your phone). MSC is responsible for interconnecting calls with the local and long distance landline telephone companies, compiling billing information. When you make a call to other network subscriber or international call, Gateway MSC (GMSC) connects MSC with Public Switched Telephone Network (PSTN). And to connect to data services, GMCS connects MSC with Integrated Service Digital Network (ISDN).

17

How network is connected? For the understanding of ‘how network is connected’, we can classify network in two parts: Access network: connection between user equipment & BTS. Backhaul network: connection between BTS & MSC. Access network can be connected via wired (copper cable or optical fibre) or a wireless medium. To provide internet service through wireless requires spectrum which is allocated by Wireless Planning and Coordination (WPC) wing of DoT which is discussed in next section. Backhaul network majorly, is connected either by microwaves or copper or fiber optic cables. An optical fiber network has unlimited bandwidth & information travels without any interruption as compared to limited bandwidth & interruption issues in microwave backhaul. In India, approximately 80% of cell sites are connected through microwave backhaul, while the rest sites are connected through fiber (as of Oct. 2018).

18

Spectrum allocation

It is important to note that spectrum is a scarce natural resource and allocated spectrum cannot simultaneously be used for other purposes. If anyone broadcast signals at any frequency, it would lead to a lot of interference, effectively rendering the spectrum useless for any kind of meaningful communication, thus it needs to be regulated. Government divided India in 22 telecom circles (earlier 23 but in 2007, Chennai and Tamil Nadu were merged leaving 22 circles) so to manage spectrum effectively across the country. The allotment of spectrum is either paired or unpaired. In case of paired spectrum, different sets of frequencies are allocated for uplink and downlink. For example in case of 900MHz spectrum, the DoT allocated frequencies between 890MHz - 915MHz for uplink, and between 935MHz - 960MHz for downlink in each circle. Uplink and downlink just refer to data (or voice, or any other signal) sent from you to the telco, and from the telco to you respectively. The telcos have to separate the two to manage the spectrum effectively. A telecom company that wishes to offer services in any of the 22 telecom circles in India must purchase a Unified Access Services (UAS) license to operate in that circle. So a telco would have to bid for a spectrum license in all of these circles to offer uninterrupted access across India - otherwise, it would have to connect with another company to offer the services in areas where it lacks spectrum, leading to roaming charges. UAS licences are valid for a period of 20 years, which can be extended by an additional 10 years.

History of Indian telecom since 1994 National Telecom Policy, 1994: Under the 1994 policy, the potential service providers in order to be eligible for bidding for licences had to partner up with a foreign company. The bidding was a two stage process for all licences (for non-metro circles). The first stage was to fulfill the criteria, which was based on the financial net worth of the company (in relation to the category of circle) and the experience of the company in providing telecom services. The second stage was with respect to the valuation of bids. The licence was awarded to the telecom service provider, which has fulfilled the pre-requisites and is the highest bidder for the licence. There were separate licences issued for the four metropolitan cities (Kolkata, Chennai, Mumbai, and New Delhi). These licences were awarded through beauty contest in metros. Drawbacks in the mechanism of issuing telecom licence: The problem arose from the implementation of the above model was that, multiple licences were awarded to a single entity which can create monopoly environment & also there were concerns regarding paying capacity of bidder since a company was awarded license having turnover of USD 0.06bn where as the estimated licence fee was USD 15bn. In order to counter these problems the government changed its policy and allowed the winning bidder to choose three circles out of the nine circles. There was rebidding in 15 circles with the government specifying a reserve price. This was due to the change in policy as the highest bidder was not able to operate in more than three circles. The response to this was very poor and it was perceived by the bidders that the reserve price was too steep. In 1998, government opened internet services for private sector. New Telecom Policy, 1999: Under this policy, cellular mobile service providers were allowed to provide all kinds of mobile services (voice, non-voice messages, data services and PCOs), which would utilize any type of network equipment that meets the international standards. The New Telecom Policy, 1999 allowed the migration of the licensees from a Fixed Licensee Fee Regime to a Revenue Arrangement Scheme. The National Telecom Policy also laid down that the licences will be awarded for a period of 20 years and it can be extended for a period of another 10 years. In 2001, first-come-first-serve scheme was implemented for issuing licences. Unified access service licence: In 2003, TRAI proposed a Unified Licensing Regime. This licence permitted an access service provider to offer both fixed and/or mobile services under the same licence, using any technology. The country was divided into 23 service areas, 19 telecom circles and 4 metro circles for the purpose of implementing unified access services (UAS). The annual licence fee is 10%, 8% & 6% of adjusted gross revenue (AGR) for Metro and Category 'A', Category 'B' and Category 'C' service areas, respectively, w.e.f. 1st April, 2004.

19

In 2007, DoT allowed issuing of licences for operating on dual technologies that is CDMA and GSM. 2008 - 2G Scam: In 2008, telecom minister A Raja issued 2G spectrum licences to nine telecom companies. The licences were sold according to 2001 rates, instead of 2008 rates & on a distorted First Come First Served (FCFS) Policy. The Comptroller and Auditor General of India (CAG) puts down the loss to government in the deals at Rs. 1.76 lakh crore (USD 24bn). The CAG said licenses given to ineligible companies and those who had no experience of telecom such as Unitech and Swan Telecom. The CAG report went on to say that licenses owners had in turn sold significant stakes to the Indian/foreign companies at high premium within a short period of time. The CBI filed 80,000 page charge sheet and said the loss was Rs. 30,985 crore only. The CBI charge sheet said bribes paid to favour firms in granting 2G spectrum licenses. Accused firms were Unitech Wireless, Swan Telecom, Reliance Telecom, Loop Telecom, Loop Mobile India, Essar Tele Holding and Essar Group. The Supreme Court later cancelled 122 licences calling them 'unconstitutional and arbitrary' and asked for a re-bid in Feb. 2012. TRAI decided to sell it at a fixed price. The new price is six times higher than 2008 levels i.e. Rs. 377 crore per MHz. The apex court imposed a fine of Rs. 5 crore each on Unitech Wireless, Swan telecom and Tata Teleservices and Rs. 50 lakh fine on Loop Telecom, S Tel, Allianz Infratech and Sistema Shyam Tele Services. However, nearly six years after 2G licences were cancelled by the Supreme Court, a Special Court in Dec. 2017 acquitted all accused, including former Telecom Minister Andimuthu Raja and DMK chief M Karunanidhi’s daughter, Kanimozhi, who were named as perpetrators of one of the biggest scams in the history of India. The court said the prosecution had “miserably failed” to prove any charge against any of the accused. There is no evidence on the record produced before the court indicating any criminality in the acts allegedly committed by the accused persons relating to fixation of cut-off date, manipulation of first-come first-served policy. 2011: Mobile Number Portability was launched. It enables mobile telephone users to retain their mobile telephone numbers when changing from one mobile network carrier to another. National Telecom Policy, 2012: According to this policy, all future licences will be ‘Unified Licences’ that will be delinked from spectrum allocation, while all existing telecom licences will be migrated to the new regime. A uniform licence fee of 8% of AGR across services and circles as compared to license fee of 10% in the Metros and category A areas, 8% in category B areas and 6% in category C areas. In 2016, Union Cabinet approved the Telecom Commission’s proposal of a flat three per cent spectrum usage charge for airwaves to be procured in future and weighted average for the remaining spectrum.

20

National Digital Communication Policy, 2018: Roadmap to 2022 Objectives • Provisioning of broadband for all • Creating 4mn additional jobs in the digital communications sector • Enhancing the contribution of the digital communications sector to 8% of India’s GDP from ~ 6% in 2017 • Propelling India to the top 50 nations in the ICT Development Index of ITU from 134 in 2017 • Enhancing India’s contribution to global value chains • Ensuring digital sovereignty To accomplish these objectives by 2022, the policy envisages three missions: 1. Connect India: Creating a robust digital communication infrastructure

Goals o Provide universal broadband connectivity at 50Mbps to every citizen o Provide 1Gbps connectivity to all gram panchayats of India by 2020 and 10Gbps by 2022 o Enable100Mbps broadband on demand to all key development institutions; including all educational institutions o Enable fixed line broadband access to 50% of households o Achieve ‘unique mobile subscriber density’ of 55% by 2020 and 65% by 2022 o Enable deployment of public Wi-Fi Hotspots to reach 5mn by 2020 and 10mn by 2022 o Ensure connectivity to all uncovered areas Strategies: o Implementation of broadband initiatives like BharatNet, GramNet, NagarNet, JanWifi o Implementation of ‘Fibre First Initiative’ to take fibre to the home, to enterprises and to key development institutions

in Tier I, II and III towns and to rural clusters o Facilitating establishment of mobile tower infrastructure etc. o Recognizing spectrum as a key natural resource which would envisage optimal pricing of spectrum, transparent and

fair mode of spectrum allocation, efficient spectrum utilization and management. o Creating a Broadband Readiness Index for States/ UTs to attract investments and address RoW challenges

2. Propel India: Enabling next generation technologies and services through investments, innovation, indigenous manufacturing and IPR generation Goals o Attract investments of USD 100bn in the digital communications sector o Increase India’s contribution to global value chains o Creation of innovation led start-ups in digital communications sector o Creation of globally recognized IPRs in India o Development of standard essential patents in the field of digital communication technologies o Train/ re-skill 1mn manpower for building new age skills o Expand IoT ecosystem to 5bn connected devices o Accelerate transition to Industry 4.0 o Ensuring the transition to IPv6 for all existing communications systems, equipment, networks and devices

21

Strategies o Catalyzing investments for digital communications sector by considering telecom infrastructure at par with other

connectivity infrastructure like roadways, airlines etc. o Ensuring a holistic and harmonized approach for adoption & implementation of new and emerging technologies. o Promoting research & development in digital communication technologies by creating a fund for R&D in new

technologies for start-ups and entrepreneurs among others. o Promoting start-ups by supporting them with various fiscal and non-fiscal benefits, reducing entry barriers and

prescribing a simple and enabling regulatory framework. o Local manufacturing and value addition by maximizing India’s contribution to global value chains and by ensuring

strict compliance to preferential market access requirements like incentivizing private operators to buy domestic telecom products.

o Capacity making by building human resource capital to facilitate employment opportunities in digital communications sector.

o Strengthening of PSUs by building focus on technical expertise and knowledge management for them. o Accelerating Industry 4.0 by creating a roadmap for transition to Industry 4.0 by developing market for IoT/ M2M

connectivity services in sectors including agriculture, smart cities, intelligent transport networks etc. 3. Secure India: Ensuring digital sovereignty, safety and security of digital communications

Goals o Establish a comprehensive data protection regime for digital communications that safeguards the privacy, autonomy

and choice of individuals and facilitates India’s effective participation in the global digital economy o Ensure that net neutrality principles are upheld and aligned with service requirements, bandwidth availability and

network capabilities including next generation access technologies o Develop and deploy robust digital communication network security frameworks o Build capacity for security testing and establish appropriate security standards o Address security issues relating to encryption and security clearances o Enforce accountability through appropriate institutional mechanisms to assure citizens of safe and secure digital

communications infrastructure and services Strategies o Establishing a strong, flexible and robust data protection regime by harmonizing communications law and policy with

the evolving legal framework and addressing issues of data protection and security in digital communications sector. o Providing autonomy and choice for every citizen and enterprise by recognizing the need to uphold the core principles

of net neutrality. o Assuring security of digital communications by addressing security issues across layers, developing security standards

for equipment and devices, formulating a policy on encryption and data retention, by harmonizing the legal and regulatory regime in India pertaining to cryptography with global standards among others.

o Developing a comprehensive plan for network preparedness, disaster response relief, restoration and reconstruction by developing a Unified Emergency Response Mechanism, enhancing the Public Protection and Disaster Relief (PPDR) plan for India by facilitating the establishment of a pan-India network for Public Protection and Disaster Relief (PPDR).

22

Revenue-Cost model of telecom operators

Cash flow for contracted spectrum = Revenue - (license fee + spectrum charge + network cost + administration, marketing & personal cost)

Currently, 6 paisa/minute. As per TRAI, from 1st Jan. 2020 it will be brought down to zero paisa (also known interconnection charges; amount charged by a network operator for the use of their network by other network operators)

Total cost of all BTS like passive infrastructure charges, power & fuel, repair & maintenance, etc.

Calculations are based on recommendations by TRAI (percent of AGR). Currently a unified license fee of 8% of AGR is charged, while spectrum charges are 3% of AGR for specified spectrum & weighted average for remaining spectrum

Employee cost, marketing expenses, etc.

Revenue

Access charges

Network operating

cost

License fee and

spectrum charges Other

costs

ARPU x VLR adjusted subscribers (VLR takes into account active number of subscribers rather than total subscribers)

23

Below are the cost break-up of top three telecom players:

Particulars As a percent of top-line

RJio VIL Airtel

Network operating expenses 24.4% 34.0% 25.9%

Access charges (Net) 21.3% 12.3% 14.6%

License fees / spectrum charges 9.0% 10.0% 10.3%

Employee benefits expense 4.8% 5.4% 3.2%

Selling and distribution expenses 4.0% 12.6% 5.7%

Other expenses 3.4% 3.3% 6.7%

EBITDA 33.4% 22.4% 33.6%

Depreciation and amortization expense 17.7% 29.4% 24.2%

EBIT 15.6% -7.0% 9.4%

Finance costs 10.2% 16.8% 11.0%

PBT 5.5% -23.8% -1.6%


Telcos earns an average EBIT margin of 6% out of which an average of 13% is required for meeting their finance costs. With an annual capex of around Rs. 40k crores for combined three players, it is obvious for the operators looking for additional debt to fund their annual capex. Without government support (i.e. lower spectrum prices and other levies) the operators especially the incumbents may not be able to come out of this debt trap.

24

Burdensome spectrum costs

High spectrum cost has created a high debt burden on the sector. Things become tougher for Indian telecom operators as operators in most countries enjoy more bandwidth than those in India. This has slowed the deployment of networks and technologies. Also foreign investors find it tough to invest in telecom sector due to high spectrum cost and cut throat competition resulting in low realizations. In the last auction (held in 2016), the 700 MHz - a highly prized band because of its ability to provide cost-effective coverage, did not attract any bids. Other bands also had a lukewarm response, despite the relatively lower amount of spectrum held by Indian operators with respect to global operators. The final bid prices were very close to the reserve price. The high reserve prices were cited as reasons for the outcome. Historically, both market and reserve prices of spectrum in India have been high compared to other developing countries which has created a high debt burden on the sector. This has slowed the deployment of networks and technologies. Below table shows the percent of spectrum costs to long term debt for telecom operators in FY18:

As per above figures, it can be seen that an average 70% of long term borrowings is on account of spectrum costs. To provide some relief to telecom operators government in Mar. 2018 enhanced number of annual installments for spectrum payment from 10 to 16 years. Lower Bandwidth: Things become tougher for Indian telecom operators as the operators in most countries enjoy more bandwidth than those in India. In such a case, the higher pricing of the spectrum comes as an additional burden to the telcos. Since telcos have to deploy more equipment and technology to deal with the lower bandwidths, the costs for the entire ordeal become extremely high. On top of that, the telcos have to deal with problems like lower smartphone penetration, government levies, spectrum usage charges and much more, which present a stifling picture for the operators. Government method for determining spectrum prices: • Trai’s method of arriving at the reserve price in many cases is based on linking it to the bid price in the previous auction. • Another aspect of Trai’s determination of reserve price is linking it with technical efficiency with respect to some other

band that is why reserve price set for 700 MHz category spectrum is set at two times than that of 1800 MHz for next auction.

However, internationally auction prices are determined by considering more than just the technical efficiency of different bands. There are several factors that determine the valuation of spectrum, including the amount of spectrum available in different bands, expectations from the next round of auctions, band characteristics, amount of spectrum held by the bidder, state of the technology ecosystem, the business strategy and regulation such as spectrum caps per band or overall caps, rollout obligations, etc.

Spectrum liabilities as a percent of long term debt Airtel RJio VIL

Spectrum liabilities (Rs. mn) 455.6 202.1 388.9

Long term borrowings as on FY18 (Rs. bn) 544.7 351.9 569.4

Spectrum liabilities as percent of long term borrowings (%) 83.6% 57.4% 68.3%


A look on TRAI recommendation on 5G Spectrum

The telecom regulator has set Rs. 492 crore per MHz of 3.5GHz 5G spectrum as the minimum rate for next generation 5G spectrum and also suggested to put block size of 20MHz. The recommended base price is 30% of the price of 1800MHz band and the regulator has proposed a limit of 100MHz of spectrum per bidder to avoid monopolization. Thus, an operator need to pay at least Rs. 98.4bn to buy 5G spectrum on the basis of suggested block size. Besides 5G spectrum, 4G bands of 700MHz, 800MHz, 900MHz, 1800MHz, 2100MHz, 2300MHz and 2500MHz will also be offered to VIL, Airtel and RJio. TRAI lowered the price of premium 700MHz band by 43% to attract buyers by setting the spectrum price at twice the price of 1800MHz band as compared to 4x in 2016 auction.

TRAI said it had been “conservative” while deriving the price of 5G spectrum, however in countries like Ireland, Spain, UK and South Korea, where the auction for 5G bands recently concluded, listed the bands for a lower price than their Indian counterparts.

Operators and experts said the sale will likely evoke a lukewarm response, with hardly any takers for both 700MHz and 5G airwaves at current prices. RJio is currently the only profitable telco, while VIL and Bharti Airtel have slipped into the red due to lower tariff. Besides, the industry has a debt of over Rs. 7lakh crore, primarily blamed on historically high bandwidth prices. Reducing the base price of airwaves is not enough to spur bidding and revive the sector, but levies such as licence fees and spectrum usage charges should also be lowered. The telecom sector wants the government to put off auction of 5G spectrum till 2019-20 to give time for a devices ecosystem to develop and allow the industry to overcome its financial stress and consolidate completely.

25

S. Korea UK Ireland Spain

Auction completion date 1-Jun-18 1-Apr-18 1-May-17 1-Jul-18

Operator SKT O2 UK Three Ireland Vodafone Spain

Spectrum band 3.5GHz 3.4GHz 3.5 / 3.7GHz 3.6 / 3.8GHz

Spectrum purchased (MHz) 100 50 100 90

Spectrum purchase cost (USD mn) 1,100.0 447.5 17.2 231.7

Price per MHz (USD) 11.0 9.0 0.2 2.6

Price per MHz (Rs. mn) 715.0 581.8 11.2 167.3

Proposed 5G spectrum price in India (Rs. mn) 4,920 4,920 4,920 4,920

India price as a multiple of others (x) 6.9 8.5 440.1 29.4


Industry transformation: After RJio

RJio’s entry changed the market in more than one way. First, the battle shifted from voice to the data front. RJio had spent the last few years building the largest LTE (long term evolution) network in the country that allowed it to provide Voice over LTE services at virtually no extra cost - enabling it to offer free calling and only charge for data. ARPU declined considerably after RJio’s pricing strategy. The second significant impact of RJio’s entry has been a consolidation wave that has swept the industry due to escalated levels of competition. This has been so intense that scale has become a necessary prerequisite. Because of this brutal price war, there was an unprecedented consolidation from eight operators to only three private operators in the market. Private players: 2016

Airtel Vodafone Idea RCom

Aircel Tata

Teleservices Telenor SSTL

Consolidation phase

Airtel

Tata

Teleservices

Telenor

Videocon

Telecom

Idea Vodafone

Private Players: Today

Vodafone Idea Airtel RJio

26

Tower sector

• Telecom tower is a vertical structure built on a small parcel of land, designed to accommodate multiple wireless tenants • Tenants utilize many different technologies, including: telephony, mobile data, broadcast television & radio and paging • Wireless tenants lease vertical space on the tower and portions of the land underneath for their equipment • Tower company typically owns or leases tower structure & ground interest under a long term contract • Wireless tenants own & operate equipment, including the antenna array, antenna, coaxial cables and base stations &

equipment shelters Illustration: Tower assets ownership classification between American Tower (AMT) & its tenants (TEN)

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Types of Towers

Monopole Height: 100-200 feet Typical use: Telephony Lattice Height: 200-400 feet Also called self support Typical use: Telephony Guyed Height: 200-2000 feet Typical use: television, radio broadcasting, paging & telephony Stealth Useful in areas with strict zoning regulations

Types of tower companies

• Independent tower companies (pure play operators) like Bharti Infratel Ltd. (BIL), American Tower (ATC), GTL,

TowerVision, etc. • Joint ventures like Indus Tower Ltd., which is a joint venture between Airtel, Vodafone and Idea

Market share by number of towers: There are close to 5 lakh towers in India for a customer base of 1.18bn & it is estimated to grow tremendously in the next couple of years with the rollout of 5G services. • Indus Towers is the leader in the Indian telecom tower market with 122,920 towers in its portfolio. • ATC is the second largest telecom tower company with 58,034 towers. • Reliance Infratel is the third largest telecom tower company with 43,000 towers in its business. • BIL has 39,211 telecom towers. • GTL Infrastructure has 28,000 telecom towers in India.

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Decline in tenancy ratio after consolidation Consolidation among the telcos led to a lower tenancy ratio of 1.5-1.8x from earlier levels of 2-2.5x. Emerging monopole towers • With the data revolution powered by 4G and now with the upcoming 5G, tower infrastructure is likely to change.

Enabling 5G (100 times faster than 4G) will require huge amounts of spectrum for a telco which is available only in the higher bands between 3.2 GHZ to 3.8 GHZ.

• These frequencies do not give coverage but they provide the capacity to handle huge amounts of data at high speeds which is the key for the data revolution.

• The new monopole towers ideally require fibre backhaul so that they can handle the huge data generated on 4G platforms (and later by 5G).

• Small towers like monopole can precisely handle more data within a smaller range while catering to a fewer number of subscribers. To reach the same number of subscribers, more of these new towers are needed to do the job of one single traditional tower.

• Rentals might be lower in these towers as the investment is less (around Rs. 10 lakh each as against Rs. 20-25 lakh for a traditional ground-based tower) but that will get neutralized by the fact that they will require many more of these towers.

• Currently, not more than 5% of towers are of monopole variety. However, in next 2-3 years it is estimated to capture 30-40% tower market.

29

27%

14%

13% 9%

9%

6%

5%

3%

2%

2%

10%

Indus Towers BSNL American Tower

Reliance Infratel Bharti Infratel GTL Infrastructure

RJio Reliance Communication Vodafone India

MTNL Others

Telecom tower operator market share (%)


Rural India: New opportunity

• With almost 70% of Indian population living in rural areas & telecom penetration of only 59.5% as of Dec. 2018, the rural market would be key growth driver in the coming years.

• Rural subscribers in the country are increasing at 9.3% CAGR over FY11-18 to reach 524.6mn in FY18. For the nine month ended Dec. 2018, rural subscriber base stood at 531.6mn.

• As per CRISIL, rural tele-density likely to cross 60% by the end of FY19. Moreover, as per certain media report, internet penetration in rural areas will expand to 45% in 2021 from current 21.8%.

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2.2

33

0.8

34

9.2

37

7.7

41

9.3

44

9.2

50

1.6

52

4.6

33.8 39.2 41.0

44.0 48.4

51.4 56.9 59.1

0

10

20

30

40

50

60

70

0

100

200

300

400

500

600

FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18

Suscribers (in mn) Teledensity %

Government initiatives: Government’s Saubhagya Electricity Scheme: In Apr. 2018, India achieved 100% village electrification under Saubhagya Electricity Scheme. The scheme further achieved its second objective on 26th Jan. 2019 by providing electricity connection to each household across the country. Electricity in each home would provide improved access to all kind of communications like radio, television, internet, mobile etc. Initiatives under National Digital Communication Policy Bharat Net: The project has the underlying objective of providing high-speed fibre optic broadband to all the panchayats in the country by Mar. 2019 with subsidy support from the government’s Universal Service Obligation Fund. The telecom players will be given bandwidth at 75% cheaper price. The plan for the project is to be implemented in three phases with the first phase providing broadband connectivity through optic fibre cable to one lakh gram panchayats. The deadline for this phase was fixed for Dec. 2017. The second phase will extend the cables to 2,50,000 gram panchayats. This time a mix of underground fibres, fibre over power lines, radio and satellite media are to be used. Mar. 2019 has been set up as its deadline. The third phase involves providing state of the art and future proof network between the districts and blocks. Companies like Airtel, Idea Cellular, Vodafone and RJio have also volunteered for collaboration. JanWiFi: The government will be establishing 2mn Wi-Fi hotspots in rural areas. Fibre first initiative: Government will be implementing a Fibre First Initiative to take fibre to the home, to enterprises and to key development institutions in Tier I, II and III towns and to rural clusters. The government aims to accord Telecom Optic Fibre cables the status of Public utility in order to promoter fibre-driven broadband. It aims at fiberisation of at least 60% base stations thereby accelerating migration to 4G / 5G.

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Internet of Things (IoT): A game changer for telecom industry

• IoT is a concept that connects all the devices to the internet & let them communicate with each other over the internet without human interaction.

• IoT’s are being deployed among various areas or sectors known as IoT use cases. Early beneficiaries include agriculture, smart homes, smart cities, health, environment, transportation, manufacturing, etc.

As per Ericsson report, there will be 29bn plus connected devices by 2022 & more than 70bn by 2025. Out of 29bn, nearly 10bn will be phones (mobile/fixed), 1.7bn PC, laptop & tablet connections and the remaining 18bn will be IoT connections. These IoT connections can be machines, connected cars, meters, sensors, point of sales terminals, consumer electronics, wearable and many more such devices. IoT devices requires very low latency to operate effectively, which could be only possible with ultra-low latency capabilities of 5G network. With current networks, it takes approximately 100 milliseconds for information to travel across a network. This is incredibly fast, but there is still a lag that makes it impossible to communicate in real time. With 5G, that latency is expected to be reduced to 1 millisecond.

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How IoT Network is connected? • IoT is defined as "the inter-networking of physical devices, vehicles, buildings and other items embedded with

electronics, software, sensors, actuators and network connectivity which enable these objects to collect and exchange data". IoT network connectivity can be divided into short-range and wide-area segments.

• Short-range consists mostly of devices connected by unlicensed radio technologies with a typical range of 100m (using Wi-Fi, ZigBee, Bluetooth).

• Wide-area segment consists of devices connected using: o Cellular or o Low-power wide area technologies (NB-IoT, LoRa, Sigfox) or satellite connection

IoT connections: More than 85% of wide-area IoT devices use cellular technology. The number of cellular IoT connections is expected to reach 4.1bn in 2024 - increasing with an annual growth rate of 27%.

IoT 2018 2024 CAGR

Wide-area IoT 1.1 4.5 27%

Cellular IoT 1.0 4.1 27%

Short Range IoT 7.5 17.8 15%

Total 8.6 22.3 17%

Source: Ericsson Mobility Report, November 2018

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NB-IoT (Emerging Low Power Wide Area technology)

• Low power wide area (LPWA) technologies fill the gap between mobile (3G, LTE) and short-range wireless (eg Bluetooth, WiFi and ZigBee) networks. As the name suggests, they have low power draw and provide wide area coverage. Most of the service providers are deploying IoT networks worldwide using narrowband IoT (NB-IoT) technology.

• NB-IoT is a 3GPP standardized new LPWA technology specifically developed for the IoT devices that require small amounts of data, over long periods and indoor coverage.

• It (and other LPWA technologies) will enable the connection of billions of devices in the IoT that will be used in machine-to-machine (M2M, or machine-type communications, MTC, in 3GPP-speak) rather than in human communications.

• NB-IoT makes use of licensed spectrum due to which it is more secure than non-standardized LPWANs like LoRa, Sigfox which run on unlicensed spectrum.

• NB-IoT needs just 200kH of bandwidth (hence the name ‘narrowband’) which means it can run adjacent to existing cellular networks. It can provide uplink & downlink rates of around 200Kbps which is enough for most M2M devices as they require low data transfer rates.

Role of telecom operators in IoT • As telecom operators are largely responsible for wireless connectivity on a global scale, operators are in an excellent

position to capture a share of the added value generated by the emerging IoT market. The size of this share will depend on the role that operators adopt in the value chain. This could range from being a straightforward connectivity provider (monetizing connectivity in new ways), all the way to being an end-to-end solution provider of turnkey solutions to vertical markets.

• A large share of connected M2M and consumer electronic devices will be applications served by short-range radio technologies such as Wi-Fi and Bluetooth, while a significant proportion will be enabled by wide area networks (WANs) that are primarily facilitated by cellular networks.

• When it comes to scalability, cellular networks are built to handle massive volumes of mobile broadband traffic; the traffic from most IoT applications will be relatively small and easily absorbed. Operators are able to offer connectivity for IoT applications from the start-up phase and grow this business with low TCO (total cost of ownership) and only limited additional investment and effort.

• Many developed countries have started deploying IoT use cases, India is currently going through initial R&D phase. According to Economics Times, an operator that is able to offer full stack of IoT services, will emerge as the leader in this space, since in India there are more opportunities and revenue in creating an IoT solution than providing mere connectivity through IoT. Network service providers can explore multiple approaches towards IoT:

33 Source: Choice Broking

IoT Telecom service

market

By Connectivity Technology

• Cellular Technology

• LPWAN

By Network Management Solution:

• Network performance monitoring &

optimization

• Network Traffic Management

• Network Security Management

By Service Type:

• Business Consulting Services

• Device & Application Management Services

• Installation & Integration Service

• IoT Billing & Subscription Management

• M2M Billing Management

By Application:

• Smart building & home automation

• Capillary Network Management

• Industrial Manufacturing & Automation

• Vehicle Telematics

• Transportation, Logistics & Traffic Management

• Energy & Utilities

• Smart Healthcare

How they can grab this opportunity? • Operators need to look beyond stable business environments towards newer revenue models as connecting most

number of devices alone will not ensure leadership. They need to partner the right solution provider and system integrators like TCS, Infosys. System integrators will have to tie-up with platform providers who offer such capabilities.

• The Indian Government is planning to develop 100 smart city projects, where IoT would play a vital role in development of those cities.

• In India, RJio, Vodafone and Bharti Airtel are expected to lead the NB-IoT deployment. RJio has already conducted pilot run on NB-IoT network and is working along with Ericsson and Samsung to deploy the network. Airtel and Verizon are looking for an IoT partnership and on the other hand Vodafone will have the advantage being a global player - thereby enabling it to provide end-to-end IoT services.

• In India, use cases across consumer and enterprises IoT, such as asset tracking, smart appliances, smart metering, security and surveillance are expected to be key targets. In verticals, major focus will lie on healthcare, education, energy and automotive.

New revenue model for telecom players (Source: voicedata, Economic Times) • New use cases will prompt operators to consider new revenue models for IoT opportunities in the 5G era. Operators

traditionally have relied on selling SIM cards or modules and charging a monthly fee for the mobile data as major revenue sources. IoT customers, however, may push for alternative billing methods or entirely new payment models more aligned with their own cost structure of running an IoT-enabled business.

• For example, a large vineyard owner might desire a crop yield monitoring solution that could integrate sensors to monitor how temperature, sunlight, humidity and soil quality affected the grapes' quality and yield.

• Since such sensors consume very little data, the owner might hesitate at being charged on a monthly basis, instead preferring to opt for a fixed amount equivalent to labor expenses. Alternatively, the owner might prefer annual billing based not on data usage, but on the lifetime value of the added benefits that the monitoring solution would provide.

• So operators must consider how much value their network and IoT solutions bring to their customers before looking for a billing model.

Emerging IoT Value Chain

34

IPv6 adoption will enable fast adoption IoT connectivity • National Digital Communication Policy aimed for substantial transition to IPv6 for all existing communications systems,

equipment, networks and devices by 2020. In India, IPv6 is currently being used for roughly 32% of overall Internet traffic according to Google. That's largely because of RJio, which accounts for nearly 70% of country's IPv6 traffic. Almost 90% of RJio subscribers are using IPv6. India leads the world when it comes to IPv6 capable rate (57%) according to APNIC, the Regional Internet address Registry for the Asia-Pacific region.

• Every device that uses the internet is identified through its own IP address. The previous version, IPv4, uses a 32-bit addressing scheme to support 4.3bn devices, which was thought to be enough. However, the growth of the internet, personal computers, smartphones and now IoT devices proves that the world needed more addresses. IPv6, which uses 128-bit addressing is likely to support approximately 340 undecillion (i.e. 340 trillion trillion trillion) devices.

• According to a report put out by Gartner, 25bn “things” will be connected to the internet by the year 2020. That’s a pretty incredible estimation, considering the same report notes that 4.9bn devices will be connected in 2015. This purported 400% increase in growth in only five years sheds some light on how much exponential IoT growth we can expect to see in the next 10, 20, or even 50 years.

• Given these numbers, it’s easy to understand why IPv6 are important for IoT devices in terms of scalability, security & connect-ability.

Key challenge for 5G implementation

• As per Ericsson, 5G is projected to cover more than 40% of the world’s population in 2024. However India is still behind in 5G implementation due to outdated infrastructure.

• Traditionally, 2G and 3G mobile networks used microwave wireless backhaul to connect cell sites to the nearest MSC over the air. To improve coverage, capacity and overall quality of experience of mobile users, telecos are adopting small cells, which strategically place the BTS closer to the users. Small cells can be backhauled either over copper, microwave or fibre.

• However, only 20-25% of mobile towers in India are connected on fibre optic cable - as a result India is slipping behind in the implementation of 5G, which requires 100% fiber connectivity. Experts say that India is running late on 5G deployments and could be at least three years behind South Korea, Japan, Australia, the US, China, France, or Germany in rolling out 5G networks. The 5G services are likely to be rolled out in these pioneer markets by late 2019 or early 2020.

• In FY20, the industry may not witness active participation in 5G spectrum auctions due to companies having other capex priorities, current immature ecosystem for 5G, and already stretched leverage profiles. Therefore, any disruption from 5G is unlikely in the near term.

Strategies adopted As per National Digital Communication Policy, Government will be implementing a Fibre First Initiative to take fibre to the home, to enterprises and to key development institutions in Tier I, II and III towns and to rural clusters. The government aims to accord Telecom Optic Fibre cables the status of Public utility in order to promoter fibre-driven broadband. It aims at fiberisation of at least 60% base stations thereby accelerating migration to 4G / 5G.

35

Key takeaways

36

Muted subscriber growth: Overall subscriber growth would remain muted or it could slightly decline with the consolidation in the subscriber base through the implementation of minimum recharge plans initiated by the incumbents.

Stability in ARPU: Elimination of low ARPU or only incoming call customers through minimum recharge plan can be considered as an initial signs of stability in ARPU for the incumbents and further improvement could be driven by competition. However, getting to a level of serviceable ARPU is 6-9 quarters distant away.

Expected recovery in gross revenue: Gross revenue is likely to recover from losses sustained in past two years to cross USD 40bn in FY21 and USD 45bn in FY22. The reason behind this increase can be attributed to the possible increase in ARPU along with increase in 4G subscriber base.

Elevated debt levels: With continued nature of capital expenditures on improving network infrastructure without any significant improvement in the realization, the industry debt is likely to remain at elevated levels, unless certain measure are taken to deleverage it. The aggregate net debt of Airtel, VIL and RJio at the end of current fiscal is estimated to be more than Rs. 3tn, implying net leverage of over 7x for the sector.

High 5G spectrum prices, a knife on wound: Despite acknowledging the high leverage position in the industry, the industry regulator has set an exorbitant high price for 5G spectrum, which is around 6.9x the price discovered in the South Korea auction. High 5G spectrum price would add to the existing liabilities thereby further deteriorating the financial position of the companies.

What we expect from government: We are of the opinion that government should wait for the improvement in the leverage position of the telcos and defer the spectrum auction by a year. However, if they plan to do this fiscal, then it should be at a rational pricing level with enough availability of the spectrum. Otherwise, the operators would end up paying high price in the scarcity of spectrum. Also certain policy steps needs to be taken to reduce the overall government levies on the operators from current 37-38%.

Debt reduction plans: Telcos are planning various deleveraging initiative like equity infusion or asset monetization in the near term.

Here we conclude: We expect positive changes in the industry as the incumbents are inclined towards recovery - which can be characterized by the operators focus on returns (viz. increasing ARPU) as well as their plans to pare debt (viz. asset monetization, asset sharing, fund raising, etc.). With these strategies, operators would be in a position to strengthen their countrywide 4G networks along with margins expansion. However, profits are contingent to the operators whose focus is on both ARPU expansion and maintaining the 4G market share. On spectrum liabilities, without government support (i.e. lower spectrum prices and other levies) the operators especially the incumbents may not come out of the debt trap.

Industry wide view: Due to heavy capital expenditures by telecom companies over last 3 years, telcos average turnover to investment ratio has declined from 62% in FY15 to less than 30% in FY18 & return on investments has declined from an average of 11% to around 4.3% during the same period. With continued nature of capital expenditures without any significant improvement in market size, ARPU & reduction in debt levels, making any returns for the stakeholders is going to be a challenging task.

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