Indian telecom worst yet to be seen - sell, sell & sell

1 Indian Telecom Space ‐ Worst yet to be seen – SELL – A different perspective

14th May, 2010

Vinit Tulsyan http://vinittulsyan.wordpress.com


Summary

Telecom stocks have been plunging since last few days, but this has come as little surprise to
me. Even before the debate over telecom growth story hitting a road block started, I was
convinced that the dynamics in telecom industry has started to change and will worsen going
forward, though I was bullish on telecom companies on two counts, which I still am but the
problem is that none of these have shown signs that they will be a significant contributor to the
top line. We are still few years away for these factors to starts contributing significantly to the
top-line (refer page no 14).

I in one of my articles dated 30th Sep’09, titled ‘BHARTI – MTN; No Cross Border Connection –
A DIFFERENT TAKE’ wrote:

• The reasons for my bullish stand on telecom sector at large are the opportunities to
scale up other services such as Data carrying/transfer, IPTV, enterprises services,
broadband penetration, and cross-borders data transfer apart from opportunities in value
added services offered by telecom companies. The penetrations of these services are
almost negligible.

• The voice business does not really excite me too much; within voice what encourages
me is the opportunity which is at hand for large exiting telecom companies, who have
already spent billions and billions of dollars for putting up pan-India or pan-world
infrastructure. More than the margins earned by large existing telecom players for voice
business, which in my opinion will be under pressure going forward, due to fight over
market share at the expense of margins by both exiting and the new players, leveraging
through sharing the huge exiting infrastructure set up by large telecom companies will be
the one which will compensate for the margins lost due to competition”.
14th May, 2010

• Click on the link to access the file http://www.box.net/shared/k92nffooq6)

The plunge in the stock price had to happen (reasons explained in next page), though it
happened sooner than later. The govt. through 3G auctions has now realized the importance



and potential of telecom sector w.r.t. revenue generation; helping it bringing the fiscal situation
under control or finance its borrowing. The stocks might bounce back in near term due to this
huge selloff witnessed recently, but in the medium to longer term, due to a complete structural
change taking place in the industry, the likelihood of telecom becoming either a growth or
defensive play is extremely remote, at-least from a three year perspective.

• Not a growth play, because, the dynamics of telecom industry will continue to see major
structural changes over next few years, which will be extremely negative for Telecom
stocks in the longer term.

• Not a defensive play, rather even defensive is a strong word for Telecom sector,
because Defensives mainly are dividend and safe (providing cushioning to the portfolio
during tough times) plays, but given the huge expenditure to be incurred by Telecom
players on various accounts (detailed below), it will just not leave enough balances on
their balance sheet to give it back to shareholders, rather the situation might arise that
they will have to over-leverage themselves.

• Telecom going forward (in my opinion after 3 years) would become defensive play, if few
things are achieved. 1) Most of the major telecom companies are done with larger
capital expenditure, 2) If there is a possibility of India witnessing at the max. 5 Pan India
Player (which even in next three years, I see as a distant dream), 3) Non-Voice services
(Data carrying/transfer, IPTV, enterprises services, broadband penetration, and cross-
borders data transfer and VAS) starts to contribute a good amount to the top line, 4)
there is a steady consistent growth in revenue similar to GDP growth, 5) companies are
not over leveraged, which is the name of the game in today’s times and finally 5) rather
than Individual companies going ahead and setting up their own Infrastructure, players
try to leverage and share their own strength with each other.

In my opinion, telecom story in India is no more about PE or EV/EBITDA, but one has to look
14th May, 2010

beyond the numbers. The numbers/multiples might look attractive but even they cannot provide
any cushion to the stock prices in the longer term (at-least for the next 3 years) due to a
complete structural change, which the sector is witnessing and will continue to witness going
forward.



Here, in the report, I look at 4 broad factors i.e. Government/Regulation, Expenditures, Newer
Customer Acquisition, M&A/Consolidation, leading to this structural change within telecom
industry, which in turn convinces me that Telecom Sector is not the sector to own, from a
medium (1-2 years) or long term (3 years) perspective. I try and look at, what is the present
scenario, and what these present scenarios can lead to in future. I am not all negative on
Telecom story but the factors I am positive about (Page No. 14) are still few years away from
yielding fruitful results.

I have tried to present a perspective, which is different, practical and makes sense (at-least to
me) by putting myself in the customers and service provider’s shoes, on what holds for Telecom
Industry in near future. I might be wrong, but hope you enjoy the perspective.

14th May, 2010



4 broad reasons to SELL Telecom Sector in the both medium and long term

1. Government / Regulation – Uncertain minister with uncertain policies

• Growth in controversies outpacing the phenomenal growth story witnessed by
the Telecom Industry:

o The growth in controversies surrounding the sector has outpaced the
phenomenal growth story witnessed by the Telecom Industry. And as
more and more companies come in (now 19 of them) and each having
their own vested interest, the growth of controversies will continue to
outpace the growth of telecom sector. This might lead to further
deterioration in already deteriorating dynamics of telecom Industry.

• Expect more bombshell from the Minister or the regulator going forward:

o Like yesterday’s bombshell dropped by the regulator (in form of
recommendation) over 2G spectrum fees, an attempt to generate revenue
from various other forms, licensing norms and M&A guidelines etc. are
something, the industry will have to live with, in coming years (at-least till
the time Mr. Raja is Mr. Telecom Minister).

• Minister under huge pressure – not good for Telecom sector either today or for
next few years: but I firmly believe that he is not going anywhere

o The minister any way is under huge pressure from everyone i.e. Media,
Public, Telecom Companies, Own Party, the ruling party, colleagues over
the way he has handled the ministry, since the time he became Telecom
minister. Now with the most serious allegation that the due to minister’s
14th May, 2010

approach, the govt. has lost Billions and Billions of US Dollars. This
debate will only gain momentum till the time 3G spectrum auctions are
over and players are finally allotted their quota of spectrum; putting more
pressure on minster that if the minister would have gone the PM’s way,
where he directed/suggested telecom minister to allot 2G spectrum



through Auction process, the govt. would have made billions of dollars.
So, now with that opportunity gone, the yesterday’s bombshell was not a
surprise. Rather, I will not be surprised, that there are more bombshells,
which could be thrown at the telecom industry, with Mr. Telecom Minister
trying to prove a point that if we could not generate as much revenue due
to earlier 2G allocation process, we can still do so, in some form or the
other.

• The 2G Bombshell

o Today’s proposal by TRAI leading to a much higher outlay
for existing players
Payment of one-time-fee or OTF for ‘excess’
spectrum (>6.2MHz) based on 3G auction prices
Increase in spectrum usage fee for spectrum above
6.2MHz
Payment of auction-linked price for spectrum
reassignment at the time of license renewal
Levy of license fee on infrastructure (tower) and
ISP businesses at 6% of Adjusted Gross Revenue
(AGR) versus NIL currently
Reversing regulators/ministry earlier stance of
creating a level field for new and old players, the
recommendation now discriminates in-between the
existing and the new players for Spectrum
allocation; this might lead to another explosion
within the Industry.

• Had to come, since the telecom minister was under huge
pressure, expect more
14th May, 2010

• Compared with 3G phenomenal response (set to give govt. ~Rs.
60,000 crores against expectation of Rs. 25,000 crores), Mr.
Telecom minister is said to have defied PM (who wanted to have
an auction for 2G as well); leading to govt. losing billions of $



• Despite this bombshell by the regulator, I believe these
recommendations might not be accepted in totality and will face
extensive debates and opposition from players negatively
impacted by these recommendations.

• The regulators and the govt. will continue to try having domination
over the way Spectrum, Licensing and M&A norms are dealt with,
which will continue to bring huge amount of uncertainty in the
market place and expect more uncertainty till the time Mr. Raja is
there, and my belief says he is not going where.

14th May, 2010



2. Expenditures (HUGE)
o The Spectrum Poison

2G and 3G spectrum fees – The biggest of all

• One just cannot calculate how much Telecom companies need to
shell out in order to get either 2G or 3G, every day there is new
policy, there is uncertainty in the market place

• This uncertainty and a war to acquire more spectrum (as during
consolidation, availability of spectrum is going to be one of the
major driver for valuation) will lead companies to leverage
themselves

The 3G dilemma - The story goes as follows – Only huge expenditure and
Risk with little return in foreseeable future (at-least in next 3 years)

• A compulsion for the companies to have 3G spectrum in order to
remain competitive

o If you have 3G, alright, nothing much to cheer about

o If you do not have 3G, then everything to lose for (because
the competitors have it)

• 3G spectrum would be used to augment 2G voice capacity
(especially in metros) rather than high data usage (so effectively
one is acquiring 2G network at a sky high price)

• Additional Capital expenditure to be incurred for 3G Infrastructure

• Where are the handset for 3G (for example, 10% of Metro
customers having 3G enabled handsets are just not going to help
telecom companies)
14th May, 2010

o We have already seen the fate of 3G services offered by
state owned telecom companies i.e. BSNL & MTNL

o I am sure that very few of Metro customers having 3G
enabled handsets have even looked at the plans offered
by BSNL & MTNL



• Talks of telecom companies passing on the increased cost of 3G
spectrum to customers is just ruled out, if any company does that,
it will be in more of a problematic situation.

o The problem is that the telecom industry is boasting so
many service providers, that formation of ‘cartel’ in order to
have a better pricing power is just ruled out.

o The future over Spectrum costs

Telecom sector pain – Govt. gain – Good for India at large but not so
good for Telecom Companies - Am sure in all likelihood, any future
spectrum allocation would be done through Auction process as govt. has
realized that Telecom could be the cash cow for generating revenues,
which could further be used towards bringing the fiscal situation in place
and the more revenue govt. is able to have, the less they will have to
borrow from market place – One way positive for India but not so good
news for Telecom Companies.

Availability of spectrum with newer entrants, will be one of the key factors
for commanding premium during Consolidation, so any future spectrum
allocation will be seen as a war zone (as currently visible in 3G) with
almost every players fighting to get some share of spectrum

o Other expenditures

2G Infrastructure expansion,

Network Rollout

3G Infrastructure rollout expenditure
14th May, 2010

Maintenance of both 2G and 3G infrastructure

Debt servicing - huge outlay as most of the companies will have to over
leverage themselves on account of:

• Huge 3G spectrum charges,



• 2G bombshell by the govt.,

• Higher prices to be paid for future spectrum acquisition, either of
them (as am sure future spectrum allocation would be done
through Auction process)

14th May, 2010



3. Newer Customers
o Competition

Increase in competitive activity in the market (have now forgot the count
on the number of existing and upcoming players within Indian telecom
space)

Increased competition will continue to keep prices under check as now
onwards:

• The customers acquired by any operators will be highly sensitive
to price.

• In other words, the loyalty from these customers towards the
brand would be negligible and

• Any company offering cheap services will be able to acquire the
other operators customer

o Given this will not be surprised to see that one operator
gains at the expense of others

o Huge newer customer acquisition cost

Competition leading to newer customer acquisition cost being higher than
the actual revenue generated,

o Inferior quality of newly acquired customers

The quality of new customers being acquired is extremely inferior w.r.t.
revenue generation (given that fact that majority of India is still below
poverty line earning only $2 or little more a day, this is the only segment
14th May, 2010

which is now left out as the left out customer segment and they are the
ones looking for telecom services after current subscriber base of ~600
million)

o Newer Customer - Not loyal – huge Churning to happen



Data points out that most of the new customers acquired are from Tier-3
and beyond

Mostly pre-paid customer acquired

Fast churning will be the name of the game within industry. Uninor
disclosure was an eye opener and substantiate this theory:

• Management was cautious on the India business (Uninor) and
referred to a “more challenging outlook” and “need to increase
usage”.

• Active subs low proportion, usage/ARPU even lower

• Uninor disclosed 2.1m active subs i.e. just 50% of the reported
4.3m as of Mar-10

• Even on active subs, ARPU at ~Rs90

o The Active subscriber theory

Many of the new mobile connections bought by
customers already having existing connection

Taking connection only temporarily to capitalize on
lucrative offerings by telecom companies

Once he has exhausted his balance, he starts
looking for more lucrative offering either from the
same operator or the other

Once he gets a better deal from some other
operators, the subscriber gets into this category of
‘Non Active’
14th May, 2010

o Rural India Customer

Telecom companies keep on talking about the huge growth potential
presented by the Rural India but:

• Rural India customers are more price sensitive; they will easily
change numbers, if another operator is offering cheap services



• New players to do anything to acquire customers (as this will drive
their valuation upwards in case of Consolidation)

• This will lead to continuation of lower tariffs for a much longer
period of time

o Acquisition of new High Value Customer – Leading to non-payment

Service providers are extremely wary of giving out post paid connection to
newer customers (due to customer profiling) due to high probability of
non-receipt of payment

14th May, 2010



4. M&A or the Consolidation debate
o Inevitable but:

Still a long time before consolidation starts taking place (at-least 2 years
away)

Not expected to provide any respite to the acquiring companies

Expected to be an extremely costly affair with little value addition even
after consolidation due to customer profiling

The cost of M&A will be huge as the valuation of these companies
(acquisition targets) will be based more on:

• Spectrum availability,

• Subscriber base;

o Logically leading them to aggressively bid for spectrum
(both 2G and 3G) and

o Acquire customers at throw away prices in order to
command a higher premium as and when they become
acquisition targets;

Further leading in continuation of lower tariffs for a
much longer period of time,

o Ultimately not helping the acquiring companies (the bigger ones) in any way

14th May, 2010



I am not all negative on Telecom story but the factors I am positive about are still few years
away from yielding fruitful results

• Other Services

o I am extremely bullish on opportunities, which are scalable in nature such as
Data carrying/transfer, IPTV, enterprises services, broadband penetration, and
cross-borders data transfer apart from opportunities in value added services
(VAS) offered by telecom companies. The penetrations of these services are
almost negligible. The problem is that they presently contribute little to telecom
companies top line and huge infrastructure roll out will have to take place in order
for these services to start generating revenues. Unfortunately, in my opinion, the
favorable results from these opportunities are still few years away.

• Leveraging by sharing the existing Infrastructure

o The voice business does not really excite me too much; but within voice what
encourages me is the opportunity which is at hand for large exiting telecom
companies, who have already spent billions and billions of dollars for putting up
pan-India or pan-world infrastructure. More than the margins earned by large
existing telecom players for voice business, which in my opinion will be under
pressure going forward, due to fight over market share at the expense of margins
by both the exiting and the new players, leveraging through sharing the huge
exiting infrastructure set up by large telecom companies will be the one which will
compensate for the margins lost due to competition. Unfortunately, this trend is
yet to be seen.

• Consolidation – only 5 players at the max
14th May, 2010

o When India has 5 players at the max (against 19 today), I will start looking at
telecom as a defensive play. The defensive would not turn as growth play until
the above two pointers starts contributing significantly to the top line. My wish for
witnessing 5 telecom players within Indian Telecom Industry in my opinion is still
5 years away.



Given below are the reports and articles I have come up with till date.

Copy and paste the link to
Date    Titled
browser to download

Greece has helped open the Pandora
Box...Yet for the time being it's just a http://www.box.net/shared/b1iz
10‐May‐10
catalyst for Market Re‐pricing ‐ as Dubai nlfx0g

was.

Fear and Panic: Unwarranted & Imaginary http://www.box.net/shared/sxitj
5‐May‐10
at‐least for now k3m6b


India Entering into Long Term Secular
Growth zone across regions and sectors due http://www.box.net/shared/qhy
10‐Jan‐10
to on the back of a truly ‘all inclusive 1r5smdt

growth'

“Dubai jitter across countries and
http://www.box.net/shared/pbu
28‐Nov‐09    investment avenues –what, why, how and
xoffjue
what’s next???”


http://www.box.net/shared/ch8
5‐Nov‐09    Where are financial markets headed?
dlgis5d


The rally returns across all investment http://www.box.net/shared/nau
28‐Oct‐09
avenues barring USD 4vh1yaz


The Chinese (GDP) and Brazilian (2% tax) http://www.box.net/shared/4c1a
21‐Oct‐09
effect in financial markets across the globe yxl0ii


October to continue lending its support to
http://www.box.net/shared/02o
12‐Oct‐09    equities & oil, a choppier, volatile and
vo7v7ii
sideways November in the store


Rally across all investment avenues to make
14th May, 2010

markets more volatile and move sideways: a http://www.box.net/shared/nvtu
6‐Oct‐09
take on gold, currencies, interest rates, frst9n

inflation, equities

Bharti – MTN; no cross border connection – http://www.box.net/shared/k92
30‐Sep‐09
a different take nffooq6





Earning season, movement in interest rates
http://www.box.net/shared/l6im
29‐Sep‐09    and inflation to make markets move sideways
flvj1k
and volatile in near to medium term


New theories emerge as the markets heads
higher. Do M&A activities signal something? http://www.box.net/shared/2kqt
28‐Sep‐09
Will currencies play the spoilsport for this pbg60a

rally in medium to longer term?

Confusion persists with conflicting data
points but in my view this confusion will take http://www.box.net/shared/kuus
13‐Aug‐09
this market even higher in medium to long kr1otz

term

Election 2009: game changer for India,
change in paradigm for Indian politics, http://www.box.net/shared/bjrh
18‐May‐09
corporate world, economy, people or India 73287n

at large

http://vinittulsyan.wordpress.co
Stress test: Cat out of bag: US financial m/2009/05/08/stress‐test‐cat‐
8‐May‐09    industry report card: more positive than out‐of‐bag‐us‐financial‐industry‐
negative report‐card‐more‐positive‐than‐
negative/


The 7us$ and 6:1 (again 7) d/e ratio push for
http://www.box.net/shared/o4t5
23‐Mar‐09    a 7% rally on wall street; but where from
39v3rg
now; is it a sign of changing times?


India & China: “love us, hate us but can’t http://www.box.net/shared/7rje
22‐Mar‐09
ignore us” bptyqa


FOMC shocker… unprecedented http://www.box.net/shared/bnui
19‐Mar‐09
campaign…massive quantitative easing… bjt2zh


Fading dark clouds…but…its’ still not bright http://www.box.net/shared/6avi
16‐Mar‐09
enough… hiseib
14th May, 2010


Hope: the rally lives on…but…they still are http://www.box.net/shared/5ms
12‐Mar‐09
bear market rallies tt5jvho


Optimism play: bulls are back at‐least for
http://www.box.net/shared/1vxp
10‐Mar‐09    now with markets trying to find a bottom on
xr5et5
the back of hope




Gold: Golden fortune: long gold / short INR: m/2009/03/08/gold‐fortune‐
8‐Mar‐09
buoyant long term outlook long‐gold‐short‐inr‐buoyant‐long‐
term‐outlook/


Getting back to reality: is there any m/2009/03/03/getting‐back‐to‐
3‐Mar‐09    investment avenues left for investors in realities‐are‐there‐any‐
today’s world? avenuesoptions‐left‐for‐
investments‐in‐today’s‐world/


m/2009/03/02/more‐“bad‐
2‐Mar‐09    More bad news in store than good
news”‐in‐store‐than‐“good‐
news”‐–‐vinit‐tulsyan’s‐views/


Things will get worse before they get better m/2008/10/26/things‐will‐get‐
26‐Oct‐08
– part I continued… worse‐before‐they‐get‐better‐
continuation‐to‐part‐i/



The worst is not over yet? Yet to be seen!!
24‐Oct‐08    m/2008/10/24/the‐worst‐is‐not‐
(part: II)
over‐yetyet‐to‐be‐seen‐part‐–‐i/


m/2008/03/31/what‐is‐
What is happening to property market –
31‐Mar‐08    happening‐to‐property‐market‐–‐
mar’08
our‐perspective‐my‐views‐while‐
at‐centrum‐capital/


Links to my few reports while I was at Centrum

ESCORTS: Reploughing for a Rich Harvest http://www.box.net/shared/2hn
21‐May‐07
14th May, 2010

(part of Investment banking assignment) gilv1i7


http://www.box.net/shared/4lgi0
1‐Feb‐08    EMMAR MGF AVOID IPO NOTE
xfyln





DLF – Bigger Aspiration (a detailed 60 page
comprehensive report with city wise focus http://www.box.net/shared/v08k
2‐Apr‐08
and co‐relation with Infrastructural nhonzo

development

http://www.box.net/shared/kgp3
Feb’08    Stock Picking Presentation
g1aehu

Thaking You,
Personal Regards,
14th May, 2010

Vinit Tulsyan
http://vinittulsyan.wordpress.com/



Disclaimer

This report is for the personal information of the recipient and can also be used to distribute publically.
This report is for the general information and entirely represents the views of the author and should not be
construed as an offer or solicitation of an offer to buy/sell any securities.

The information contained in this report has been obtained from sources that are considered to be reliable.
However, I have not independently verified the accuracy or completeness of the same.

This report expresses my opinion on the structural changes taking place in the telecom sector and is not specific to
any companies within the sector. I have exercised due diligence in checking the correctness and authenticity of the
information contained herein, so far as it relates to current and historical information, but do not guarantee its
accuracy or completeness.

There might be some forward looking statement, which is entirely based on my understanding of telecom sector,
and I do not accept any liability arising from the use of this document. The recipients of this material should rely on
their own judgment and take their own professional advice before acting on this information.

I am in no way responsible for any loss or damage that may arise to any person from any inadvertent error in the
information contained, views and opinions expressed in this report.

I have used the logos of Telecom service providers, which is just for informational purpose and have been taken
from publically available website(s). I by no means intend to gain from this report in any form.

14th May, 2010


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