Big guys push smaller telcos in a corner: Why M&A is the only solution

The big guys are getting stronger while the smaller ones seem to be on a weak wicket in the telecom space.

Not only do Bharti, Vodafone and Idea account for a bulk of Indian mobile telephony subscribers, the revenue they earn from circles where revenue potential is the least is also less compared to challengers. Put simply, this means the three incumbents have to maximum subscribers on their networks and maximum high revenue subscribers across the industry too.

Does this mean the mobile telephony market in India is meant only for incumbents, the big daddies, who came in decades ago and have slugged it out through thick and thin? There is surely a need for consolidation among Indian players, with most markets across the world accommodating only four of at best five big players instead of the plethora in India. Now that the Government is finally readying the norms for mergers and acquisitions in the telecom industry, perhaps it makes sense for the smaller guys to either align with the biggies or to just pack their bags and sell out.

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[caption id="attachment_1098417" align="alignleft" width="380"] The big guys are getting stronger while the smaller ones seem to be on a weak wicket in the telecom space. Reuters[/caption]

That the big guys - Bharti, Vodafone and Idea Cellular - are getting bigger can be gauged from two things: their volume market share which tracks number of net subscriber additions each month and subscriber led market share; and value market share which tracks each operator's share of the revenue.

Volume market share:

As late as September this year, when the GSM industry added 4.4 million subscribers (this data does not include CDMA operators), the big three - Bharti, Idea and Vodafone - lead the pack with combined subscriber addition of 3.6 million or eight in 10 new mobile phone subscribers chose one of these three networks.

Though all private operators added subscribers in September, Idea lead the way with net additionrs of 1.2 million.

Ankur Rudra and Utsav Mehta of Ambit Capital said in a note to clients recently that these three companies represented 81% of the additions, which is

significantly higher than their combined GSM market share.

"This reflects the continued consolidation in the industry. We remain buyers of Bharti (target price of Rs 380) and Idea (target price of Rs 185), owing to the improving pricing and regulatory environment."

Aircel was the only other telco which also added subscribers in any significant number, at 0.6 million. Videocon (0.3 million) and Uninor (0.1million) also added subscribers.

Rudra and Mehta noted that the three incumbents combined have represented 78% of the additions in the previous six months, again showing their strength.

Value market share:

Now lets come to value market share. A story in the Business Standard this morning clearly says that with 70% revenue share of the mobile teleohony market, Bharti, Vodafone and Idea have ensured that telecom in India is becoming a three horse game. This story said the three incumbents' value share three years back was 60% and five years back only 50%. So in effect, 70 paise of every rupee earned by the telecom industry is going to the big three and the remaining 30 paise is distributed among the rest of the players.

Shobhit Khare and Anil Shenoy of Motilal Oswal said in a note to clients last month that circle-wise RMS (revenue market share) analysis reconfirms dominance of incumbents across footprint. Incumbents or the three big daddies have lowest aggregate revenue contribution from challenger circles (<15% RMS). Bharti has no circle with <15% RMS while such circles constitute 11% of revenue for Vodafone and 33% for Idea. In contrast, challenger circles contribute 45% of revenue for Aircel, 84% for RCom and 100% for Tata Tele/BSNL-MTNL/Telenor.

The BS story says over the past five years, Idea has nearly tripled its quarterly adjusted gross revenues (AGR) - to around Rs 5,400 crore in the June quarter of this year from Rs 3,000 crore in the corresponding quarter of 2010 and Rs 1,800 crore in that of 2008 - according to Telecom Regulatory Authority of India figures. This has enabled the Aditya Birla group company to nearly double its revenue market share in five years to a little over 15 per cent. During this period, Vodafone's quarterly revenue doubled to Rs 7,500 crore in June this year, from Rs 3,800 crore five year ago. The UK-based telco now accounts for 22 per cent of the industry's revenue - up from less than 17 per cent in 2008. Bharti Airtel's revenue growth kept pace during the period, rising around 50 per cent and allowing the company to maintain its revenue share at around 30 percent.

Need for M&A:

That the telecom industry is ripe for consolidation is not in doubt. And the driver of consolidation will obviously be gain of spectrum which a target company already possesses besides financial implications. The thing to watch out for here is 3G operations and how 3G spectrum could drive the M&A in the near future. Motilal Oswal analysts Khare and Shenoy pointed out that while the current 3G data revenue contribution remains low (2-2.5%), data revenue is a key growth driver signifying potential requirement for 3G spectrum.

Incumbents Bharti, Vodafone and Idea currently have 3G spectrum in 13, 9 and 11 of the 22 circles, implying revenue coverage of 69/65/73%. "With 3G intra-circle roaming remaining a contentious issue and possibility of spectrum trading being allowed, there could be opportunities for incumbents to acquire 3G spectrum and increase their 3G revenue coverage." Another M&A driver would be potential funding requirement for incumbents.