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India: What’s the Big Idea?

Certain of India’s dominant telecom operators have generally seen a downturn in their stock, amid massive consolidation in the industry and a fierce struggle for growth.

To date, shares of Vodafone Idea (NSE: IDEA) and Bharti Airtel (NSE: BHARTIARTL), for example, have plunged roughly 64% and 28%, respectively, from their latest 52-week highs – set around this same time in 2018.

The activity falls against a landscape of an ever-increasing migration of customers to higher-speed telecom networks and lower cost plans, as well as a reduction in the number of India’s operators.

One Big Idea

One response to India’s heated fight for market share came in May 2018, when British telco Vodafone (NASDAQ: VOD) announced a mega tie-up between its local Indian unit and Idea – creating India’s largest telecoms operator in terms of subscribers.

The deal, which closed at the end of August 2018, primarily aimed to accelerate the pan-India expansion of wireless broadband services using 4G/4G+/5G technologies, as well as support the introduction of digital content and The Internet of Things (IoT) services, among other motives.

At the end of 2018, the company boasted 387.2m customers, and as it targets an expansion of its broadband coverage and capacity, it eyes further growth in voice-only plan upgrades to data services, digital content and payment services.

In Q3 FY’19, Vodafone Idea touted a further increase in its broadband subscriber base to 107.9m from 99.7 in the prior quarter and 95.3 in Q1 FY’19. Total data subscribers also surged to 146.3m in the latest quarter from 140.1m in Q2 FY’19.

The Reserve Bank of India has also observed customers’ general desire for higher speed communications.

The RBI noted in its monetary policy report earlier in February that in the communication sub-segment of India’s services sector, the telephone subscriber base contracted in October-November 2018, while that of broadband continued to expand in October.

Lower Average Revenue Per User (ARPU)

However, while customers are eyeing faster forms of communications, they also appear to be grappling with costs.

Among Vodafone Idea’s financial results for Q3 FY’19, the firm said that customers continue to switch to lower ARPU plans and has had to implement “various initiatives to improve its revenue, profitability and competitive standing.”

While at a slower pace, its revenue continued to decline 2.2% quarter-over-quarter, compared to a 7.1% plunge in Q2.

India Ratings and Research had warned of lower ARPU adversely affecting Vodafone Idea in early December 2018, when it assigned a ‘AA-’ credit rating, with a negative outlook.

India Ratings analyst Prashant Tarwadi noted that Vodafone Idea’s profitability is likely to remain under pressure in FY19-FY20, as “competition intensity in the sector would limit a substantial recovery in average revenue per subscriber (ARPU).

Tarwadi also said that synergy benefits from the merger will “partially be offset by the upfront integration costs,” and “weak” profitability, along with high debt levels and continued investments in network enhancement, would keep leverage at “elevated levels.”

Vodafone India’s gross debt at December 31, 2018 was Rs. 1,237bn, including deferred spectrum payment obligations due to the Government of Rs. 915bn. Meanwhile, cash and cash equivalents were Rs. 89bn, resulting in net debt of Rs. 1,148bn, up from Rs. 1,125bn in Q2 FY’19.

Moreover, as the Indian government readies the country for next-generation, 5G roll-outs by 2020, Vodafone India, along with other players, will likely require increased capital spending.

Not Alone

Vodafone India wasn’t the only telco to feel an adverse impact to its balance sheet.

Although Bharti Airtel’s revenues rose 1.9% year-on-year, its net income fell to Rs. 860m from Rs. 3.06bn in the same year-ago quarter, with an increase in debt of Rs. 146.5bn year-on-year to Rs. 1.06trn. Bharti’s EBITDA also contracted roughly 15.5% year-over-year, with its core Indian mobile segment, which it largely depends on for profit, continuing to suffer.

Moody’s Investors Service earlier in February cut Bharti Airtel’s credit rating into ‘Ba1’ junk status from a low-tier investment-grade ‘Baa3’ with a negative outlook, citing “uncertainty as to whether or not the company’s profitability, cash flow situation and debt levels can improve sustainably and materially, given the competitive dynamics in the Indian telco market.”

Service Sector

Overall, business activity growth in the Indian service sector cooled further at the start of 2019, amid the weakest upturn in new work since last September, according to Nikkei and IHS Markit

The seasonally adjusted Nikkei India Services Business Activity Index fell for the second straight month in January, from 53.2 in December to 52.2, indicating a softer expansion in output. A sharp and accelerated rise in manufacturing production offset the slowdown in activity growth across the service economy.

Pollyanna De Lima, IHS Markit economist noted that expansion rates in the Indian service sector have been at “modest levels for the past four months, with January data extending the recent trend.

“There is some sign that growth may run out of steam, in the short-term at least, as seen by the weakest improvement in demand for four months and relatively subdued optimism.”

India is slated Tuesday to provide an update on its Nikkei India Services PMI for February and may foretell continued weakness in the telecoms sector.

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Steven Levine

Steven Levine is a Senior Market Analyst at Interactive Brokers, (IBKR), which provides online trade execution and clearing services to institutional, professional and individual investors for a wide variety of electronically traded products including stocks, options, futures, forex, bonds, CFDs and funds worldwide.

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