When Mukesh Ambali’s Jio entered the telecom market last year with free voice calls for life and free data for a limited period, it was clear that a shake-up was imminent in the market. At one point, India’s telecom market had close to a dozen players but competitive intensity had already whittled this number down to three large ones – Bharti Airtel, Vodafone India and Idea Cellular – and less than half a dozen fringe players. So when Jio trooped in with a promise of unlimited freebies and a known appetite to absorb losses, it was apparent that the telecom market pecking order had to change to survive.
India is the world’s second-biggest mobile phone market by subscribers, behind China, but high competition in the crowded market has traditionally kept profits under pressure for all players. With competition rising due to Jio entry, consolidation is the only way forward. In this scenario, whispers of a possible merger between Vodafone and Idea have been doing the rounds for months – they were finally confirmed by Vodafone only last week.
If these discussions do fructify into a merger, the new entity will be the undisputed leader of India’s telecom market in terms of subscribers. And the biggest loser in this scenario would obviously be the long standing telecom czar, Bharti Airtel. Jio, whose arrival triggered an industry-wide consolidation, will also find the going tough in future since customer acquisition will become tougher.
So Why Are Vodafone And Idea Cellular Exploring A Merger At All?
The country’s number one telco by subscribers is Bharti Airtel, with Vodafone a close second and Idea coming in at number three. A merger between Bharti Airtel and either of the remaining two would have caused trouble as India’s merger and acquisition rules allow a merger, only if the percentage of adjusted gross revenue market share of the merged entity does not exceed 50 per cent in any particular telecom circle. The guidelines also specify that the combined entity should have less than 50 per cent of spectrum in each band individually in addition to having less than 25 per cent of the spectrum allocated to all operators in all bands in all circles.
So in the event that Bharti Airtel and Vodafone, say, explored a merger, these caps would have been violated in a large number of circles. The only other option was for the number two and three to explore synergies – which is what is happening right now.
How Does This Merger Benefit Vodafone And Idea?
Vodafone Plc has had to write down close to $5.5 billion in India, has been talking of a listing on Indian bourses with little success and has never been profitable in the world’s second largest telecom market. If a merger were to happen, it gets to not only perhaps reduce its losses but also gets to list on the bourses since Idea is already listed, without having to undergo the initial public offer (IPO) process. For Idea too, a merger makes sense. Analysts say it has been weighed down by debt of over Rs 40,000 crore and a merger would enable a re-rating, possible increase in market cap.
Why Has Jio’s Arrival Spooked The Market So Fast?
Jio came with its freebies, including lifetime free voice calls and cheap data plans, but the heat has been on for all three players even before its arrival. Now, thanks to the freebies, margin pressures have only increased.
This article shows how market leader Bharti Airtel suffered in the third quarter due to increased competitive intensity. Third quarter net profit slumped 55 per cent from a year earlier as its voice and data businesses felt the full impact of Jio’s free services. Revenue fell 3 per cent as data and voice rates fell and more subscribers left the operator. Bharti Airtel managing director and chief executive Gopal Vittal said: “The quarter has seen turbulence due to the continued predatory pricing by a new operator…This has led to an unprecedented year-on-year revenue decline for the industry, pressure on margins and a serious impact on the financial health of the sector.”
Rivals including Bharti Airtel were forced to slash effective data rates and offer free voice calling on some plans across price segments. Telcos had started cutting tariffs even before Jio’s launch, hurting key operational metrics such as average revenue per user (ARPU) and average revenue per minute (ARPM). Even after cutting data rates sharply, the company’s data customer base fell 12.4 per cent quarter on quarter, pulling down data usage by 3.5 per cent.
What Kind Of Muscle Will The Merged Entity Have?
As Jio continues to extend its freebies, consolidation could well be a necessity as both Vodafone and Idea will need to protect revenues, profitability and valuations. Fitch Ratings said in a note to clients last week that a planned merger between Vodafone and Idea should help them withstand intense price competition in the market. The ratings agency said it expects the merger could improve the combined EBITDA margin by 250-350 basis points due to cost savings – mainly on network and marketing expenses. The combined entity will also have a more balanced subscriber mix, as Vodafone is strong in urban areas whereas Idea focuses more on the rural mass market. “We estimate the merger would create an entity with 390 million subscribers, a leading revenue market share of around 40 per cent, revenue of $11-12 billion and an EBITDA margin of about 28 per cent to 30 per cent,” the Fitch analysts said.
Will This Merger Be Easy To Achieve?
As with any mega corporate deal, possible merger between Vodafone’s Indian operations and Idea would face challenges. As explained earlier, M&A norms may cause some trouble. Brokerage firm CLSA has pointed out earlier that a merger of these two companies would breach the revenue market share ceiling in five out of 22 telecom circles. But a telecom market expert says the knotty problem of revenue market share cap breach may get resolved once Jio – which is offering free services till now – begins charging and the revenue market share dynamics shift. All in all, a merger will work as long as both partners work out a solution to the M&A caps. Of course, the usual merger issues such as valuation, which partner gets to control how much in the new entity and which gets to run the new entity will also need to be resolved as the talks progress.
Is The Telecom Industry Game For Further Consolidation?
If the Vodafone-Idea merger happens, then the merged entity and Bharti will together control over 70 per cent of India’s telecom market share by revenue. This obviously spells doom for remaining small players. Industry estimates peg post-merger market share for Tata Teleservices at 6.5 per cent, BSNL and MTNL combine at 5 per cent, Aircel at 5.7 per cent and Sistema at 4 per cent. Reliance Communications (RComm) is estimated to be close to Sistema’s share at 4.2 per cent.
It then becomes incumbent upon these small players to either unleash another round of consolidation or wind up. Tata Teleservices is embroiled in a legal tangle with its Japanese equity partner DoCoMo and this alone may prevent any near term consolidation.
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.