Callateral damage: The far-reaching consequences of Vodafone Idea going bust

Kumar Mangalam Birla has been camped out in Delhi for over a week now. Birla, the chairman of beleaguered telco Vodafone Idea Limited (VIL), first rushed to the smog-filled national capital at the end of October, after a Supreme Court judgement which shook the telecom industry. The apex court ruled that telecom operators owed a combined Rs 1,31,000 crore ($18.23 billion) to the government in line with a broader definition of what constitutes taxable revenue.

Suffice to say that the already ailing VIL is now on life support. This past week, VIL posted the largest quarterly loss in the country’s history—Rs 50,922 crore ($7 billion) for the quarter ended September 2019. All of this has been enough for Nick Read, CEO of Vodafone Group, to publicly lambast India’s “unsupportive regulation and excessive taxes”, even questioning VIL’s ability to stay in business.

While Read later walked back these statements after drawing criticism from the government, Birla’s mission in Delhi makes it clear that they weren’t off the mark. Birla is seeking a stay of execution.

The VIL chairman has already met with Indian Prime Minister Narendra Modi. During his meeting with Modi, Birla apprised the PM of VIL’s precarious position and sought immediate relief from debt payments. According to sources, he was given no concrete assurances.

“He was told that the government understands the situation and that they are working on something,” said a senior industry executive aware of the meeting. A few days later the government formed a Committee of Secretaries (CoS) to look into the matter. Forming a CoS is generally seen as a response to exceptional circumstances. The last CoS was formed 20 years ago to help telcos transition from a fixed license fee regime to a revenue share one.

The SC ruling has turned the spotlight from VIL to the government. “If VIL had a few more years and months of life, the SC judgement has put the patient on a ventilator,” an international consulting firm executive said. Now, if VIL files for bankruptcy, the blame will be on the government. “It will be egg on the face of the policymakers,” said a Mumbai-based analyst. 

The measures the CoS and the government decide on will effectively determine the future course of the Indian telecom sector. And whether VIL will be part of that future or a footnote in its history. 

Even before these latest quarterly results, analysts were already speculating that VIL would end operations in telecom circles where its revenue market share is less than 15-20%. Now, there is talk about writing off intangible assets such as goodwill from its financials.

At stake is not just VIL’s fate, but also the future of the telecom market. With government-owned operators MTNL and BSNL already buried under mountains of debt, Vodafone going belly-up will result in a duopoly and a shaky one at that. 

“The worst fear in a two-operator market is regulatory hijack, wherein all policies are formulated to favour only one operator,”

—A senior industry executive

In the absence of competition, current players have little incentive to invest in their networks, resulting in a poor experience for customers. And even as quality suffers, tariffs could go up as the remaining players take advantage of the customers’ lack of alternatives. 

The government’s spectrum auctions, previously a cash cow on account of multiple companies jostling for spectrum, would also see a lukewarm response. Debt-laden telcos with scant competition have little reason to improve their services and no appetite for expensive spectrum.

If the government offers no relief on repayment of dues, Airtel, too, will not have the funds to continue investing in its network for the next year and a half. Networks, already choking in India’s bustling cities, will only get more congested, with quality of service indicators—call drops, for instance—worsening considerably. Airtel’s plight is made worse by the tower sharing agreement it has with VIL.

“We have a situation where the Indian telecom sector may not see investment in capital expenditure (capex) in a sector which contributes anything from 4.5-6.5% of GDP,” said Rajiv Sharma, head of institutional equity research at SBICAP. This will hurt the government, which is already fighting an economic downturn. Not to mention it will have to forego the Rs 90,000 crore VIL owes it should the company file for bankruptcy.

And as the government mulls its options, the vultures are circling.

Can’t always get what you want

The unprecedented bloodbath on VIL’s balance sheet was due to the company earmarking spectrum and licence related dues scheduled to be paid in the coming quarter, in line with the apex court’s order. Even without this, though, VIL was already struggling. Its EBITDA (earnings before interest, tax, depreciation, and amortisation) fell from Rs 3,650 crore ($508 million) in the previous quarter to Rs 3,347 crore ($465 million) in the quarter ended September 2019.

Already, the company is bleeding subscribers. Since the merger, it has lost over a quarter of its users—some 119 million of them.

With the government currently reluctant to budge, however, things are set to get worse. According to various industry sources The Ken spoke with, VIL requires a capex of about Rs 15,000 crore ($2 billion) annually to maintain and upgrade its network to 4G. If it receives no relief on the dues owed to the government, this will not be possible.

To begin with, VIL wants a two-year moratorium on annual spectrum payments. In addition, VIL executives have appealed to the government to allow for the payment of license fee and spectrum usage charges—which currently amount to over Rs 44,150 crore ($6.14 billion)—over an extended period. The company also wants the government to lower licence fees and spectrum charges. Rajan Mathews, head of industry body Cellular Operators Association of India (COAI), says COAI has made repeated appeals to bring licence fees down to 3% and spectrum charges to 1%. Currently, the government charges an 8% licence fee and a 3-5% spectrum usage charge. 

A reduction in levies alone, however, won’t help. Any reduction in cost must go hand in hand with an increase in revenue. However, increasing the average revenue per user (ARPU) in the current environment is an uphill battle. Ever since Reliance Jio entered the market in September 2016 and crashed tariffs with its cut-throat pricing, the industry has seen ARPUs drop precipitously.

A 2G monopoly

Crucially, in 2G, where VIL and Airtel have the maximum subscriber number of subscribers (279.3 million and 176.71 million, respectively), the latter would be left with a virtual monopoly. Its only real competitor would be the struggling state-owned BSNL since Reliance Jio has no 2G subscribers.

This could be dented further by telecom regulator Trai’s proposal to scrap interconnection fees—the fee paid by an operator on whose network a call arises to the operator on whose network the call terminates. Presently charged at Rs 0.06/minute, Trai intended to scrap the charge altogether beginning in 2020. At an open discussion held last week, both VIL and Airtel voiced their opposition to such a move. Reliance Jio, however, was in favour of it—as the Mukesh Ambani-owned operator sees more outgoing calls on account of its long-running free calling offer.

One regulatory solution the CoS is considering is floor pricing—a minimum tariff on voice and data services which no service provider can go below. Even if voice calls are charged as low as 10 paise ($0.014)/minute (presently, there’s no minimum charge), it will increase the ARPU of all operators by Rs 20-30 ($0.28-0.42), say analysts. According to an SBICAP Securities report, this could lead to additional revenue of $6.3 billion for the sector. “Revenues of Bharti and Vodafone may improve by $2.1 billion and $1.9 billion, respectively,” the report said.

Even Reliance Jio, which has become the country’s leading telco on the back of its low tariffs, would benefit from this. The company is desperately looking to sell some of its fibre assets to manage its debt, according to one consultant. Jio’s debt currently stands at Rs 1,08,000 crore (~$15 billion).

Another potential fillip for the debt-laden telecom operators is the Goods and Services Tax receivables windfall the government is currently sitting on. Amounting to over Rs 30,000 crore (~$4 billion) for the entire industry, Vodafone’s share alone is roughly a third of the total. “This could be easily adjusted against the pay of out of license and spectrum fees,” says Mathews. 

No strength in numbers

These measures could, quite literally, buy VIL the breathing room it so desperately needs. However, for VIL to find a way out of its current mess, it has a lot of soul-searching to do.

VIL’s current predicament is a massive fall from the initial promise the 31 August 2018 merger of Vodafone India and Idea showed. Even Bharti Airtel founder Sunil Mittal had called the merger a perfect match. The reality, though, has been quite the opposite. The user base has gone from 430 million subscribers at the time of the merger to 311.1 million today. ARPU, too, has plummeted—from Rs 180 ($2.5) to Rs 108 ($1.5).

Industry executives working closely with the VIL said the merger had been poorly handled. “Look at these two companies—you are present in the same market, offering the same product,” exclaimed a senior telecom expert with an industry body.

While Vodafone and Idea held substantial spectrum—more than Reliance Jio or Bharti Airtel—a lot of this was 2G. In addition, network integration has been a struggle. While network planning looks nice and clean on paper, the real world permutations and combinations have been more complicated than VIL expected. There has been a great deal of overlap between the coverage areas of Vodafone and Idea, and as the company looks to integrate the two networks, service has suffered. 

The merged entity says it will achieve full network integration by early 2020, but the diminished customer experience in the meanwhile is causing an exodus of subscribers.

These struggles have meant VIL’s 4G coverage has grown very slowly. While its 4G coverage has improved from 40% to 65%, both Bharti Airtel and Reliance Jio have managed more than 90%. VIL is now focusing its efforts on the top 303 districts, which account for 86% of its revenue.

Apart from upgrading its network, VIL also has to take tough calls regarding its 30,000-strong workforce. Instead of merging its teams, the original Vodafone and Idea teams continue to operate separately within the merged entity. VIL, for instance, still has two separate marketing teams. As it looks to integrate these overlapping teams, redundancies will be an inevitability. The industry executive quoted earlier says that a third of all employees will have to go. Already, there has been no new hiring, with all openings handled internally, say sources. VIL declined to participate in the story.

Mired in the struggle to find synergy, the operator has all but forgotten about subscriber outreach, say analysts. “Our strategy is to fix [network] integration in one group of telecom circles and then reach out to subscribers with promotional offers, and only then move on to the next group of circles,” said a senior VIL executive on condition of anonymity. With a network choking due to a lack of investment and minimal subscriber outreach, dissatisfaction among customers is inevitable.

Could all of this have been handled better? Probably. Could it have been avoided? Not really, says the senior VIL executive. “There is no precedence of any such merger of this scale anywhere in the world.” As VIL struggles to find synergy though, time is running out.

Two’s a duopoly, three’s a crowd

With its own promoters ruling out ploughing more money into the business, VIL is sweating on leniency from the government. If that doesn’t happen and the company files for bankruptcy, it will send shockwaves through India’s economy.

“You will create instability in the financial system. A financially unhealthy telecom sector will not be helpful for any of the stakeholders—government, subscribers, etc.,”

—Rohan Dhamija, partner, Analysys Mason

The government will have to write off VIL’s Rs 90,000 crore (~$12.5 billion) debt. This isn’t including the Rs 30,000 crore (~$4 billion) owed to banks or the Rs 44,150 crore (~$6 billion) payment ordered by the Supreme Court. “The 2G report of CAG presented a presumptive revenue loss. This is a real loss to the government,” said the VIL executive quoted earlier. This loss will create instability in the financial system, torpedoing the government’s growth ambitions.

The telecom industry itself will likely never be the same again. The exit of Vodafone—which has pumped billions into India over the last 15 years—would likely deter any foreign players from entering the space in the future.

VIL’s demise will have a knock-on effect on Airtel. At present, Airtel and VIL have a tower sharing agreement. The absence of VIL will lead to a decline in tower sharing, decreasing Airtel’s earnings from the tower sharing model. According to the SBICAP Securities report quoted earlier, this could result in rising costs and overall capex for Airtel. Airtel, an industry source said, has made up its mind to spend capex overseas rather than in India.  

Net neutrality

Duopoly in telecom could also pose a threat to small- and medium-sized internet-based products and services companies. The remaining telcos may act as gatekeepers to the internet. This could lead to monopolisation of telecom networks and would go against the principle of net neutrality and stifle innovation.

Worryingly, none of the remaining players is equipped to handle the mass migration of VIL’s users should it go out of business. They will need additional spectrum, base station and towers to serve the hundreds of millions of VIL subscribers. The mobile number portability system also cannot handle this burden. “It will be chaos for two to three months before the subscribers are migrated to a new operator,” the telecom industry executive quoted earlier said. 

Regardless of network quality, though, what’s certain is a rise in tariffs. “When you have only two players, there are always fears of a multifold increase in tariffs,” said the Mumbai-based analyst quoted earlier.

The lack of competition won’t hurt just consumers. For the government, it will mean lesser returns from future spectrum auctions. “The auction price of spectrum may virtually be the same as the reserve price fixed by the government due to reduced competition,” said Rajat Kathuria, director of the Indian Council for Research on International Economic Relations.

With Airtel’s balance sheet also under stress, there will be virtually one bidder in the auctions—Reliance Jio. The government may give away the spectrum at an administrative price, Kathuria said. The ball is now in the government’s court.

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