And Then There Were Three: Fitch Says Jio Will Prompt Consolidation And Only A Few Will Survive

We have a negative outlook on the Indian telecom sector and we think there will be a re-run of the price war as Jio’s offering for free voice and SMS and a tariff of 70 cents to $1 for per GB for data services, is about 25 to 30 percent cheaper than what the incumbents are offering right now. I think that will affect their EBITDA margins by 250 to 300 basis points. The incumbents blended revenue per user will fall anywhere by 10 to 15 percent from the existing $2. And there will be a lot of churn in the market towards the Jio network because of this attraction that you can get the free services for the next three months. So there will be a lot of mobile number portability requests and a lot of churn toward the Jio network from the incumbents. And the incumbents will start feeling lot of challenges and pain in the next 12 to 18 months, especially for the smaller telecom companies like Idea Cellular and Reliance Communications which don’t have pan India 4G network services and also they have a lower subscriber base and don’t have so much of financial competing power like Bharti Airtel and Jio. So they will feel most of the pain in the coming 12 months.

We have already come a long way. There used to be 12 to 15 operators in India and the market is already consolidated with many smaller telecom companies have either exited or which have merged with each other. And the consolidation is still going on with Reliance Communications wanting to merge with Aircel. Going forward in the next three to five years, we believe that there’ll be around four to five players in this market. Even now this market’s nature has changed drastically. Today onwards this market will have rock bottom prices and very high volumes, so only a large telecom company with larger economies of sale will be able to make money in this market. It’s a game of large economies of scale now, and the smaller telecom companies with small subscriber bases will find it very difficult to make money in this market. So, I believe that smaller telecom companies including Telenor, Reliance Communications and Aircel are anyways trying to merge with each other, public sector companies like BSNL and MTNL, they will be the first ones who would clamour to either merge with each other or try to exit the market or be acquired by larger incumbents because there is no way they can compete at such lower prices.

I think in the medium term, pricing power will come back to the sector. In the short term what we will see is a price war that will happen in the next 12 to 18 months as Jio comes out with its low tariff and the incumbents will, more or less, have to retaliate with the same kind of tariffs to retain their existing consumer base. But in the medium term they will have to raise prices at some point of time, innovatively, or will come out with tariffs which will give them better price realisations. Because at this pricing I am not sure even Jio will be making EBITDA (earnings before interest, tax, depreciation, amortisation) profits in the next three years. They have invested $20 billion in this sector and at a $2 ARPU (average revenue per user) with free voice and SMS and with all these free applications for next one year and three months, it will be very difficult for them to make any money. Also remember that they will be paying lot of inter-connection revenue, even though they are not charging their customers but they will have to pay a lot of interconnection revenue to the incumbents for the voice calls which are terminating on their network. And they are also paying lot of rental leases for leasing the telecom towers. So their operating expenses bill is quite large. For them to make positive EBITDA, it will take two to three years. So at some time the incumbents and Jio will have to raise prices to make sufficient return on investment, on the large investment they have made in this industry.

I think Jio, Vodafone and Bharti Airtel will still be there and the small telecom companies would either merge together under a new name or will be acquired by the larger telecom companies. At the moment I don’t think Idea and Reliance Communication have robust competitive positions to sustain on a long term basis, so they will have to find some merger and acquisition opportunities to improve their competitive strengths in the long term.