Spectrum Payouts And Network Capex To Keep Telcos’ Free Cash Flow Negative

Telecom companies exercised a balanced approach in the recent spectrum auctions, however the purchase of spectrum and non-spectrum linked capex will keep free cash flows (FCF) of the telecom operators negative, says India Ratings and Research. There were no major surprises in the spectrum auction and as expected by India Ratings spectrum bidding was rational, therefore India Ratings maintains its outlook on the sector as “Stable to Negative”.

There were no takers for the pricey 700 MHz band and 900 MHz, while active participation was seen in the 1,800 MHz and 2,300 MHz bands, and the most active participants were Vodafone India Ltd. and Idea Cellular Ltd. Each operator’s spectrum acquisition strategy was to ensure data capacity build up, which was indicated by the bigger block spectrum acquisition in the higher bands of 2,300 MHz/2,500 MHz.

As against the Rs 5.6 lakh crore valuation at reserve price, only Rs 65,789 crore was realised. The winning prices were moderately higher (up to around 15 percent) than the reserve prices. The most steeply priced 700 MHz representing 72 percent of the total reserve price remained unsold. India Ratings believes that the rationalisation in prices of 700 MHz is a prerequisite for its successful auction in future, given the strong divergence of views between operators and the regulator.

The immediate concern for the auction winners will be to put in place an optimal funding mix to meet the upfront (Rs 32,000 crore) and subsequent staggered payments. Incumbent operators have the existing balance sheet strength to raise funds from the domestic or global markets. However, identifying the right long term funding mix to optimise the cost of funds and the monetisation of non-core assets to reduce the debt burden will be crucial for the credit profile. Upfront payment needs to be made within 10 calendar days from the issue of the demand notice (namely 10 October 2016).

Funding for the new spectrum will be a combination of equity and debt for all players. Vodafone raised equity of Rs 47,700 crore, which will be used for the upfront spectrum payment and also support additional capex. Idea has incremental capex plan of Rs 1,000 crore post the spectrum acquisition, and its upfront payout for the spectrum will be part-debt funded given its moderate cash balances (first quarter of financial year 2016-17: Rs 780 crore). Bharti Airtel Ltd. had Rs 2,050 crore of cash and equivalents at end-1QFY17; hence part debt funding could be used for the upfront spectrum payment.

India Ratings expects debt burden to rise for the top telcos, with the increase in spectrum and non-spectrum debt capex. In addition to the upfront spectrum payouts in FY17, network capex needs to be ramped up, which will keep FCF negative. India Ragins believes that the benefits of higher data volumes trickle down impact on revenue growth will be back ended. The launch of life-time free voice calls by Reliance Jio Infocomm Ltd. has threatened the major contributor of telcos revenues, namely voice calls. India Ratings thus expects Reliance Jio’s entry strategy to squeeze operational cash flows of the sector in FY17-FY18.

Idea reported negative FCF (post capex and spectrum payment of Rs 1,180 crore) in FY16. Bharti had a positive FCF of Rs 14,800 crore in FY16, mainly supported by Rs 5,700 crore sale proceeds from tower assets and Rs 6,770 crore from sale of investments.

As India Ratings had highlighted in the report ‘Market Wire: Telcos to Exercise Selective Bidding; Spectrum Acquisition Strategy to Revolve Around 4G’, the bidding strategies revolved around augmenting 4G capability, and data centric bands (1,800 MHz/2,300 MHz) saw high traction. In line with India Ratings’ forecast, Bharti and Reliance Jio focused on plugging in spectrum gaps, while Idea and Vodafone focused on strengthening their position in key circles. The 800 MHz band was taken up by Jio to fill in the gaps in Gujarat, Punjab, Rajasthan and Uttar Pradesh (East) circles. Bharti and Jio bought most of the data-centric 2,300 MHz spectrum band, whereas Idea and Vodafone bought most of the 2,500 MHz spectrum band. Vodafone strengthened its presence in its existing circles and also increased 4G capability to 17 circles from the earlier nine, while Idea has increased its presence to 20 circles from 11 earlier.

The schedule of payment under the deferred payment option for the 1,800 MHz, 2,100 MHz, 2,300 MHz and 2,500 MHz bands includes an upfront payment of 50 percent of the bid amount and the balance to be paid after a moratorium period of two years in 10 equal annual installments at an interest rate of 9.3 percent, reduced from the earlier 10 percent in the spectrum auctions of 2015. For the 800 MHz band, 25 percent payment is upfront and the balance will be paid after a moratorium of two years in 10 equal annual installments.

(India Ratings and Research a wholly owned subsidiary of Fitch Group is a SEBI and RBI accredited credit rating agency operating in the Indian credit market.)