NTP 2011 impact: a butchered EPS but smarter M&As

The government recently unveiled the draft New Telecom Policy (NTP 11) that proposes a slew of regulations for India’s showcase sector.

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A Firstpost analysis reveals that the main highlights of NTP 2011 are clauses that could have a negative impact on the financial position of companies, such as one-time excess spectrum charges, charges on spectrum renewal (net present value of the impact), changes in roaming regulations, a five-paise reduction in termination charges and a 8 percent license fee for tower companies.

The NTP 2011 also proposes certain modifications in merger and acquisition (M&A) regulations that would facilitate easier exit and entry into the telecom sector.

Here’s an assessment of how the changes will impact the industry and individual companies:

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One-time excess spectrum charge: This is a charge that telecom companies need to pay in case the spectrum held by them is over and above 6.2 Mhz. Though a one-time charge, it’s the market leaders who will feel the biggest pinch. It will, most likely, create cash-flow problems, perhaps even negative balances, for some companies. It will affect large companies the most, since the smaller ones hold spectrum below this limit.

Spectrum renewal charge: Since none of the licenses acquired by the telecom companies have come up for renewal so far, there was no policy to address the issue. The draft NTP seeks to redress that through a spectrum renewal charge, which has received a less-than-lukewarm response from the larger players.

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The renewal fee is higher than what was paid by the companies to acquire the licence, which the government believes was given at throwaway prices. The renewal fee aims to correct that policy.

Clearly, it looks like Bharati, Idea and Vodafone will have to pay for the mistakes of the past since it is their licenses which will come up first for renewal in the near future. The smaller companies still have some time to go before their licenses expire.

Payment of 8 percent of revenues by tower companies: Till now, revenues generated by telecom tower companies were not chargeable to license fees. Here again, smaller companies will not be affected as they use the services of tower companies on lease. But the bigger companies have a stake in companies operating telecom towers, so they will have to cough up 8 percent of their share of revenues as license fees to the government.

Scrapping of roaming charges: This proposal will mean free nationwide roaming calls and affects 5-6 percent of cellular revenues of Bharti/Idea and 7-8 percent of EBITDA (operating profit), since these revenues have higher margins.

The complete abolition of roaming charges would have a negative valuation impact of Rs28/share on Bharti, Rs12/share on Idea, and Rs7/share for RCom (assuming implementation on 1 April, 2012), according to an October report on the telecom sector by Kotak Institutional Equities.

How NTP 2011 affects the interconnect regime

The interconnectivity charge is the amount paid by one service provider to another for calls made under one service provider to another. Under law, interconnectivity charges received is a source of income, called termination charge, whereas the amount paid is a cost.

A five-paise cut in termination rates, if passed on, however, will have a negative impact on the net profits of various companies: Rs 835 crore on Bharati; Rs 429 crore on Idea; and Rs.1.65 crore on RCom, according to the Kotak report.

The bigger players stand to lose revenues as termination charges (paid by other players) outweigh their expenses on the same. The smaller companies, meanwhile, will be able take advantage by offering lower call rates to their customers and increasing their subscriber base.

How NTP 2011 affects M&As

The take of the policy on mergers and amalgamations (M&A) seems to be much more lax than the rules already in existence.

The limit of market share held by a company, subject to which it is eligible to acquire or merge with another corporate, has been increased, which acts as a boon to bigger players like Bharati and Idea. Also, they no longer have to wait for approval from Trai or DoT (Department of Telecom) to merge with other companies.

The cherry on the cake is the ability to retain spectrum of the newly acquired company on payment of a one-time charge to the government. Under current regulations, once a company is acquired, an acquirer does not have the option of retaining spectrum held by the acquired company. Bharati and Idea, in particular, will be especially glad of the imminent changes.

On the plus side…

The NTP also proposes some changes that will undo the harm caused by the negatives, including a reduction in licence fees and lower USO (Universal Service Obligation) fees.

More than a flat reduction of license fee, a uniform charge across all services for all providers is what will will leave little room for the manipulation of accounts. USO is required to be paid by urban companies to the government for investing in unviable rural telephony.

So, who gains, who loses?

At first glance, customers will in all likelihood walk away with the biggest prize, given the increased transparency due to uniform licence charges and drastic tariff cuts by smaller players because of lower interconnectivity charges and the end of roaming charges.

But, in the long run, the negatives outweigh the positives, and will make a drastic impact on per share earnings of companies. A reduction in tariffs could also lead to unhealthy competition, malpractices and price wars that take eventually takes us back to where we began: recovering from the biggest corporate scam and wanting a policy that will clean up the sector.