A game changer?

3G service: Video, games, music & internet will add sheen

A game changer?

After 34 days of intense bidding, the auction for 3G (third generation) spectrum licence finally came to an end last Wednesday making the government richer by Rs 67,718.95 crore from the licence fee. The final bid amount is nearly double of the Rs 35,000 crore that Finance Minister Pranab Mukherjee was hoping to raise.

The overwhelming bidding for saw a pan-India licence valued at Rs 16,750 crore and of the two key circles Delhi got the highest bid of Rs 3316.93 crore followed by Rs 3247.07 crore for Mumbai against their reserve price of Rs 320 crore for each. The total bid amount from seven successful private players was Rs 51,000 crore against the reserve price of only Rs 3,500 crore.

The government-owned companies Mahanagar Telephone Nigam Ltd (MTNL) and Bharat Sanchar Nigam Ltd (BSNL), who were allotted 3G spectrum about 18 months ago will now pay Rs 6,564 crore and Rs 10,186 crore, respectively, as licence fee as per the bid rate. The government is also expected to garner another Rs 30,000 crore from the auction of Broadband Wireless Access (BWA) (or Wimax) which began last Friday.

Surely, the unexpectedly high spectrum fee will help the government partially meet its budget deficit, but for the 3G licence winners it may make a big hole in their pockets. Most telecom experts and analysts are undivided in their opinion that at least for the next 4 to 5 years 3G will not make any positive contribution to telcos’ bottom line already battered by severe competition.

Too expensive
There was a mad scramble for 3G licence though India is a late entrant — 3G service started in Europe 10 years ago. Bharti Airtel, the largest telecom company in the country, for example, will pay Rs 12,295 crore for 13 telecom circles, including Delhi and Mumbai. Similarly, Vodafone Essar will pay Rs 11,618 crore for nine circles and Reliance will pay Rs 8,585 crore for 13 circles. These three top players are also banking heavily on Delhi and Mumbai circles for which they will pay Rs 6,564 crore each for 3G spectrum. Add to it the licence fee for BWA, as most large players will bid for this, and estimated 3G rollout cost of around Rs 4,000 crore for each player.

Companies will also have to pay a hefty interest charge for funding 3G. Bharti, for instance, will have to fork out an estimated Rs 1,360 crore towards interest every year on its Rs 17,000 crore investment – including rollout cost – for 3G. A Bharti spokesperson agreed, “Auction format and severe spectrum shortage, along with ensuing policy uncertainty, drove the prices (licences fee) beyond reasonable levels.” The interest cost for all players together on the total 3G bid amount of Rs 67,719 crore will be a huge Rs 6,772 crore a year at 10 per cent rate. 

Method in madness
Beneath the apparently-irrational exuberance of the telecom operators for 3G, there seems to be a well planned strategy behind bidding. Firstly, they have bid aggressively to protect their existing major markets built over the years with a lot of investment. The second influencing factor was the potential of circles to migrate to more expensive 3G services and thirdly, the relative cost of customer acquisition when the 3G service is rolled out. Said a telecom analyst in a Mumbai-based broking firm, “Players have bid from the point of their unique relative strengths It was cherry picking after doing detail homework.”

To protect its most lucrative markets Bharti Aitel, the largest telecom player, will pay Rs 12,295 crore for 13 circles. These circles, according to official data, contributed 60 per cent (Rs 8,613 crore) of the company’s total revenue (Rs 14,425 crore) for the January-March 2010 quarter. With 82.64 million subscribers at the end of April 2010 these circles also make up for 63 per cent of Bharti’s 131 million total subscribers. The second biggest bidder Vodafone Essar will offer 3G in 9 circles that account for 58 per cent of its total subscriber base.

Both players have also gone for most expensive Delhi and Mumbai markets and more affluent state circles because the average revenue per user (ARPU) in these circles are much above the national average of Rs 150. Bharti’s ARPU in Delhi was Rs 260 and Vodafone’s Rs 251 in the January-March quarter of 2010. The same for Mumbai was Rs 267 and Rs 303, respectively for Bharti and Vodafone. Bharti has also wrestled its largest market Karnataka (12.88 million subscribers) where ARPU is Rs 203. In all higher-ARPU circles, analysts believe that a fairly large number of subscribers will migrate to 3G.  “In metro markets 10 per cent subscribers account for 40 per cent of the revenue. A large number of them already have 3G handsets that will enable incumbents such as Bharti to quickly transition these subscribers to its 3G net work” said a Deutsche Bank analysis. Customer acquisition cost in these circles will also be lower because the awareness of 3G benefits is greater.

New rules of the game
But 3G is unlikely to be a game changer in the short term. Firstly, it will now create a new divide in the industry: seven players with 3G and an equal number without it.
The industry is already ravaged by a price war among 14 players, leading to steadily-declining ARPU which now stands at Rs 150 for GSM and a pittance Rs 82 for the CDMA players. Smaller and newer players who did not try for 3G will continue to use predatory pricing as the main tool to grab customers. 3G players, therefore, will continue to witness price pressures on voice market which brings 80 per cent of the revenue for telcos in India.

But 3G technology will offer many options to entice customers and ultimately make them pay more. Said IDC India Strategic Business Advisor Kapil Dev Singh, “The 3G phase is expected to witness introduction of innovative services and heightened collaboration between telecom players, application developers, IT infrastructure providers, content providers and consumer products companies.”

Unique applications
Though the best use of 3G spectrum is for data, at the initial stage companies will use it mainly to enhance their burgeoning voice call handling. Since most large companies these days find their network chocked for the want of spectrum it is expected that companies like Bharti and Vodafone will now go for aggressive customer acquisition for voice through 3G spectrum which is three times faster and more efficient than 2G.  But the ultimate objective of the operators will be to leverage 3G technology to provide high value-added services like high speed web browsing, internet TV, video calls, mobile gaming, fast download of music and movies, navigation, etc, leading to higher ARPU.
But experts believe that 3G service may start making profits only 3 to 4 years after its launch – operators in Europe too took that much time. “For the first few years, 3G services will dilute margins because of the increased network operating costs and sales and sales and marketing expenses without a commensurate revenue increase,” said Crisil Research Director Mukesh Agarwal. Crisil estimated that to become value-accretive an operator needs to have at least 25 million 3G subscribers in the fifth year at average revenue 35 per cent more than 2G.

Troubled times
To make matter worse, the industry regulator Telecom Regulatory Authority of India (Trai) has recently recommended that all telecom companies should pay for the additional 2G spectrum they acquired free over the past many years. Trai wants companies to pay at the 3G rate for spectrum above 6.2 MHz.

If the department of Telecom (DoT) accepts Trai’s recommendations, it is estimated that all telecom players together will have to fork out an estimated Rs 16,000 crore for the additional 2G spectrum. This is an added burden at a time when the telecom operators are either losing money or making small profits due competitive pressures.  According to Trai data, Bharti’s gross revenue in the December 2009 quarter at Rs 8,580 crore, for example, was two per cent lower than the same quarter previous year. Worst affected are the public sector telecom companies. MTNL, for example, recently announced that for the first time it has turned into red in the financial year 2009-10 when it recorded a net loss of Rs 2,515 crore against a net profit of Rs 212 crore in the previous year. The company will now have to pay around Rs 10,000 crore for 3G licence and for additional 2G spectrum, completely wiping out its cash reserve of Rs 5,000 crore.

The other PSU telecom giant Bharat Sanchar Nigam Ltd (BSNL) is also in trouble. According to recent reports it has made an operating loss of Rs 8,291 crore in 2009-10 despite government’s grant and interest income from deposits. BSNL will now have to pay around Rs 10,186 crore for 3G licence, Rs 7,000 crore for BWA and an estimated Rs 2,600 crore for the excess 2G spectrum as per Trai formula. All together it will have to pay Rs 18,786 crore, wiping out half of its reserve of Rs 36,392 crore.

Investors are not very enthusiastic about 3G either as they have given thumbs down to the telecom stocks. All listed companies like Bharti, Idea, Reliance and MTNL have seen huge erosion in their share prices. Even Vodafone was forced to knock off $3.2 billion (Rs 14,600 crore) from the valuation of its Indian subsidiary Vodafone Essar as ‘impairment of value’.


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