Spectrum auction puts pressure on telecom operators’ balance sheets

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The high costs paid by telecom operators at the spectrum auction in early October is credit negative for the Indian telecom sector as such expenses will further boost their debt levels as well as aggravate balance-sheet problems. Moreover, the combination of higher debt and lower profitability from downward pressure on prices – due to competition — will together raise industry-wide leverage. However, over the long term, the spectrum purchased at the auction will benefit players who have consolidated their positions in the 4G space.

The costs of these spectrum purchases will pressure telecom operators’ balance sheets and cash flows, as debt levels will – as indicated — rise materially for most companies, including incumbent Bharti Airtel Ltd and larger international groups, such as Vodafone Group plc. Operators generally will see a reduction in their ability to fund further expansion or to absorb the effects of weaker profitability as the level of competition rises.

The highly expensive 700 MHz band did not attract any bids from telecom operators at the auction; indicating that the newly launched mobile services operator Reliance Jio Infocomm Limited and its parent, Reliance Industries Limited, which have a spectrum-and-infrastructure sharing agreement, will continue as the only players with access to pan-India spectrum in the sub 1 GHz band, best suited for 4G services in urban centers.

Intensifying competition, in part also spurred by the launch of Jio, which is offering a free data service through December 31, could push tariffs lower. In the medium term, this will lead to contracting average revenues per user (ARPU) and a decline in industry revenue and profitability over the next 12-18 months. This trend may, in turn, lead to rising leverage in the telecoms sector. The silver lining though lies in the growing demand for 3G/4G data services in the country, which will continue to drive each company’s ability to recover its spectrum costs.

Despite the steep prices paid by the companies and the short-term repercussions, there will be tangible benefits for operators in the long term. The spectrum that the operators have purchased at this latest auction will help them maintain their competitive positions, support their strategies on data growth and enhance their cash flow generation. The operators’ high debt burdens may also lead to recapitalization events and further industry consolidation, which will in turn ultimately benefit those incumbents well positioned in the 4G space.

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