Telecom Travails: Will Reliance Industries' Entry Mean Competition or Consolidation?Published: June 17, 2010 in India Knowledge@Wharton
The competitive balance in India's telecom industry is about to be disrupted. Reliance Industries, headed by Mukesh Ambani, its chairman and managing director, has bought a 95% stake in a firm that won a broadband wireless license. That deal was made possible after Mukesh and his brother Anil recently canceled a non-compete pact. Meanwhile, market watchers predicted that Mukesh may make further peace moves with Anil at Reliance Industries' annual shareholder meeting on June 18, according to a Bloomberg report.
Reliance Industries bought into Infotel Broadband Services just hours after it emerged as the sole winner of a pan-India broadband wireless spectrum (BWA) license, paying US$1 billion (Rs4,800 crore at Rs46.46=US$1), in addition to the US$2.8 billion Infotel will pay the government for its license. Reliance has estimated its total investment in telecom services at US$5 billion, including infrastructure and rollout costs. Anil Ambani's group withdrew from the auction for the BWA license when the bids went too high. At that stage, the brothers had agreed on withdrawing their non-compete pact, but had not yet announced it. The Ambani group later said it said it looked forward to offering its telecom infrastructure and content services to Reliance Industries and other BWA licensees.
Mukesh Ambani may have bigger ambitions in telecom, according to Wharton management professor Saikat Chaudhuri. "He may well buy into and merge existing entities -- as he has started to do -- instead of starting yet another network," he says. "Consolidation will happen, leaving only a set of players anyhow in the end." The Indian telecom market is indeed "highly competitive, with substantial pricing and hence margin pressure - hence adding another large player seems on the surface daunting," Chaudhuri notes. However, Reliance Industries' entry has to be viewed against the backdrop of the Indian telecom industry's "tremendous growth and the remaining volume to be had."
The build-up to Mukesh's telecom foray had all the ingredients of family drama. On May 7, India's Supreme Court delivered its judgment in a long-running Ambani vs. Ambani feud. Mukesh and Anil, the two sons of the late Dhirubhai Ambani, have been warring ever since the patriarch's demise in 2002. The brothers formally parted ways in 2006 with a settlement mediated by K.V. Kamath, then ICICI Bank's managing director and now non-executive chairman. That settlement included a non-compete clause that barred the brothers from encroaching on each other's turf. Anil's territory included financial services and telecom, while Mukesh retained crude refining and exploration, among other areas.
While the non-compete agreement has been respected, the battling brothers -- the richest pair in the world -- have been building roadblocks to thwart the other's plans. In the best-known instance, Mukesh's Reliance Industries thwarted an attempt by the Anil Dhirubhai Ambani (ADA) group's Reliance Communications (RCom) to take over MTN of South Africa. The Supreme Court ruling in May -- which involved the quantity and price at which natural gas was to be supplied by RIL to Anil Ambani's power ventures -- favored elder brother Mukesh. It came with a rider: The court asked the two brothers to go back to the negotiating table.
On May 23, in an unexpected move, peace between the two parties was officially declared. The non-compete arrangements were cancelled. "[This] will provide enhanced operational and financial flexibility to both groups, and greater ability to participate in high-growth sectors of the Indian economy, such as oil and gas, petrochemicals, telecommunications, power and financial services," said an RIL statement. "RIL and Reliance ADA [Anil Dhirubhai Ambani] Group are hopeful and confident that all these steps will create an overall environment of harmony, co-operation and collaboration between the two groups." Added an ADA Group statement: "These developments will eliminate room for any further disputes between the two groups, on matters relating to the scope and interpretation of the non-compete obligations." The two Ambani groups are reportedly also eyeing a banking license, especially after this year's Union Budget permitted private sector entry in banking.
Mukesh had originally steered Reliance into telecom, but had to hand over RCom over to his brother in the 2006 partition of assets. Mukesh's second opportunity came with the recent telecom spectrum auctions in India. After the auctions for third-generation (3G) spectrum licenses concluded in May, there was speculation that some of the winners were willing to sell out, but they may have been at uncomfortably high prices, given the 3G bidding frenzy. The next opportunity was the auction for broadband wireless access (BWA) that followed the 3G auctions, but RIL wasn't among the bidders. Besides, though labeled 4G, BWA was considered inferior to 3G because it was an untested technology and, according to Indian laws, did not allow voice. BWA technology has yet to prove itself as "consistently commercially viable," according to K. Raman, head (infocomm, media & education) at the Tata Strategic Management Group (TSMG), a consulting firm.
The Reliance Effect
What does the entry of Reliance mean to the telecom market? Says Raman of TSMG: "Even at present, apart from the competition in the market, the telecom space in India is going through a lot of regulatory challenges. The entry of an influential player like Reliance increase both competition and regulatory complexities. Reliance will attempt to shape regulations in a way that will help [Mukesh Ambani] get a better share of the market. Being the only pan-India spectrum holder [in the new generation spectrum] puts Reliance in a very strong position."
"We can certainly expect RIL's entry to create a significant disruption in the Indian telecom industry," says Rajesh Jain, managing director of Netcore Solutions, a mobile and messaging services company. (Jain is on the advisory board of India Knowledge@Wharton, which partners with Netcore for its mobile edition.) "It is going to be very unsettling for the incumbents and very good for consumers. Reliance is known for innovations and very attractive price points. It will certainly introduce a significant dimension of competition in the marketplace."
Chaudhuri believes the Indian government has managed the opening up and liberalization of the telecom industry in a "superb" way. "Instead of simply opening up the market in one go and allowing foreign players to come in and dominate the scene, the government, through its controlled and deliberate liberalization process implemented in multiple phases over time, was able to create a highly competitive market that benefited the consumer with ample supply and low prices," he says. That facilitated the telecom industry's "massive growth, built a strong national telecom infrastructure, and allowed home-grown players to emerge that are competitive not only locally but have been able to develop the capabilities to become global players," he adds. He also commends the stability of policies over time. "[It is] perhaps most remarkable is that this entire process has not been carried out by one government, but has been consistently moved forward by successive governments involving transitions in political parties and ministers."
Clearly, that policy consistency helped the industry plan for the long haul. Alok Shende, principal analyst at marketing and consulting firm Ascentius Consulting, feels that the Reliance plan was no overnight strategy. "This is clearly a well-crafted entry and has been in the pipeline much before the brothers smoked the peace pipe," he says. The Monday after the Infotel purchase was announced, Reliance Industries moved up 1.64%. That was in line with the market movement of 1.6%. There will be no dividends for Reliance immediately; analysts expect operations to break even only after several years. But ADA companies can expect an earlier payoff, even if only from the truce. The top gainers on the Bombay Stock Exchange were Jai Corp. (17.37%), Reliance Natural Resources (17%), Reliance Capital (6%) and Reliance Power (5.53%). Jai Corp. is run by Anand Jain, Mukesh Ambani's school friend and financial advisor. The other three companies belong to the ADA Group.
Reliance's Game-Changing Strategy
The Reliance deal is a game-changer. Says Jain: "Even if regulations do not allow voice on BWA, RIL will get around it. I don't think RIL has got into this only for data." Shende says it is typical of Reliance to have "a very strong vertical integration strategy" in every one of its businesses. "Having control over the complete vertical chain gives it a monopolistic power in that sector," he adds.
But data is where Jain is putting his money. "Voice is being commoditized in India. There is a huge potential to offer a wide range of next generation data services through a variety of connected devices. There may not necessarily be one killer application; the thickness of the pipe itself through which a host of innovative data services can be delivered through devices other than PCs and mobiles will be the key. The disruptive, blue-ocean opportunities are in high-speed broadband wireless access."
Working out the technology choices is the first step. And there could be some complicating factors. Take one: U.S.-based Qualcomm has won four BWA circles, including the important Delhi and Mumbai. The obvious aim is to promote its LTE technology. Reports morning newspaper DNA: "While supporters of WiMAX, including Samsung, Intel and Motorola, worry about the implications of Qualcomm's win, the Chinese equipment vendors too are very worried. They fear that they are not in Qualcomm's good books as they cater to both LTE and WiMAX technologies, unlike the European vendors such as Nokia Siemens Networks and Ericsson who only support LTE. At stake is around US$3 billion worth of 3G equipment and installation contracts, besides around US$2 billion worth of 4G equipment contracts." Reliance has indicated that it will opt for LTE.
As Mukesh Ambani plans his next telecom move, he might attempt to buy the ADA Group's RCom, among other candidates, according to Shende of Ascentius. RCom received board approval on June 6 to sell a 26% stake to a "strategic investor." Though Abu Dhabi's Etisalat was tipped as the favorite, RIL is now leading the pack. "It is a foregone conclusion that on the voice front Reliance will go in for a big-bang acquisition of a 2G-3G company," says Shende. "Three likely targets are Aircel [owned by Maxis of Malaysia], Idea [Aditya Birla Group] and RCom."
Raman of TSMG also feels it is imminent that Reliance Industries would find a way to enter voice-based telecom services. "I can't think of even one player worldwide who has successfully built an entire business from only the new generation technology," he says. "Typically telecom operators have a mix of different technologies [2G, 3G]. But that in no way means that a new unique model cannot emerge from India. This story has to evolve along the Indian context and to that extent it becomes more challenging. Any telecom player would want to offer the entire range of services. So my reading is that Reliance would like to get into voice also at the earliest. However, while from a technology aspect, voice is possible on BWA, it may be relatively more expensive as the technology is still evolving and both the back-end equipment and the customer premises equipment are more costly because of lack of scale. There may also be regulatory issues since IP-based telephony is not allowed within the country. I wouldn't be at all surprised if Reliance goes in for another acquisition of a different type of a license-holder."
Indian call rates have reached one cent a minute and are still falling. The 3G auction in May raised US$15 billion. The BWA auction netted US$8 billion. Together, that's around three times what the Budget expected. But, despite skeptical analysts, valuations of telecom companies are still increasing: RCom, for one, has gained nearly 200% from its troughs during the past 52 weeks.