On November 12, Tokyo-based NTT DoCoMo announced it was entering into a strategic alliance with the Tatas. The Japanese telecom giant which, with 53 million customers and 51.5% of the Japanese market, is one of the world’s largest players in the telecommunications industry, bought a 26% stake in Tata Teleservices Ltd (TTSL) for $2.7 billion. NTT DoCoMo followed up this deal with an open offer for 20% in Tata Teleservices (Maharashtra) Ltd — TTML — the listed subsidiary of TTSL. At Rs24.70 (50 cents) a share, this means another $191 million. The offer will open in January. “We are hoping that this will be a long-term partnership as we are like-minded companies,” Tata group chief Ratan Tata told a media briefing soon after the deal was struck.
“The Indian telecom industry is poised for the introduction of new technologies,” says Anil Sardana, managing director of TTSL. “Having DoCoMo as a partner will enhance our ability to evaluate, introduce and manage next generation technologies, as and when opportunities arise.”
This is obviously a big deal at a time when mergers and acquisitions (M&A) activity has declined in India. It is, in fact, the biggest deal in the Indian telecom market since early 2007, when Vodafone bought a 67% stake in Hutchison Essar (now Vodafone India) for $11.1 billion. Yet the Japanese entry didn’t make too many waves.
Both the Tatas and the media are partly responsible for that. The media has been celebrating outbound takeovers — Jaguar Land Rover (JLR), Corus, Novelis. An inbound acquisition in this environment is a step in the opposite direction. Besides, Indian telecom companies — Bharti Airtel and Reliance Communications (RCom) — were supposed to be spreading their wings abroad, targeting MTN of South Africa. Was NTT DoCoMo planning a takeover against the tide? At the media briefing, there were questions about this issue. “At the moment, we have no intention of increasing our stake,” Ryuji Yamada, NTT DoCoMo president & CEO, noted.
For the Tatas, this is a time to be cautious. On November 6, Ratan Tata sent an email to the top managers of the 100 or so group companies asking them to tighten their belts. The email asked all CEOs to “put on hold any plans for acquisition unless considered strategically critical and also defer non-essential capital expenditure and capacity expansion.” It painted a bleak picture. “Some of our companies with substantial foreign operations or those which have made substantial acquisitions are already facing major problems in raising capital or establishing lines of credit for their operations…. In India also, many of our companies already are or will soon face major problems in their access to credit due to the lack of liquidity in the domestic market and also their inability to effectively raise equity due to the depression in the stock market and the erosion of investor confidence…”
Tata, like other companies, has felt the effects of the erosion of investor confidence. A rights issue of Tata Motors to partially finance the JLR takeover had to be bailed out by the promoters — the group holding company Tata Sons. Some observers wonder whether the NTT DoCoMo deal was influenced by the need for Tata Sons to raise more money. (Tata Sons has a 45.4% stake in TTSL.) The numbers, however, paint a different picture. The deal values TTSL at $10.14 billion, which pitches it above the listed RCom at $8.6 billion. Bharti Airtel has a market capitalization of $23.7 billion. These market cap numbers are, of course, swinging wildly in an extremely volatile market.
Besides, TTSL comes in only at No. 6 among the telecom players, according to the Telecom Regulatory Authority of India (TRAI) data. At the end of September, Bharti led the pack with 77.5 million subscribers. Anil Ambani’s RCom had 60 million, Vodafone 54.6 million, the public sector Bharat Sanchar Nigam Ltd (BSNL) 39.2 million and Idea Cellular (of the Aditya Birla group) 30.3 million. TTSL brought up the rear with 29 million.
By another measure, TTSL has been valued at around $350 per subscriber. This is better than the $300 per subscriber that Telekom Malaysia paid when it took a 15% stake in Idea earlier this year. But it is less than nearly $800 per subscriber that Vodafone paid for Hutchison Essar.
“It is a great deal,” says Alok Shende, principal analyst at Ascendia Consulting. (Shende used to be vice-president, ICT practice, at business research and consulting firm Frost & Sullivan.) “There are benefits for both the parties. The Tatas have already set up the network and DoCoMo has great understanding of technologies, market development and competition. When the Tatas get the 3G (third generation) license, DoCoMo’s expertise will add tremendous value.”
Great deal it may be, but it has its risks. One reason is that telecom deals have been controversial in recent times. This goes back to late last year when the government sold pan-India licenses for $333 million apiece, amid a welter of controversy. New players, with no experience in the business, got these licenses on a first-come-first-served basis. Now they are making hay — or some might say gold — with these pieces of paper.
Unitech Wireless, a part of real estate group Unitech, got one of these licenses. Telenor of Norway has now picked up a 60% stake in the company for $1 billion, putting the valuation of the license at $1.78 billion. It is the license alone that the firm has as an asset; there are no subscribers or infrastructure. The UAE-based Etisalat has bought a 45% stake in Swan Telecom for $900 million valuing the company at $2 billion. Swan, too, has only a license.
“The government has a lot to answer for,” says Arvind Mahajan, executive director (advisory services) of international accounting and consultancy firm KPMG. Ravi Bapna, a professor of information systems at the Carlson School of Management and executive director of CITNE at the Indian School of Business (ISB), Hyderabad, notes: “It’s a step back from a transparent and proactive policy that I’ve been recommending for a long time.”
A. Raja, Union minister for telecommunications and information technology, has been facing most of the flak. “I have simply followed the decision of the Cabinet and the recommendations of the TRAI,” he told Business India magazine. “These funds (invested by Telenor and Etisalat) will be used for the establishment of networks, including infrastructure….The valuations reflect the value of the funds applied to the business and not the value of the license or spectrum.”
Shende of Ascendia disagrees. “The government has made a very poor decision,” he says. “It is a decision that does not recognize the economic value of the transactions. There is a whole lot of ambiguity around it.”
According to Shende, the bigger question is how the new operators will make money. They have been late entering the market, which means that existing telecom operators have already signed up millions of customers. In seeking to encourage subscribers to switch over, the new entrants may seek to offer services at a lower price. “But this will not be sustainable over the long term,” he points out. “More importantly, they do not have the capabilities to offer services at a lower price because they need to set up huge infrastructure. The current operators have already set up their infrastructure and have amortized the costs.”
So why is everybody making a beeline for India with checkbook in hand, prepared to pay big bucks even when there is nothing on the ground? The answer is in the numbers. India had 315 million wireless connections at the end of September. In March this year, it had overtaken the U.S. to become the world’s second-largest telecom market. And though China will stay ahead for the next few years, the gap is narrowing.”
“Telecommunication service providers in India currently add more than nine million subscribers a month with the potential of taking the total tally of subscribers up to 700 million in the next five years,” says Bundeep Singh Rangar, chairman of IndusView, a Delhi-based research and advisory firm focusing on multinationals seeking to enter India. “In terms of expected revenues, that translates to more than $37 billion by 2012 growing at a CAGR (compounded annual growth rate) of 18%. Such growth potential offers enough incentive to overseas service providers to vie for their share of the pie. And investor-friendly regulations by the government, allowing up to 74% holding in a domestic entity by a foreign player, is the icing on the cake.”
Valuations are going up, Rangar notes. “In early 2006, Temasek (an investment arm of the government of Singapore) picked up a 9.9% stake in TTSL, valuing the company at around $3 billion,” he says. “The NTT DoCoMo deal values the company at more than three times that in less than three years.” Rangar estimates that capital investment of more than $73 billion will be needed in the next five years in the telecom sector. A good part of this will be through foreign direct investment (FDI). The rush of foreign players — facing saturated markets at home — will continue.
Some skeptics point to the aviation industry — a growth sector that has hit an air pocket. Along with telecom, it has been one of the twin drivers of the Indian success story in recent years. Today, the aviation sector is deep in the red, waiting for a government bailout. Could telecom go the aviation way as the slump in the economy lengthens?
“In contrast to aviation, mobile operators in India have been showing healthy earnings,” says Bapna of ISB. “It is unfair to put them in the same bucket. The market and growth potential for telephony and related services such as data and mobile applications is significantly larger than aviation. The current operators are well positioned to create and capture this value.” Adds Shende: “The Indian telecom story is still very strong.”
“The telecom market will continue to be one of the bright spots of the economy,” says Mahajan of KPMG. “This does not necessarily mean that everyone associated with this sector will do well. We will see the market become much more competitive. India has among the highest number of operators and the top six or seven are all replicating national infrastructure. With so many operators, it will not be viable for some of them to continue. Most of the new players will find it very challenging, especially if they try to replicate their strategies from other markets.”
Penetrating Rural Markets
India took 14 years to reach 250 million subscribers. That milestone was achieved in 2007. It will take just three years — by 2010 — to double that number. But, according to a Federation of Indian Chambers of Commerce and Industry (FICCI) study, 100 million of these subscribers will come from rural areas.
Even in the urban areas, the low-hanging fruit have been plucked by the early movers. The new customer segments are the lower end of the urban market (maids, drivers and vegetable sellers), the rural market, and the high-value urban customers who will opt for enhanced services and 3G.
3G has more potential than is apparent at first sight. But it needs to be structured properly. “For the high end of the consumer segment, 3G will bring more value-added services, such as rich media and business-to-business productivity tools,” says Bapna of ISB. “If handsets can be subsidized (and serious thought needs to be given to this as it is opposed to the Indian model so far), the value may be even greater for the middle and low ends of the consumer spectrum as it will be the only way the vast majority of Indians will have access to the Internet. For this segment, the 3G mobile could serve as a platform for education, healthcare and financial services.”
That’s for the future. In the short run, “3G is going to be limited in its appeal,” says Shende. “We are not going to see a huge amount of consumers shifting to the 3G bandwagon immediately because the pricing of 3G (both service as well as the handset) is going to be higher. Also, consumers use more voice and not data.” Adds Mahajan: “The value-added services that will come in with 3G will be very niche.”
The big numbers are at the bottom of the urban pyramid and rural India, which may require different strategies. First, the service providers may have to settle for a far lower ARPU (average revenue per user) than they collect today. At present, ARPU in India is around $10, compared to $100 for telecom companies in the West. But Indian companies admit that for rural subscribers, the ARPU is as low as $2. Analysts say that the rural markets could accommodate just about two profitable players, who will make their money on volumes. The rest — including many who are entering right now — could fall by the wayside.
The incumbent telecom companies are already honing their marketing strategies. Even handset manufacturers are working on products for the rural market. Nokia, for instance, is launching a model with multiple address books. Their reasoning is that in rural areas, several people may be using the same handset because of its high cost. Nokia already has a handset that incorporates a torch, needed in power-cut-prone or yet-to-be-electrified rural India.
But the foreign entrants may enter these markets much later. Initially, they are likely to be technology facilitators. “We hope to launch 3G and 4G in India with DoCoMo’s help,” says Sardana of TTSL. TTSL is already a big player and has made rural forays. But the newcomers with a license (but no subscribers) in which foreign companies are pouring in money are likely to concentrate on urban niches. “They will be boutique players,” says a telecom consultant. “Amid the intense competition, few will survive.”
But there is opportunity for those who are prepared to think big. “Teledensity in India has jumped from 1% in the 1980s to about 30% now,” says Rangar of IndusView. “The government has set a target of 45% in the next five years. We are looking at more than 700 million subscribers by 2012, a CAGR of 21%.”
Shende of Ascendia sees a future problem. “The real challenge that the industry will face is what happens after the 500 million subscriber base is crossed,” he says. “With a large percentage of India below the poverty line, growth in telecom beyond 2012 or so will not come from new customer acquisitions. Growth thereafter is likely to occur through value-added services and increased minutes of use.” When that happens, the strategy of getting more Indians talking on their mobile phones may have to change to getting Indians to talk more.