Indian Telecoms:Termination rate review to decide sector tariffs

We understand the Indian regulator (TRAI) is close to deciding mobile terminationcharges, which stand at 14 paisa and which, based on history, could be lowered.

    Incumbent telcos recently asked the regulator to share the cost models basis with which ithas set the rates so far and moreover suggested that termination rates need to beincreased to reflect full costs. 4G entrant Jio (not listed) has asked for zero terminationcharges. It is difficult to predict an outcome, but our analysis suggests at currenttermination rates, Jio makes no more than 11% EBITDA margins even if it reaches somekind of steady scale with c320m subs and average ARPU of INR c195. If we assumed 7paisa as the termination rate, Jio could approach EBITDA breakeven with c270m subsand average ARPU of cINR170. For our analysis we assume Jio’s cost structure is similarto Idea Cellular’s and we do not assume any near-term monetisation from Jio play.

    Jio occupies c55% of the 4G market, however share of voice is likely somewhat lessgiven the higher data usage in this segment. This may change with Jio targeting the lowerend of the market with its zero cost 4G feature phone. The feature phone segment isvoice heavy and data adoption may be more gradual. Adding voice heavy subs on thenetwork at the prevailing termination rates may put more pressure on Jio’s profitability.

    That said a continuously increasing subscriber base may see a pick up in on-net callingand imply reduction in interconnect pay-outs, albeit gradual.

    Our sector base case assumes the potential decline in interconnect rates at nomore than 2 paisa, with anything lower being negative for Bharti and other incumbenttelcos. As per our analysis, if termination rates were halved it may add c5% risk to Bharti’sEBITDA and lead to another round of pricing disruption in the sector. We think the worstoutcome for incumbents would be a move to a “bill and keep “regime by the regulator. Ontiming, we believe if TRAI were to share its estimation model for termination rates withtelcos and then seek comments, there could be a delay of a couple of months; otherwise,we could see a decision in weeks. We rate Bharti Airtel Hold with a DCF-based TP ofINR400: in our view the market is not pricing in the potential downside risk to interconnectcharges. We rate Idea Cellular Reduce with a DCF-based TP of INR77. We remaincautious as leverage is still a concern, with 2018e net debt/EBITDA at 6.4x. Fordiscussion on risks for both companies please refer to page 4.

    Key ratings and estimates