Trapped in transition: The rough road ahead of Vodafone Idea

The key takeaway from telecom giant Vodafone Idea’s first ever analyst meeting was this—the company doesn’t expect the two-year-old tariff war to continue. From here on out, the company believes that tariffs will cease the downward spiral they have been on since Reliance Jio first sent the telecom industry into a tizzy by lowering data prices and forcing competitors to follow suit. This belief carries hope for Vodafone Idea, something that’s been in short supply since it announced its maiden quarterly results just over a week ago.

The predicament the company finds itself in is not something most would have seen coming just two years prior. Back then, the decision to merge Idea Cellular and Vodafone India seemed like a match made in heaven. Even their competitors agreed. At the World Economic Forum in Davos in January 2017, Bharti Airtel chairman Sunil Mittal openly backed the idea of Vodafone India and Idea Cellular merging to become the largest telco in the country. “It’s a perfect match… The strength and weaknesses match very well. Rural and urban [subscribers]. Spectrum portfolio,”  Mittal said.

This sentiment was evident when the two companies finally announced their merger plans in March that same year. After all, they had a lot to offer each other. Vodafone India had been looking to list on the Indian stock exchanges since around June 2016. Idea, as an already listed company, would help them achieve this. In addition, while Idea had made inroads into rural areas, Vodafone had a larger presence in metros. The merger was supposed to help the companies consolidate their capital and operational expenditure, reduce their debt, and raise their average revenue per user (ARPU) on data plans.

So, when the merger finally went through in August 2018—with the two companies forming a merged entity called Vodafone Idea Ltd—it should have been good news. A bulwark against the unceasing creep of rival telco Reliance Jio.

The maiden quarterly results, however, were more nightmare than fairytale. To begin with, the company posted a net loss of Rs 4,974 crore ($690.35 million) during the September quarter. Vodafone Idea lost 13 million subscribers during the quarter—more than double the subscribers lost by Airtel in the same period. Hopes of an increase in ARPU also proved unfounded. ARPU in this quarter declined to Rs 88 ($1.23). Vodafone Idea has now launched new minimum recharge plans aimed at stemming the ARPU depletion. While its rivals also saw a drop in ARPU, Airtel’s ARPU for the same quarter stood at a comparatively better Rs 100 ($1.4), while Jio’s was an even higher Rs 131.7 ($1.85).

Unsurprisingly, revenue took a body blow. Total revenue fell 7.1% quarter-on-quarter to Rs 12,023.8 crore ($1.66 billion). Earnings before interest, taxes, depreciation and amortisation (EBITDA) was Rs 978.8 crore ($135.85 million), a steep drop of 28.7% from the preceding quarter. EBITDA margins reduced from 10.6% to 8.1% since the preceding quarter. To put this in perspective, when the merger was announced in March 2017, Idea Cellular alone had a much healthier EBITDA margin of 26.1%.

Yes, Vodafone Idea does have a larger customer base than its rivals—more than 400 million in total—but this base is fast eroding. Analysts say that as the networks of the erstwhile Vodafone India and Idea Cellular integrate, Vodafone Idea’s network quality is in shambles, leading customers to port their numbers to other operators. Meanwhile, it needs to set up more broadband sites and expand its optic fibre infrastructure to create more capacity for the data explosion currently taking place in the country. All of this requires more capital expenditure if Vodafone Idea is to remain competitive, but soaring debt has left the company hamstrung.

The company even issued a statement following the dismal results that was meant to show resolve. Its promoters would infuse Rs 25,000 crore ($3.47 billion) of capital to shore up the balance sheet of the newly formed entity and help it stay competitive. And the tone of Vodafone Idea’s first analyst meeting was meant to underscore this. The message the company sought to put out at the meeting was that, far from being on the brink of disaster, they were in an opportune situation where they could extract the best of the two companies.

During the merger talks, Idea Cellular’s management had told analysts that, on both the capex and opex side, the merged entity would have a savings run-rate of around $2 billion once the networks of both companies integrated in four years. The company was expected to save Rs 8,400 crore ($1.18 billion) on the opex side. But during the analyst meet, the management claimed that Vodafone Idea could achieve the opex savings two years earlier than previously planned.

But all this posturing is equal parts bravado and optimism. This is no ideal situation. Vodafone Idea is faced with a glut of problems. It needs to figure out how to reduce its debt, ringfence subscribers, and protect its revenue market share.

Debt on arrival

High on the list of Vodafone Idea’s woes is debt. A growing mountain of it. Yes, debt has, over time, become a badge that Indian telcos now wear as a sign of maturity. But even so, Vodafone Idea’s situation is worrying—its net debt stands at Rs 112,500 crore ($15.61 billion), a 3.02% increase from the previous quarter.

The size of its debt is particularly concerning to analysts as it stands over 10 times higher than the company’s EBITDA. A July 2018 report from brokerage firm Credit Suisse pointed out that debt interest payments alone would eat into around half the EBITDA generated by the merged company. This leaves little room for capital expenditure. The report projected that Vodafone Idea would not cross an annual EBITDA of around Rs 16,000 crore ($2.24 billion) for the next three years.

At the analyst meet though, Vodafone Idea tried to paint a far rosier picture of future EBITDA. They added the combined ARPU of Vodafone India and Idea Cellular over the last 12 months to their forecasted opex synergy of Rs 8,400 crore, and used their ARPU levels prior to the merger to forecast an annual EBITDA of Rs 43,000 crore ($6.04 billion). An analyst privy to the meeting indicated to The Ken that this was little more than wishful thinking.

Despite not having to worry about spectrum auctions—with telcos looking to better utilise existing spectrum and prepping for 5G in the future—there is still a need to increase capital expenditure. As the industry shifts from voice to data, Vodafone Idea must spend big to increase its number of mobile broadband sites and upgrade its optic fibre networks. Airtel, for instance, revised its capex guidance for the financial year to Rs 25,000 crore from Rs 20,000 crore ($2.77 billion). In stark contrast, Vodafone Idea’s capex for the same period is a little over a quarter of Airtel’s—Rs 5,816.9 crore ($807.34 million).

To ease out some of the capital expenditure problems, Vodafone Idea’s board of directors announced plans to infuse equity capital worth Rs 25,000 crore from the company promoters. This was on the pretext that balance sheet flexibility was necessary to execute their strategy. According to a company statement, UK-headquartered Vodafone Group would be willing to contribute Rs 11,000 crore ($1.5 billion) while the Aditya Birla Group is willing to invest Rs 7,250 crore ($1 billion) towards the capital raise. The proposal is expected to close by the end of the financial year.

This, however, is unlikely to remedy Vodafone Idea’s capex shortfall. Instead, analysts say that the bulk of the equity infusion should be used for debt deleveraging. More than half of the equity infusion, say about Rs 15,000 crore ($2.1 billion), should be used to push their debt levels down. Speaking to The Ken, a Mumbai-based analyst at a financial firm opined that even if Vodafone Idea were to do about Rs 16,000 crore EBITDA annually, they should ideally have no more than Rs 60,000 crore ($8.41 billion) of debt. After deleveraging, the remaining capital can be used for capex and interest payments.

Good optics

Vodafone Idea said that it is exploring a potential sale of its optic fibre assets to ease its balance sheet further. The company says that the sale will include 156,000 km of inter and intra city optic fibre networks.

Tower power

Industry observers say that the capital after deleveraging will not be enough for Vodafone Idea to stay competitive. Instead, the company will have to sell off some of its assets to raise some capex firepower. Their tower assets, for example, could fetch the company some much-needed cash. Cash they need sooner rather than later.

If they sell the tower assets, then they will be able to survive. If the tower sale does not happen, it is a slow death,” says a senior executive with a telecom gear manufacturer. In the run-up to the merger, both Idea Cellular and Vodafone India sold their standalone tower businesses to ATC Infrastructure Private Limited for a total of Rs 7,850 crore ($1.08 billion).

All that’s left now is the company’s stake in tower company Indus Towers. While Vodafone owns a 42% stake in the company, Idea owns a further 11.5% stake. Indus Towers is currently awaiting approvals for a merger with Bharti Infratel, the standalone tower company of Airtel. This merger gives Vodafone Idea an opportunity to make a full or partial exit, which could improve the balance sheet further.  Globally, Vodafone has been mulling selling its towers business in Europe for around €12 billion ($13.67 billion) to bring down its overall debt.

Unfortunately, Vodafone Idea does not have a healthy balance sheet and they can’t put in as much money as Airtel is putting in. Forget about what Reliance Jio is spending on capex,” said an analyst in a Mumbai-based brokerage firm. He sees a correlation between the amount of capex a telco is putting in with the mobile broadband subscriber additions, an important aspect as broadband subscriber additions translate to a higher ARPU and stronger revenue growth. And while Vodafone Idea seems limited in its ability to bring on board high-ARPU customers, it’s also in danger of losing low-end users as well.

Swing low

In the same 2017 interview where Sunil Mittal was supportive of the Vodafone-Idea merger, he also spoke of the biggest thorn in his side—Mukesh Ambani-led Jio. While talking about Jio as a competitor, he mentioned that Jio would have a tough time as its 4G-only network would only cater to smartphone users. The rest of the customer base—on 2G and 3G networks—would remain intact.

This premise boded well for Vodafone Idea’s low-ARPU base. However, the introduction the JioPhone, Jio’s 4G feature phone, has turned this situation on its head. As we reported earlier, the JioPhone—which costs around Rs 1,500 ($21.1) and supports web-based services like YouTube and WhatsApp—is targeted at low-ARPU customers. This play has led Airtel to say it does not see value in trying to retain low-ARPU customers. Instead, it’s now focused on getting more of its subscribers on 4G and converting them to mobile data subscribers.

Vodafone Idea is particularly susceptible to Jio’s quest for low-ARPU subscribers. At the end of the September quarter, Vodafone Idea said that it had only 140.1 million data subscribers. This means that a majority of their customers, 281.9 million of them to be exact, are still on 2G voice networks. These customers tend to be low-ARPU subscribers, recharging for small amounts and primarily using their phones for voice calling.

These users are vulnerable to the overtures of Jio, which is offering JioPhone customers unlimited voice calling on recharge packs as cheap as Rs 50 ($0.70). This, in addition to a taste of online messaging, video calling and video streaming.

To protect itself, onboarding broadband customers will be critical. However, during the preceding quarter’s analyst call, Idea Cellular’s management expressed disappointment that it wasn’t able to add more broadband customers. This trend seems to have continued even after the merger, with Vodafone Idea only able to add 4.4 million mobile broadband customers in the September quarter. This pales in comparison to Airtel, which has added 7.4 million mobile broadband customers in the same period.

Vodafone Idea has continued to expand its mobile broadband network in anticipation of gaining more data customers. But while the company has increased its data capacity, it has been unable to get enough value from these investments. Mahesh Uppal, director at telecommunications consultancy company ComFirst, is sympathetic to Vodafone Idea’s situation. “Telecom operators are in a bit of bind: they have to invest to develop data markets, but data services are yet to provide the cash flows they need,” explains Uppal.

And even as they expand their network, the network quality is causing a fresh set of headaches for the beleaguered telco.

Choppy network

Vodafone Idea boasts the largest spectrum portfolio among Indian telcos. At present, it has 1,850 MHz of spectrum, which can cater to 2G, 3G and 4G customers. However, while it may have the most spectrum, it doesn’t necessarily have the best spectrum.

While Vodafone Idea is currently offering 4G services in all 22 circles, it has only deployed 4G-exclusive spectrum—the 2,300 MHz and 2,500 MHz bands—in 16 circles. In other circles, the company has simply repurposed existing frequencies which were originally used for 2G voice services. The repurposed spectrum, however, does not have great propagation characteristics and offer 3G speeds at best.

Jio, meanwhile, is at a significant advantage despite a smaller spectrum portfolio. Not only does Jio have a significantly denser, single technology network, its spectrum is also more effective. “They have 850 MHz band spectrum which has fabulous propagation characteristics,” says an analyst in Mumbai.

In telecommunications, lower frequencies such as the 800 MHz band and 700 Mhz band have superior propagation and better coverage indoors. Vodafone Idea does not have spectrum in either of these bands. Because of its debt situation, it cannot bid for these spectrum bands even if the government decides to hold auctions. Vodafone Idea, in the recent analyst meet, indicated that it would be focusing heavily on network since it is key to data services. The company intends to do dynamic spectrum refarming and other things in and around spectrum to improve its network quality.

However, the company’s network problems seem to go beyond their spectrum portfolio. Analysts have expressed concern over the pace of network integration between the companies. Rather than bolstering its capabilities, the merger has left Vodafone Idea with a patchy network. Analysts say that the company’s network is now its weakest link. This could be a reason for Vodafone Idea’s subscriber exodus. Noting that Vodafone Idea has been losing active subscribers, a report from Mumbai-based brokerage firm Motilal Oswal stated that the “loss reported by the merged company was due to its deteriorating network quality which could possibly be on account of network integration issues.”

It is reminiscent of Vodafone Plc’s 2012 acquisition of Cable & Wireless Worldwide in the UK. The move adversely affected Vodafone’s financial performance in the UK, even causing serious customer complaints and reputational damage.

For its part, Vodafone Idea says that work on spectrum and network consolidation has already begun. “Circle level capex planning for the network integration has been completed, including vendor selection. Equipment ordering is in the final stages,” the company said in its quarterly report.

But while things are looking decidedly grim for Vodafone Idea, the end isn’t nigh. In a post-integration company, employee challenges are not there. More importantly, the equity infusion will buy it some breathing room. Financial services company HDFC Securities noted in a report that, coupled with the tower assets sale, it would buy the company time for 6-8 quarters, including interest payments.

The equity infusion also sends a message. To investors. To competitors. Vodafone Idea will not throw in the towel. They are still in this fight. The analyst meet reinforced this. The top management is confident. It believes it has what it takes to sail through the next two years, come what may. But regardless of this sentiment, the company has a long, uphill road ahead to turn itself around.

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