India Telecoms:Interconnect rates need to hold up

As per news reports (Economic Times, 22 February) the Telecom Commission hasasked the TRAI (Telecom Regulatory Authority of India) to implement tariff ordersin letter and spirit and review existing rules to ensure the industry’s financial growth. TheCommission has expressed concerns over the decline in sector revenues in Q3 FY17.

    Our analysis suggests that FY17e sector revenues are likely to decline by c6% at leastand a similar revenue decline is estimated in FY18e given the increased competitiveintensity. We understand that it is important for the government to protect the financialhealth of the sector as more than USD22bn of spectrum auction instalments are pending.

    Moreover with sector debt estimated at USD70bn, it is critical that the sector’s financialgrowth is protected. With respect to near-term reviews, the TRAI is in the process ofreviewing the interconnect rates/termination rates which are currently at INR0.14. Webelieve that it is important that these rates hold up, or sector revenues may see a furthercorrection as voice tariffs may see a sharp correction.

    Lower termination rates may trigger price wars in voice as the cost for GSM newentrants will come down. However GSM new entrants may not benefit despite the costadvantage as incumbents will match lower rates to maintain market share, with the netresult being lower voice tariffs, a sharp decline in sector revenues and lower taxcollections. While lower tariffs is one of the regulator’s objectives, a sharp correction intariffs may not be warranted as they could impact the financial health of the sector.

    Irrespective of lower revisions in termination rates, we see sector ARPUs declining by asmuch as 13% in FY18e, driven by unlimited voice and data plans. In such a scenario asharp decline in termination rates may only add to ARPU pressure and incumbent telcosare likely to be impacted the most and notably they account for more than 70% of pendingspectrum instalments.

    Retain Buy on Bharti with a DCF-based TP of INR385 and Reduce on IdeaCellular with a DCF-based TP of INR62. However lowering of termination rates will benegative for both in our view as this may result in a sharp correction in voice tariffs.