In tower sale, Indian telcos face their version of marshmallow test

Stanford University’s famous marshmallow test showed that a child’s ability to delay gratification resulted in better academic achievements and even a lower body mass index as an adult.

India’s largest telecom companies now face their version of the test. They can choose instant gratification by selling their tower business at a high valuation, or they can delay rewards by negotiating for lower rentals instead.

Last quarter, all telcos reported high levels of cash burn thanks to the tariff war and a sharp cut in interconnection usage charges. In this backdrop, negotiating on rentals to stem the bleeding seems like the sensible choice.

“Incumbents (are) fighting shy of taking a tough long-term business call on tower rentals: (they should) push for savings on this front to ensure long-term cost competitiveness,” an analyst at Kotak Institutional Equities wrote in a 7 February note to clients.

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Of course, it would be tempting to settle for a high selling price and strengthen the balance sheet as far as possible. But that would also mean agreeing on high rentals with the new owners of the tower firms for years to come. In order of priority, lower rentals is the way to go— if operations are sustainable, funds can be raised in the future. A high-cost structure can lead to continued erosion of the balance sheet.

Reliance Jio Infocomm Ltd’s relentless onslaught has forced incumbents to cut costs wherever possible. But tower companies have come out unscathed, possibly because telcos want to protect value in those companies before the impending sale to a consortium of private equity investors.

Things have now come to a point where these conflicts have become too large to ignore. Bharti Infratel Ltd reported a return on capital of 34.6% for 2017, up from 29.6% in 2016. Return on Bharti Airtel Ltd’s invested capital, on the other hand, fell to 4.9% last year, from 7.1% in the preceding year.

In Airtel’s India wireless business, returns could soon turn negative. Last quarter, the division’s Ebit (earnings before interest and tax) amounted to only around 1.5% of revenue, and some analysts expect losses at the Ebit level in the March quarter. Idea Cellular Ltd already loses Rs14 at the Ebit level for every Rs100 in revenue.

At a time such as this, it’s strange that a provider of ancillary services to the industry can enjoy return ratios of as high as 35%.

Kotak’s analyst had pointed out in an earlier report that Reliance Jio has a significant network cost advantage compared to Airtel and Idea. A cut in rentals by incumbents can help bridge the gap, and help them cope with the new normal of low tariffs.

Recent statements by Idea and Vodafone India Ltd suggest that they have pinned their hopes on a recovery in tariffs, stating that Jio stands to lose by cutting tariffs as well. But Jio’s thoughts on tariffs are in the realm of unknown unknowns, to borrow from Donald Rumsfeld. It’s far better for incumbents to tackle things that are within their control. Negotiating tower rentals is one obvious area.

The recent correction in valuations affords a good opportunity to revisit the tower sale. Bharti Infratel’s share price has corrected by nearly a third from its peak in mid-October last year. Even if telcos settle for instant gratification, it won’t be as satisfying as striking a deal three-four months ago would have been. They should use the opportunity to revisit rental deals, and settle for delayed rewards. That way, like the kids who passed the marshmallow test, they can look forward to better returns in the long run, and less flab in the cost line.livemint