Share prices of Bharti Airtel Ltd and Idea Cellular Ltd have risen by 22-23% from their lows last week. This translates into a gain of Rs40,300 crore or $6.2 billion in the market value of the two companies.
It’s worthwhile noting that this comes just a couple of weeks before these companies report their worst results for the wireless business in years. What’s more, things will go further downhill in the December quarter, thanks to the 57% cut in interconnect usage charges (IUC), a decent revenue source for incumbents.
While the near-term outlook is bleak, some investors are celebrating the improvement in the long-term outlook. First, the relatively small-sized Tata Teleservices Ltd practically gifted itself to Bharti Airtel. Second, Reliance Jio Infocomm Ltd is set to raise tariffs on 19 October.
Investors are salivating at the thought of an oligopolistic market structure, where Airtel, the Idea-Vodafone combine and Jio will each have a 30%-plus market share, with considerable pricing power. But this optimism is reflected the most in the shares of Reliance Industries Ltd, Jio’s parent company. Analysts are valuing its telecom business at over $30 billion, not much lower than Airtel’s India wireless business.
The catch, of course, is how the aspect of demand elasticity plays out. Jio has been able to grow its user base of over 130 million by offering free and then deeply discounted offers. Higher tariffs may impact its customer addition to some extent, and the company can be expected to calibrate its tariff increases. Besides, if its discounts disappear soon, that will take the pressure off incumbents. Perhaps, for this reason, Jio has offered customers cashback vouchers this month, which can be used to get discounts in the future. For those who have the vouchers, a tariff increase of, say, Rs50 would effectively mean their outgo will remain the same for some time to come.
As such, it remains to be seen how soon investors’ hopes of optimal pricing are realized.
In the meantime, investors have to live in the reality of losses and significant cash burn. Each of the above-mentioned large companies are bleeding, and the recovery process can be long-drawn-out. Idea has already been running losses for some time, and by the time the impact of the cut in IUC sets in, Airtel too can be expected to report pre-tax losses in its India wireless business.
And while Jio reported an Ebitda (earnings before interest, tax, depreciation and amortisation) margin of 25.3%, what matters far more is free cash flow. Of course, the company didn’t report a cash flow statement, but it did tell analysts that cash outflows in the form of operating and capital expenditure stood at around Rs11,700 crore in the September quarter. Revenues, on the other hand, were only around Rs4,500-5,000 crore, after adjusting for revenues spilling over from the June quarter. As such, Jio has a long way to go before it bridges the gap in cash flows.
Of course, higher tariffs will help it bridge the gap to some extent, but what’s far more important is to get to a much higher subscriber base. Analysts at IIFL Institutional Equities estimate that Jio’s revenue market share stood at 11.5% in the September quarter; in other words, there is a long way to go before Jio reaches the market share it is after.
So while investors are drooling over a cozy market structure, the fact remains that the road to this dream steady state structure will be messy, as Jio continues to go after customers serviced by incumbents.