Telecom Package Will Save Vodafone From Imminent Death, But Long-Term Survival Issues Remain

The best thing about the reforms and rescue package for the telecom sector is that it immediately relieves the pressure on payment of government dues. But, as a policy that will ensure the future growth of the sector, which needs huge surpluses to reinvest in the business, it is lacking. It kicks the can further down the road and it is far from certain that the primary beneficiary of the package, Vodafone Idea, will remain in the race.

The key elements of the package (read some details here, here) cleared by the cabinet yesterday (15 September) are the following.

One, there is a four-year moratorium on spectrum dues payable to the government, but with the rider that these dues have to be paid back with interest after that. What this does is free cash flows for four years, but the debt pile at the end of the moratorium period will be even bigger. Unless telecom revenues have soared by then, the problem may not go away, especially for the weakest player of them all, Vodafone Idea.

Two, in future, the sector’s adjusted gross revenues (AGR), on which spectrum payments are calculated, will be restricted to telecom-related income. A definitional death-blow was inflicted by the Supreme Court verdict in the AGR case a year ago, in September 2020. The Supreme Court’s decision was wrong — it stuck to the letter of the wordings in determining what is 'gross' revenue rather than taking a common sense view that these revenues should relate to telecom. This reading is now confirmed by the government’s own decision to redefine AGR more narrowly.

While legally the government may not have had much room to write off or whittle down past dues as a result of the Supreme Court verdict, it could have over-compensated by reducing the future redefined AGR. Or cut levies in other ways. This could still happen, but reform in bits and pieces may not provide a sector with policy stability when large expenses — on 5G spectrum purchases and infrastructure rollouts — lie ahead.

Three, the government has opened up the possibility that some of the dues that accumulate due to interest can be converted to equity, but this implies that those who opt for this conversion will see a further dilution in promoter equity, when that is what will help a weak company like Vodafone in play. Vodafone has been losing subscribers by the million every month to Airtel and Reliance Jio. A Goldman Sachs report says that Vodafone will save around Rs 16,200 crore in cash flows annually, which means it will end up having to pay over Rs 64,000 crore, plus interest, from 2025, by when it will need another Rs 30,000 crore for buying 5G spectrum and invest in related infrastructure. This implies that it will have to manage a difficult balancing act: raise tariffs regularly, while also retaining and growing its subscriber base.

Given the unequal burdens of debt on Jio, Airtel and Vodafone, the other two operators may well choose to use the opportunity to gain market shares from Vodafone. This trend may accelerate when Jio launches its cheap smartphone by Diwali. Airtel will follow soon after. The cost of subsidising the handset for users will be carried by the telcos, which can only do further damage to Vodafone’s market shares.

Four, the package has small mercies like simplification of the rules for seeking permissions to set up new towers, elimination of the 0.5 per cent spectrum usage charge when spectrum is shared between telcos, and elimination of penalties and interest charges for delayed payments to the government. But the simplification of rules for setting up new towers (a huge need when 5G is rolled out) may provide only limited help, since many of these permissions have to be obtained from states, local bodies and various ministries at the Centre. It is only the process of declaring this information that has been eased, not the permissions themselves.

In the current package, Jio is best off as it can choose not to take the moratorium and pay its smaller dues to the government; Airtel could partly accept the moratorium and also have enough room to invest in 5G, as its promoters are willing to pump in more money. It is only Vodafone, which has two promoters reluctant to pump in further equity, that will be left holding the sack. Airtel has around Rs 25,000 crore of AGR dues to repay, and also annual spectrum charges of around Rs 7,800 crore, according to Business Standard.

If the aim of the reforms and revival package was to provide relief in general and also retain Vodafone as a third private sector player, it is difficult to see how that will happen given the industry’s huge challenges in the 5G rollout, whose auctions will happen by early 2022. It surely gives Vodafone a much-needed breather, which it will take as a lifeline, but leaves the larger issues untouched.

The unresolved questions related to policy are the following:

1) How long will the government keep raising spectrum charges determined through auctions, when the industry badly needs much lower spectrum prices to grow? The government needs to stop its rent-seeking behaviour and bring down spectrum reserve prices and make up for the presumptive revenue 'loss' when the industry expands and becomes profitable. It is not necessary to make all your money from spectrum. A healthy industry is a better guarantor of revenues than a sick one.

2) Why should the government demand full repayment of past spectrum dues from companies going into liquidation, when this makes the task of retrieving bank bad debts worse? Especially when spectrum is the main asset (apart from telecom towers) of telcos.

3) The moratorium will enable Vodafone from defaulting on bank loans, which add up to over Rs 1.2 lakh crore. But banks too will need to recast some of the loans and take haircuts since Vodafone will need further loans to invest in infrastructure and retain customers. Banks will be relieved, but they are not entirely off the hook either.

4) Large increases in tariffs are now inevitable, but it is not clear if Jio, which wants to take its revenue market share upto 50 per cent, is willing to let go of the advantage of using tariffs and bundled handset-plus-tariff plans to gain at the expense of Vodafone.

In one line: the package is much-needed, but one has to flag doubts it will ultimately save Vodafone. One can only think of the package as the first instalment on the long road to rescuing Vodafone. We are still heading for a two-player sector (ie, excluding the public sector Bharat Sanchar Nigam Limited).

But there is one sliver of hope. The package allows 100 per cent foreign direct investment in telcos, which means either Vodafone itself could take over from Kumar Birla, or a third promoter-investor added to infuse fresh equity in the company. Airtel’s promoters will also have a chance to exit at a huge profit, assuming they want to cash out at some point. Jio may remain the only fully-owned domestic player in due course.