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Tuesday, April 20, 2010

High 3G capital costs add to telecom companies’ woes

Seven days into the 3G (third-generation) spectrum auction process, the bids for pan-India spectrum totalled Rs5,710 crore, or 63% higher than the base price of Rs3,500 crore set by the government. Besides, there are roughly four bidders for pan-India spectrum, while only three slots are available in most circles, or telecom operating areas.

Analysts had expected that there would be serious bidding by at least five companies in the metro and “A” circles. Although the number of bids has been fewer than expected, bidding intensity has been relatively strong, as is seen from the bid prices. According to analysts Rumit Dugar and Manoj Singla at Religare Institutional Research, pan-India 3G spectrum is expected to cost in excess of $1.5 billion (Rs6,675 crore). “As such, we remain concerned about the high acquisition price of 3G and expect limited revenue upside in the near term,” they added.

According to another analyst, telecom operators will have to invest $400-500 million annually for the next two-three years in setting up the 3G telecom network. With such high capital costs, winners of 3G spectrum are likely to see dilution in their earnings in the next two-three years.

Telecom shares had rallied just before the start of the 3G auction process on 9 April. Shares of Bharti Airtel Ltd and Reliance Communications Ltd have corrected by 6-7% from their highs just prior to the auction. Perhaps the relatively high bids are causing a reality check on telecom companies’ valuations.

And it’s not that 3G is the only overhang on telecom stocks. Profit growth in the existing operations has been under check because of intense competition. For the past few quarters, average revenue per user has been declining at a fast pace because of “free minutes” offered to customers.

The Religare research note added that “intense competition is leading to higher churn and greater distributor incentives, which, in turn, is driving up subscriber acquisition costs”. So although the industry’s subscriber addition numbers continue to be impressive month after month, the underlying reality is that the cost of acquiring and retaining subscribers has increased, which will lead to erosion in profitability. Since all this will show in the results of telecom companies in the coming quarters, their shares may continue to be under pressure.

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