Telecom Companies Following Path Airlines Did – Digging Their Own Graves
Lately, we are seeing telecom companies cutting voice and SMS rates in an attempt to keep up with one another. The main focus in these rate cuts is to ensure that they maintain (or increase?) their market share. The rates are now being calculated in paisa per second for voice and one paisa for one SMS message. Coming from the consumer side these are best times to be using cellular phone for communication. To me, pricing these services in terms of paisa and seconds means this is practically free, relative to what a rupee can buy in today’s market. More so, when you start thinking about the capital expenditure in developing these communication networks and licensing fees involved.
As an investor, I believe these telecom companies are digging their own grave. These do not seem to make any economic sense. You will not find Rs 5 cutting tea on the roadside, but you can use a high tech wireless communication network for 30 minutes for less than Rs 5. Something is missing here. The rates for making calls were already among the lowest in the world. Now, this mad race will bring it down further, and will perhaps make them the lowest in the world. I am passing few of the publicly traded companies through my stock screen to see if it generates interest in me.
Bharti Airtel:
- Operating Cash flow (positive and growing trend, growth rates are slowing down)
- Debt (currently manageable but room for error is less. cash flow is 1.5 times debt, high reserves is negated by liabilities)
- Dividends (one time only, not favorable)
- Reported Net Profit (positive and growing trends, and below operating cash flow)
- Margins (good margins, above 20%)
- Capital Usage (good)
Idea Cellular:
- Operating Cash flow (positive and growing trend, growth rates are slowing down)
- Debt (increasing but currently manageable, less room for error, cash flow is 0.38 times debt)
- Dividends (no dividends)
- Reported Net Profit (positive and growing trends, and below operating cash flow)
- Margins (good margins, mid teens to mid 20s)
- Capital Usage (acceptable)
Reliance Communications:
- Operating Cash flow (positive but reducing trend)
- Debt (high, cash flow is 0.06 times debt)
- Dividends (yes, but not good quality)
- Reported Net Profit (positive and growing, but above operating cash flow)
- Margins (good margins, mid teens to mid 20s)
- Capital Usage (very low)
TATA Communications:
- Operating Cash flow (positive and increasing trend)
- Debt (high, cash flow is 0.47 times debt)
- Dividends (yes)
- Reported Net Profit (positive, and above operating cash flow but has been less twice)
- Margins (acceptable margins, mid teens)
- Capital Usage (very low)
Mahanagar Telephone Nigam Limited:
- Operating Cash flow (positive, but dropped in 2009)
- Debt (low and practically zero)
- Dividends (yes)
- Reported Net Profit (positive, and above operating cash flow)
- Margins (poor relative to peers, single digits)
- Capital Usage (very low, in low single digits)
This screen shows me except Bharti Airtel, none of them have any qualities that I am looking for long term investor. In case of Bharti Airtel, even if it were trading in my fair value range, I would not initiate a new position at this point in time. My stock screen shows it is a very well managed company, however, the trends are not in its favor. Its reserve appears to be high which most likely gives an impression of great balance sheet. However, the liabilities will balance out the reserves. The best aspect about Bharti Airtel is that it is generating substantial cash flow, which allows it to service its already low debt. The average revenue per user is continuously going down. And it can no longer bank on continued increase in subscriber. Half of our country already has a cellular phone, and hence the subscriber growth rates will slow down. In addition, I expect the price war to cut its cash flow. Furthermore, whenever it rears its head for acquisition (e.g. twice for MTN), I makes me worry about the price it will pay.
For my buying objectives of long term buy and hold, all telecom companies, are not worth a consideration. These telecom companies are going down the path of Airline companies. Almost all airline companies are in red now. Jet Airways was well managed and profitable company (same like a Bharti Airtel); but competition, mad race for price cuts to keep market share, and Sahara acquisition messed it up.
So, for now, telecom companies will not get my investment rupees.
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Agree completely with the analysis. I had Idea [bought last year at basement!] and VSNL and I dumped both completely this year. In addition to the factors mentioned by Tip, there are a few more:
1. Govermnent regulations – they play a significant role in profitability of the companies.
2. Future investments – as 3G/LTE looms on the horizon, continuous investments will be needed to bring the technology to the market. Unless the companies have a huge cash flow, this means raising funds – either via debt or equity, and either option depresses returns.
Cheers,
Arun
I did not think this way. You mentioned about long term, how about short term. Since bharti is the best among them, does this mean the bad ones will go bankrupt, and that way bharti has competitive advantage. What do you think about Airtel and NTT docomo? Did you ignore them for some reasons?
What are your thoughts? Thanks in advance.
Hello Surinder,
No short term for me. It is possible Bharti will have competitive advantage due to strong balance sheet. It is a likely scenario.
My understanding was Airtel and NTT docomo are not publicly traded yet. Either they are private or fully owned subsidiary.
Thanks for your comments.
hi, these telecom companies are in investment stage they have made capital expenditure and now with the lower rates, it will in effect increase consumption, i.e. more revenue.
and 3G will bring in more revenue because of data services.
Is not this a correct thought process? I also think Bharti will be at an advantage becuase others smaller player will have problems.
For 3G, its not just spectrum auction which incidentally also needs money.
Its the investment in new gear that’s needed to be able to support 3G. GSM gear cannot automatically support 3G. The technolgies are completely different, so new hardware, new software and new network needs to be rolled out – its fresh investment all over again.
In Europe, the 3G auctions were great for governments but really bad for the service providers that “won” the licenses and were unable to provide any meaningful 3G services. Many Telecom equipment vendors are still in withdrwal pains that arose from the investments in 3G/UMTS.
Now, of course, the new kid on the block is LTE, or 4G.
Cheers,
Arun
Arun,
You captured it correctly.
Furthermore, 3G will require bigger investments than 2G. I just wonder where will they get the capital (without getting debt laden).
I think government should skip 3G, and move directly to LTE/4G.
Best Wishes,
tipguy
I have been analysing the above companies too since they hit the 52 week lows.
have a look at the reliance communications annual report. does it look clean. I dont think they are making profits (forget the book profits). they have all kinds of charge offs to reserves and all other kinds of accounting stunts. they have 30K cr of debt and still have interest income ..isnt that amazing ??!!
idea has accumulated losses which it has to recover.
the only player which has a sound balance sheet and decent profit is bharti airtel, so if one has to buy the sector (which is a big if)..it should be bharti
the telecom sector is an ideal sector to apply game theory. with this price war on, it is race to the bottom now.
finally in telecom the marginal cost for marginal revenue is almost zero and hence the drop in rates. ofcourse that does not cover capex and other expenses
rgds
rohit
Hello Rohit,
I tried not to go into individual company details (although I did not succeed).
I fully agree with you on reliance communication. The way I screen that is using operating cash flow, debt, reported net profit. Its ability to generate cash is only 0.06 times its debt (a disaster waiting to happen!), and reported net profit is more than operating cash flow.
First, its cash generating ability relative to debt is next to nothing. Second, it is showing more profits than it can generate operating cash flow (accounting stunts!). I won’t be surprised if RCOMM does some M&A, divest, or merge, or do some financial engineering or team up with investment bankers to clean itself up. With its current business in mess, I don’t know how it will enter 3G, or it may use 3G to clean up its balance sheet. We will see….
Same observation on Idea, however, operationally it is doing fine. Although still very low at 0.38 times only, its ability to generate cash is marginally better than RCOMM. It does not seem to do accounting stunts. If it continues down that path, it can catch up on past debt. However, these rate cuts will mess up its cash flow (i think?).
Bharti Airtel, although seems to be fine operationally, I would still keep an eye on its liabilities. Too high. But good part is it has reserves to cover it. Here also, I won’t be surprised if the owner bails out to cash on its strong position. Like Ranbaxy did.
I understand what you mean by marginal cost for margninal revenue (MC/MR). But I tend to differ that in telecom MC/MR is almost zero. Let me think about it how to address this and I will discuss in next post. I view that as root cause of mess. We should understand this in proper context and not standalone.
Thanks for stopping by.
Best Wishes,
Hi TIPguy
The advantage for investors like is us that we dont ‘have’ to be invested in telecom or any such sector. we can do an academic study and leave it at that.
agree with your comments on RCom and idea. Idea is doing decently and working through its accumulated losses.
The analogy of telecom and airline is valid, but breaks off at the point of marginal cost and marginal revenue.
In an airline, the marginal cost is quite high. if a plane is already schdeduled to fly, then the MC is low, but at a point every new plane in air means a step increase in marginal cost.
telecom is different in that sense. once you have the basic infrastructure in place, adding customers to a certain point does not cost much. further capacity expansions require additional capital, but the point is much higher than any other commodity industry. for ex: if you add 1000 more customer in telecom..it would not cost much for the company as operational costs are low and some like license are fixed. in comparison 1000 additional customer in airline or 1000 tn steel requires much higher MC.
the above point is the reason the MR is being driven to 0.
ofcourse this logic has its limit ..at a certain point, even a telecom company has to add equipment and people. this where the current strategy will hurt the industry.
I think 3G could add to more problems to the industry if you have the players overbidding for it as it happened 10+yrs back and several players got hurt big time ..remember the huge bids for earlier auctions from hfcl and like ?
I got out of Telecom about a couple of months ago. I am looking for a company that is vendor to the telcos. There could be some opportunity there. Do you have any suggestions?
Hello Manshu,
Haven’t looked into in recent times. But you may like to read more about Nu Tek India, Goldstone Infratech, and Valiant Communications.
Most of them are in small caps, so I don’t think buy and hold is good method for such companies. For such stocks buy and sell based on valuations/opportunities is good approach.
Best Wishes,
Good Analysis. Unfortunately I am investedin Rcom(260) and Bharti(360). What is the best way to get out of this loss now? Any ideas?
I wish I had looked at this analysis before investing…..ordone it this way…Thanks anyways.
Hello Naveen,
I responded by email.
Best Wishes,
No it is not true, If you really digg into the matter can realise that the Companies and Retailers are still making huge profits but the distributor (who stand between two)is surviving or bear the brunt.
You can check, no distributor can do this for long if somebody doing it is bcoze they entere into whirlwind. there are lot of cases of suicide by distributors.
shetty.
Hello Sunil,
Thanks for letting me know its not true.
Best Wishes,