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Why Reliance Jio will keep data prices low for 2 years: Credit Suisse explains

Wireless data prices in India, which crashed from Rs 250 per GB to about Rs 10 per GB after the entry of Reliance Jio, will continue to remain under pressure for at least two more years, said analyst firm Credit Suisse.

That is the minimum amount of time that the new entrant will take to achieve its market share goals and this period could stretch further, analysts Sunil Tirumalai, Badrinath Srinivasan and Viral Shah said in a note to clients.

This is contrary to the view among investors and industry officials that data prices will start climbing again from this month and that the pain will start easing.

However, said Tirumalai and team, Jio is unlikely to reduce the pressure on its rivals for another two years as it needs this time to get a strong foothold in the market. This is, in turn, required if the company has to make returns on its investment, they said.

“We believe the crux of the bull argument on Indian telco stocks is that Jio will end its current phase of ‘shock and awe’ quickly, and start taking up tariffs along with other operators. We are worried that the term ‘quickly’ here could stretch for a few years (rather than a few months).

“We believe industry revenue growth will stay low as long as Jio is in the ‘market share grab’ phase. We currently build this in as a two-year phase lasting until financial year 2019 (although we believe the actual timeline could be longer),” the analysts said.

UPGRADE FOR JIO

Keeping in view the extra aggression showed by the new entrant in recent days, Credit Suisse analysts said they now expect Jio to get a larger share of the Indian telecom business compared to what they were expecting earlier.

While they had earlier expected the newcomer to achieve a market share of 25% by March 2023, they now expect it to reach a share of 31% by March 2022.

COST OF MARKET SHARE

Credit Suisse said that every 1% of market share in 2025 is worth spending up to $1.4 bln (Rs 10,000 cr) now.

In other words, Jio can spend up to Rs 4 lakh cr for a 40% market share by 2025 and it would still make business sense.

Reliance has already spent around Rs 2 lakh cr on the telecom business, and according to this yardstick, the company can double this investment over the next 5-7 years to gain a 40% market share.

For comparison, Idea Cellular has invested a total of around Rs 0.75 lakh cr in all since it started its business, while Bharti Airtel has invested around Rs 2.25 lakh cr.

Moreover, the impact of extra market share on the profit will not be linear, but geometrical.

If, for example, Jio gets only a 20% market share by 2025, the business will generate cash of just around 9,529 cr per year, the analysts estimated. This cash will barely be enough to cover the capital requirements of the business, and will result in a net loss for the business.

However, if Jio is able to double its market share to 40% by 2025, it will be able to increase its cash flow by five times to 48,225 cr.

At the same time, this higher market share will not call for a big increase in capital expenditure either. Total capex will increase to 13,400 cr from 9,529 cr. Not only will the business not be in losses, it would generate handsome profits for Reliance Industries.

So, said the analysts, Jio will continue to push for market share in the coming 2-3 years and continue putting pressure on its rivals — even if it loses tens of thousands of crores per year.

It will stop doing so only if one of two things happens — either it runs out of cash, or the rival operators also start imitating it and defending their market share by burning cash.

If either of these two things happen, Jio will stop its aggressive price-based competition, the analysts said.

“The first of the above conditions depend on the operator’s appetite to invest, and the second would depend on its competitor’s appetite to invest. Once each operator has reached its respective maximum appetite of cash losses, market shares should largely stabilise to the kind of equilibrium we saw in India until a few months ago,” they said.

A MARKET OF EQUALS

Although Jio has set a goal of gaining 50% of the market, eventually, the analysts believe, the market will stabilize with three equal participants, each with “31-33% share”.

While industry revenue will remain flat till 2019 or so, it will start picking up after that as Jio stops its price-based competition, they predicted.

This will lead the way to a ‘recovery phase’ as the “industry ‘catches up’ on lost growth and delivers an 8.5-9.0% annual growth rate for three years, before settling down to normal levels of growth.”

WHY JIO IS HARD TO TAME

The analysts said the entry of the Reliance Industries’ unit is very different from that of other new players, such as Tata DoCoMo, Aircel and MTS, in the past.

“In most markets, new entrants have a gradual expansion of their networks: even many quarters after their commercial launches, new networks would still be quite behind the incumbents on coverage. This puts a natural cap on how quickly the new entrants can gain market share.

“However, Jio has taken the approach of nearly matching incumbent coverage—even before the first SIM card was sold (we suspect its 75% population coverage at launch last year probably covered 90% of the addressable industry by revenue potential. It has targeted 99% pop coverage in the ‘coming months’).

“Thus, Jio is not really constrained by the coverage limitations of a typical new entrant. Instead, the telco would be keen to maximise revenues quickly on the high fixed cost network it is running already nationwide

“A market leader (such as Bharti in India) would want this to happen as soon as possible as it would continue to get the best share (and hence returns) of the improved market even over the long term, while it would like to avoid near-term reduction in cash flows.

“However, a new entrant such as Jio would want to lock in as high a market share as possible (until its capital/cash burn appetite allows it to do so!): stopping at a low market share early would no doubt help industry revenues and profitability, but the company would structurally limit the long-term returns it can hope to generate for itself,” it said.

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