Airtel’s stock performance (2002-2017)

The stock of Bharti Airtel is at a two-year high, not far from its life-highs of late 2007, but going by the latest tariffs unveiled by Reliance Jio, investors will do well to hold off on the bubbly for a while longer.

Airtel closed at Rs 461.30 on Tuesday, buoyed by two factors — the positive sentiment of the Tata Group handing over their mobile business to Bharti for close to nothing, and news that Jio will again raise its rates today (Thursday.)

The last time Airtel’s stock was in the Rs 460 territory was in August 2015, just before Mukesh Ambani, chairman of Jio, dropped a bombshell by announcing his new firm will not charge for voice.

From 460, the stock fell all the way to Rs 300. The reason for the precipitous decline was not far to seek.

Voice did, and continues to, account for the vast majority of Bharti’s revenue and profit, and if Ambani was pricing voice at effectively 10-15 paise per minute against the incumbents’ 50 paise, there was a problem.

But 2017 has been a good year for Airtel stock. Factors such as the near destruction of smaller players like Reliance Communications, Telenor, Aircel and Tata Teleservices have turned investors bullish on the company.

With RCom’s proposed merger with Aircel turning out to be a dud, the entire telecom market was there for the taking of just three players, Jio, Airtel and a combined Vodafone-Idea. The Sunil Mittal firm has always been seen as more nimble and stealthy compared to Vodafone, and a combined Idea-Vodafone entity is not expected to pose much of a competitive risk to Bharti as far as strategy is concerned.

The second factor was pricing in the market. Mukesh Ambani seemed ready to follow through on his promise of regular increase in Jio’s consumer prices to more realistic levels, having effected a steep tariff increase of about 33% in July and planning another for today.

Last year, he had promised to price his mass-oriented 1GB/day plan at about Rs 320 per month — twice the average revenue that Airtel was able to get from its average customer.

If he succeeded, it was good news for Airtel as it too could look forward to a doubling of its ARPU by bundling data with voice, and if he failed, it was also good news for the company to see a rival floundering in his ambitions.

Investors suddenly saw the stock in a new light, like waking up from a bad dream. Analysts upped their expectations.

With two days remaining for Jio to announce its second tariff hike, Goldman Sachs predicted that Ambani will raise his prices by “24%”.

“We expect Jio to raise tariffs by 24% on its most popular plan (Rs 399) in the next few days, based on the pattern of its recent price hikes. We already expect Jio to take away promotions altogether by end of FY18 and any such move in the near term would be viewed positively by investors,” it said on Tuesday, the same day when the Airtel stock hit a 2-year-high.

REALITY

However, the reality of the price increase has  not been as rosy, and suggests that incumbents will need to continue to make more adjustments and cut more costs to survive.

First, the increase in prices has been only 15% or about Rs 20 per month.

Against Rs 135 per month, most Jio customers will now pay Rs 155 per month, and not Rs 168 as Goldman Sachs predicted.

The second problem is not with quantum of increase, but with the nature of it.

In all its previous price increases — in April and July — Jio was careful not to sell its new plans as ‘regular’ tariff, but as promotional offers — Summer Surprise, Dhan Dhana Dhan and so on.

It also declared up front that the discounted tariffs were available only for 84 days, and the price would triple after that. This was good news for the rivals as they could look forward to a turnaround after the 84 days.

This time, however, the new plans have been filed as regular tariff, and are valid for any number of recharges and not just for the first 84 days.

In other words, these are ‘permanent plans’ and not ‘offers’.

This is likely the result of feedback from customers about its last price hike carried out in July.

Jio has probably found that there is not much more scope for increasing prices without causing a sharp drop in uptake and usage.

For now, this seems to have given pause to the company’s scheme to raise its average billing rate to Rs 320 per month — if it indeed had such a plan in the first place and it was all not part of a strategy meant to lull competitors into a false sense of hope.

IMPACT ON INCUMBENTS

What this pause means for the incumbents is that the price upgrade cycle is over, at least for the short, and possibly for the medium, term.

Jio’s base rates have been defined —  it will offer 30 GB per month and unlimited calls for about Rs 155 per month including tax.

To compare this with incumbents’ current prices, we need to convert them to price per GB and minute.

The average consumption of voice on Jio’s network is about 626 minutes per month and an average person on a 1GB/day plan consumes about 7.8 GB of data per month.

Assuming that half of the Rs 155 per month charge is for voice and half for data, this works out to a realization of 12.5 paise per minute on the voice side and Rs 10 per GB on the data side.

These will be the short to medium term tariff that the others will have compete against. However, it doesn’t mean that they have to match it.

Incumbents offer technological compatibility with older handsets and technologies, and these customers cannot move to Jio without buying a new phone. So, they can still price their 2G voice or 3G data 50% higher and get away with it till their customers find it convenient to buy a 4G phone.

On a blended level, therefore, their voice pricing can be 30% higher than Jio’s and still be competitive, while on the data side, it can be 15%-20% higher and still give the new entrant tough competition.

Therefore, voice prices can be as high as 16.25 paise per minute, and data as high as Rs 11.50 to 12.00 per GB.

Going by recent trends, we can see that Airtel is presently charging about 20 paise per minute for voice and Rs 45 per GB for data.

This means that there would be a correction of about 20-25% in voice prices, and a correction of about 70-75% in data prices over the next six to nine months.

Voice contributes 71.5% of Airtel’s total revenue, while data contributes about 23%.

A fall of 20-25% in voice revenue and 70-75% in data revenue could shrink the company’s overall turnover by 38%.

However, such price declines has always been accompanied by a sharp increase in consumption as consumers responded to the lower tariffs. This has prevented drastic declines in revenue.

For example, over the last one year, Airtel’s voice charges fell by 34%, while average voice consumption increased by 22%.

Similarly, Airtel’s average data price fell to nearly one-fourth of what it was a year ago, while per-head consumption increased to almost three times of what it was.

As a result, overall net revenue from India fell only 12% despite the price corrections.

So, while the prices will continue to head south over the next six to nine months, chances are the company’s revenue will remain largely stable due to higher consumption and a growth in the number of consumers.

However, what will continue to erode is profitability.

The company has seen a 21% decline in its profit before depreciation (charges for wear and tear of equipment) over the last one year, and a 44% decline after depreciation to 2,523 cr per quarter.

Add to it the impact of interest costs, the company’s profit has fallen by 72% over the last one year to 923 cr from 3,261 cr a year ago.

Unless the operator is able to reduce its considerable interest costs, it could come very close to posting its first loss in over a decade in the next 6-9 months as it brings its prices in alignment with market conditions.

After this period of adjustment, its margins will improve as the impact of its ‘Project Leap’ brings down operating costs in line with that of Jio. At present, Airtel spends about thrice as much (Rs 3,935 cr per quarter) on keeping its network running as Jio (Rs 1,372 cr).

The pain, however, is likely to last for about two years for Idea and Vodafone as they are in a process of merging their operations, before margins start improving.

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