Thou Shall Pay 10x for Spectrum

Everything was going well for Indian telecom, but then came 2012. First, the Supreme Court judgement on cancellation of 122 2G licenses slapped the smiles off the operators' faces. And then came Trai's 'Recommendations on Auction of Spectrum'. It will not just further decelerate the industry, but all the hard work done by the policy makers, regulators, and operators in the last 18 years will also go for a toss!

The telecom industry is still seeking answers, but hardly any are coming forth. There is a big silence on the whole spectrum auction salvo launched by Trai. It is time for the policy makers and the government machinery to wake up and take corrective measures, and quickly, before it snowballs into a major disaster for the government. Correct measures taken now will go a long way in helping the industry recover and move forward, and regain its lost glory. It will also help build back the government's image, reeling under a “policy paralysis”, with the world watching us so closely.

Now let us rewind and see how things have unfolded in last couple of months. On February 2, 2012, the Supreme Court's two-judge bench of Justice GS Singhvi and Justice Asok Kumar Ganguly in its 2G judgement with respect to writ petitions filed by Center for Public Interest Litigation and others vs Union of India and others and Dr Subramanian Swamy vs Union of India and others directed the following terms:

“(i) The licenses granted to the private respondents on or after 10.1.2008 pursuant to two press releases issued on 10.1.2008 and subsequent allocation of spectrum to the licensees are declared illegal and are quashed;

(ii) The above direction shall become operative after four months;

(iii) Keeping in view the decision taken by the central government in 2011, Trai shall make fresh recommendations for grant of license and allocation of spectrum in 2G band in 22 service areas by auction, as was done for allocation of spectrum in 3G band;

(iv) The central government shall consider the recommendations of Trai and take appropriate decision within the next one month and fresh licenses be granted by auction”.

On the basis of the Supreme Court's verdict, Trai came out with a pre-consultation paper followed by a consultation paper on the auction of spectrum. It also conducted an open house, and finally came out with its recommendation with respect to the auction of spectrum on April 23, 2012, which was earth shattering for the industry!

The Supreme Court's 2G judgement mandate as per para 81 (iii) of February 2, 2012 talks about “Keeping in view the decision taken by the central government in 2011, Trai shall make fresh recommendations for grant of license and allocation of spectrum in 2G band in 22 service areas by auction, as was done for allocation of spectrum in 3G band.”

The basic question is that when the Supreme Court asked Trai to make fresh recommendations for grant of license and allocation of spectrum in 2G band, why did they not follow the directives of the Supreme Court and come out with the allocation of spectrum in 2G band? Just following these directives would have helped the regulator and also the government.

Commenting on the recommendations, CS Rao, president, RCom says, “Trai should have stuck to the recommendations of 2G reserve price fixation only, which is the effective mandate to Trai from the Supreme Court.”

The Auction

Under a microscope, it would look as if Trai is focusing on 4G and not on 2G spectrum auction at all. Maybe it feels that the era of voice services is over and that of data services has begun. Though that's not the case in India. And that's the reason the reserve price for all bands of spectrum has hit the peak. As per Trai's own quarterly report: “The Indian Telecom Services Peformance Indicator”, released on April 13, 2012, the total telecom subscriber base stands at 926.53 mn. Of this urban contributes 611.19 mn and rural 315.33 mn subscribers.

In terms of teledensity, urban stands at 167.85 whereas rural stands at 37.48. So there is still a lot of scope for rural tele-density for voice, as they have a lot of catching up to do vis-a-vis urban teledensity. And there is a lot of scope for voice still left in India unlike in developed economies where the focus now is on 'broadbanding' the economy.

Even the rollout obligation laid down by Trai in its latest recommendation: “Rural Rollout Obligations Applicable to all Spectrum Holders” (Table: Rural Rollout Obligations Applicable to all Spectrum Holders) talks about connecting all villages with population of more than 2,000 within 4 years from the effective date (April 1, 2012). So it seems that Trai is contradicting its own statement! The rollout obligations should have focused on broadband connectivity or data services and not on connecting voice subscribers if they were focusing on 4G services.

This is further ratified by Wireless Intelligence in its recent report on “The Global Cellular Industry Balance Sheet” which says, “Voice revenues still account for 75% of recurring revenues on average in developing countries and 70% in developed countries whereas data-only revenues (which exclude revenues from messaging services) represented 16% of total revenues on an average in the developed region in 2010, compared to 11% in the developing region. In 2012, over one-third of total revenues globally will come from non-voice services and data-only services will represent close to 20% of total revenues.”

On the one hand, Trai is talking about connecting the rural population in the new recommendations but on the other, it is keeping the reserve price for different bands of spectrum extremely high. Telecom pundits cannot comprehend this, considering the fact that the rural population is not as prosperous as urban and it is difficult to provide services in rural areas due to lack of infrastructure. So, shouldn't connecting rural be more premium than 3G or BWA?

If one goes by the recommendation, Trai has proposed a pan-India reserve pricing per MHz for 1,800 MHz at `3,622.18 crore, for 800/900 MHz at `7,244.36 crore, for 700 MHz at `14,488.72 crore, for 2,100 MHz at 3,773.24 crore, and 2,300 MHz at `723.52 crore. In 2008, the operators had got pan-India 2G license for `1,658 crore to get 4.4 MHz. Similarly in 2010, the operators got a pan-India 3G license at `16,828 crore to get 5 MHz and pan-India BWA license at `12,848 crore to get 20 MHz.

Goldman Sachs

Trai recommendations on spectrum auctions to be negative for incumbents/new entrants
Reserve price for 1,800 MHz/900 MHz 2G spectrum to be 1.08x/2.0x the winning 3G price
Entire spectrum of 800/900 MHz to be refarmed at the time of license renewal
5MHz of 1800 MHz to be auctioned in 2012-13 in blocks of 1.25 MHz each

HSBC

Trai suggestions on pricing does not take into account the significant leverage of the Indian telcos overall return on investment and the amount of tariff hike which may happen as a consequence of these recommendations
Spectrum re-farming policy is in conflict with the regulators' objective to increase rural penetration

Bank of America Merrill Lynch

Trai recommendations appear to be a major negative surprise for the industry
Reserve price benchmarks for future auctions are higher than winning bids during recent 3G auctions
900 MHz spectrum held by incumbents may be completely refarmed or replaced at new prices

UBS

TRAI recommendations are flawed
Solely trying to maximize revenues for the government
Restricting the amount of spectrum (1 block of 2x5 MHz) to be auctioned thereby reducing supply and making business case for new operators unviable
Using 3G auction prices to determine 2G prices when there are huge differences between voice carrying capacities between the two technologies

In the present scenario, the operators will have to pay `18,111 crore for a pan-India license in 1,800 MHz to get 5 MHz. So the operators are paying a price premium of 10 times vis-a-vis the 2008 price point. The operators are also paying a premium of 7.6% more vis-a-vis the 3G license auction in 2010 and 41% more compared to the BWA license auction held in 2010!

Initially, the operators need to pay 33% of bid amount in case of 1,800 MHz, 2,100 MHz and 2,300 MHz whereas the operators will have to pay 25% of bid amount in case of 800/900 MHz and 700 MHz. There would be a 2-year moratorium and the balance amount will be paid in 10 equal installments annually. The regulator has also reduced the spectrum usage charge to 1% of Adjusted Gross Revenue (AGR) from 3-8% of AGR which operators are currently paying, depending upon the spectrum that they are utilizing. Even deferred payment and reduced AGR is not going to help the industry as the reserve price is extremely high.

Operator's Point of View

Commenting on the spectrum auction, the Cellular Operators Association of India (COAI) and the Association of Unified Telecom Service Providers of India (AUSPI) have vehemently expressed their disapproval of these recommendations and termed them as being “arbitrary, regressive and inconsistent”. The industry was looking forward to a reasonable spectrum reserve price recommendations from Trai in the light of the government's own articulated policy directions on affordability and rural penetration.

“Under such an inconsistent, regressive and uncertain regulatory environment, how will the telecom industry, which is already in a state of doldrums, deliver on the government's vision of affordable communications, rural penetration, and rollout of data services,” say COAI and AUSPI in a joint statement.
On the same Lars Henrik Stork, CEO, ZOOSH (Augere Wireless Broadband India) says, “Trai reserve price would have a severe negative impact for the sector. It will not stimulate foreign investment and adversely affect consumers in terms of higher tariffs. Also, surprisingly, it is inconsistent with the objectives of the new telecom policy-for eg, to bid for 700 MHz for 4G services it would cost about $86 bn as per the recommended reserve price! This would certainly not promote planned growth in broadband subscriptions to meet the government's objective.”Given the current volatility in the sector, it makes it impossible for operators to compete and generate an acceptable margin, adds Lars.

Jagannadham Thunuguntla, strategist and head of research, SMC Global Securities has this to say: “Trai recommendations focus on collecting as high revenues as possible out of this spectrum sale. The government is attempting to get as much windfall as possible from this to handle the fiscal deficit. It seems that Trai is of the opinion that whether commercially viable or not, it needs to be analyzed by the telecom companies. But it can be reasonably assumed that the best days of Indian telecom companies are behind us. The windfall gains that the industry produced during the 1999-2009 period is almost history. And with such a high reserve price, the pressure on RoI is appearing to be a matter of certainty.”

“We believe that several of these recommendations are retrograde and if accepted, will do irreparable harm to the industry,” Vodafone India said in a official statement.

What is your initial comment with respect to the Trai recommendations on spectrum?

The Trai recommendations could appear to be progressive in outlook with distant future supporting liberalization of spectrum usage, however, recommendations ignore completely the ground realities for near term needs till 2017. A stable and sustainable 2G industry with growth is considered essential for any futuristic 4G driven subscriber services dominated by wireless data applications. TRAI recommendations do not seem to address this critical issue. These recommendations of very high reserve price with low SUC is taking the industry back to pre 1999 era. TRAI should have stuck to the recommendations of 2G reserve price fixation only, which is the effective mandate to Trai from the Supreme Court.

With this recommendation what would be the total cost of spectrum with respect to annual revenue? What was it before the recommendation?

This depends on the applicability on the cost of spectrum for established operators or recent entrants or a fresh entrant to come into the domain. The cost of spectrum for past operations of an established telco cannot be given due to the fact that the 2G spectrum was given on an administered basis.

However, the spectrum cost impact for established operators henceforth could be in the range of 5-10% on per annum basis wrt revenue in the first 5 years, and could go down to 4-7% over the next 5 years.

It seems that Trai is contradicting its own statement. On the one hand Trai is talking about connecting the rural population, but on the other it is keeping the reserve price for different bands of spectrum extremely high...

We are afraid that Trai recommendations may affect rural growth where a different socio-economic class of India is expecting the service to be available at more affordable prices at higher tele-density levels in the next 5 years. Artificial scarcity created in the availability of only one slot of 5 MHz in the 1,800 MHz band is likely to affect the telcos significantly in their ability to have access to spectrum to sustain the techno-economic model based business plans and also to address the low ARPU base of India's hinterland.

If these recommendations get through, is there RoI for operators at such high reserve price? If yes/no, why?

At the recommended high prices for 1,800 MHz and twice the recommended price for 800 MHz, operators would not find any business case with any RoI for many years in most of the circles as the effective remaining market access available during 2014-2025 time period is hardly about 150 mn subscribers on pan India basis to be shared by at least 8 operators. The current ARPU levels are not expected to increase significantly to change the business plan for a better return on investment. It is very much improper to consider and estimate the ARPU levels to increase at the rate of 10 percent increase year over year with about 35 percent of the existing subscriber base likely to contribute data revenues during this period and data ARPUs to be at 3 times the voice ARPU.

It seems the recommendations are based on European models-Sweden, Denmark, Ireland and the UK. Is this the right model or should the regulator have taken the view of larger markets like China and the US?

The recommendations seem to be influenced by the European models where, compared to India, the scalability of services is considered low and the portion of the consumer wallet for telecom spend is considered high. Indian societal demographics and vast area is unique with its much lower digital literacy rates and much lower affordability of services and devices.

CS Rao, president, RCom says, “We are afraid that Trai recommendations may affect rural growth where a different socio-economic class of India is expecting the service to be available at more affordable prices at higher tele-density levels in the next 5 years.” For Ashish Basil, partner, transaction advisory services, Ernst & Young, “The Trai policy objective seems to be for maximizing revenues for the government and will not be helpful for building a cost efficient telecom services for the masses, which once India was known for in the global telecom market. It will hamper the ability to connect the unconnected and goes against the objectives of National Telecom Policy of ensuring improved rural tele-density and right to broadband.”

Commenting on Trai's recommendations Uninor says, “While we study them in detail, it seems obvious that some of these recommendations will create severe negative impact on the entire industry. It is up to the political leadership of India to now ensure that the gains of the past few years of affordable phone calls for India's people are not undone.”

Even fund managers like Goldman Sachs, HSBC, Bank of America Merrill Lynch and UBS are not optimistic about the Indian market in terms of Trai's recommendations on spectrum.

Ernst & Young estimates the total telecom revenues in the region of $40-50 bn for the year, growing less than 10% in the last few years despite achieving some satisfying mobile penetrations. Speaking about revenue increase Ashish Basil says, “Currently, the value of the spectrum held by operators, based on the new recommendations, will be much higher than the total telecom revenues (not factoring the proposed auction of additional spectrum). It is difficult to envisage that telecom revenues will go up substantially to justify such valuations of the spectrum. Given high penetrations and high MoU (minutes of usage), one major way revenue can increase is through higher tariff which then has an opposite effect on the MoUs and penetration.”

Speaking on RoI, CS Rao says, “At the recommended high prices for 1,800 MHz and twice the recommended price for 800 MHz, operators would not find any business case with any RoI for many years in most of the circles as the effective remaining market access available during 2014-25 time period is hardly about 150 mn subscribers on pan-India basis to be shared by at least 8 operators. The current ARPU levels are not expected to increase significantly to change the business plan for a better return on investment.”

And all this will have a multiplier effect on mobile tariffs in the country which is against the objectives of NTP.

So it seems that the Trai recommendation are not going to benefit any operator except the BWA and 3G operators. For all others it looks like an uphill task-be it canceled license operators like MTS and Uninor; old operators like Bharti, Vodafone, Idea, and Aircel; government operators like BSNL and MTNL; or dual technology operators like RCom and Tata DoCoMo.

It is also quite surprising that none of the representation made by these operators either in open house or written replies talked about such high reserve price numbers. So, the ball is in Trai's court. It has to justify the relevance for such a high price and the motive for such astronomical numbers.

Against NTP Objectives

The recommendation is also against NTP '94, NTP '99 and NTP '2012 vision. As per NTP '94 objectives the focus was on-availability of telephone on demand, provision of world class services at reasonable prices, ensuring India's emergence as major manufacturing/export base of telecom equipment and universal availability of basic telecom services to all villages. Even the NTP '99 objective says, “Availability of affordable and effective communications, provide balance between universal services in rural areas and provision of high level services, encourage development of telecommunications facilities in remote, hilly and tribal areas...”

The draft NTP 2011 preamble also says, “Telecommunication has emerged as a key driver of economic and social development in an increasingly knowledge intensive global scenario, in which India needs to play a leadership role. National Telecom Policy-2011 is designed to ensure that India plays this role effectively and transforms the socio-economic scenario through accelerated equitable and inclusive economic growth by laying special emphasis on providing affordable and quality telecommunication services in rural and remote areas.”

So, if one goes by NTP'94, MTP '99 and draft NTP '2011 the objective remains the same-that of providing affordable and quality telecom services in rural and remote areas. So, if this is the objective, then what is the basis of keeping a high reserve price for all spectrum bands? And we believe that the Ministry of Communications and Group of Ministers (GoM) should think a lot before accepting the final recommendations of Trai.

Two questions come out of this recommendation. First, if the recommendations are so diagonally opposite, why were they finalized? Second, if these are accepted by the government, the auction process would be floated and if the response is lukewarm, then will the government go back to the drawing board and change the reserve price thereby wasting time in the whole process? The industry believes that the government should proactively do all these things rather than keep the industry on a standby mode.

Spectrum Refarming

Trai also reiterates the view that the entire spectrum in 800/900 MHz should be refarmed. This will be applicable to all the service providers in all the service areas and should be carried out progressively but not later than the due date of renewal of license. So, the spectrum available with the service providers in 900 MHz should be replaced by spectrum in the 1800 MHz. Similarly, the license holders of 800 MHz spectrum should be assigned in the 1,900 MHz band. There are bigger issues with respect to the price to be paid by operators to move to a new frequency band.

Jaideep Ghosh, Partner, KPMG says, “Liberalization and refarming of spectrum and its auctioning to both incumbent and new operators would lead to a level playing field between service providers. However, TRAI recommendations on the hike in reserve prices appears significantly on the higher side and is likely to be a strain on the resources of the bidders, especially with a highly competitive market landscape. Higher reserve price and resultant auction price is likely to lead to an increase in tariffs by service providers.” An NSN spokesperson says, “Operators refarming GSM frequency to support 3G and 4G rollouts can free up to 30% of their spectrum, reduce total cost of ownership by 20% and potentially double their average 3G and 4G data speeds.”

Industry experts say that technology neutrality is easy to speak of but difficult to practice as one has to make a significant investment in the guard band. For eg, coexistence of both 2G (1,710-1,785 for uplink and 805-1,880 for downlink) and 3G (1,920-1,980 for uplink and 2,110-2,170 for downlink) will create interference and compatibility issues. Being a non standard, one has to customize products for the Indian market.

So, one has to see whether the government accepts the Trai recommendations in toto or make some amends in the spectrum auction policy so that the business model looks 'somewhat' attractive for all operators. If the complete recommendation is accepted by the government, then the operators will have to revisit their business plan and use spectrum more judiciously and efficiently than what they have done in the past-which would not easy. It seems the battle for spectrum has just started and one will see lot of bloodshed as we move forward.