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(Revenue-) Sharing The Spoils

A necessary bail-out? Or an undeserved bonanza? Once again, the telecom sector is abuzz with controversy. As the questions over the package for telecom operators multiply, BT examines whether the troubled industry has been policy-wired for growth. Finally.

By Rukmini Parthasarathy & Swati Kamal

''Be careful what you ask for. Because you just might get it.''

Retail RevelationsOn the night of July 6, 1999, India's private telecommunications operators finally got what they had been calling for. Along with a fat bill. That was the night the Union Cabinet inked a deal that could mark the end of the fixed licence-fee system in the country. Although the final passage was fairly smooth, the build-up had been stormy. The National Telecom Policy unveiled by the A.B. Vajpayee Administration in March, 1999, had promised to make revenue-sharing the basis for awarding the next round of telecom licences. But it had not specified how the existing operators, saddled with huge licence-fee obligations, could migrate to the new revenue-sharing regime, leaving room for controversy.

And what a controversy it was too. First, the Attorney-General, Soli Sorabjee, expressed his reservations about devising a migration mechanism that was legally tenable. Then, the Union Minister for Communications, Jagmohan, vehemently opposed any deal that did not involve the surrender of licences by the operators. But the Prime Minister's Office was intent on resolving the mess in the sector. So, in quick succession, the minister was transferred, the Attorney-General changed his opinion, and a policy was drafted. Declares Arun Seth, 47, Managing Director, BT (British Telecom) Worldwide India: ''The government has clearly demonstrated its will to revive the telecom sector.''

THE DEAL: A Question Of Survival

Essentially, the existing operators have the option of migrating to a revenue-sharing system. If they exercise it, these operators will pay the Government of India (GOI) a share of their revenues as a licence-fee instead of a fixed amount. Since the GOI has agreed to forego future duopoly rents (fixed licence-fees amounted to the sale of monopoly rights by the Department of Telecommunications (DOT) to private operators), the operators will have to give up their duopolies.

A. Seth, MD, BT Worldwide India

"The GOI has demonstrated its will to review the telecom sector."
A. Seth
MD, BT Worldwide India

Like other prospective entrants, the operators will have to pay a one-time entry-fee. Except, unlike the new entrants, the licence-fees due upto July 31, 1999, will be treated as the entry-fee, ensuring that the operators do not wriggle out of paying their licence-fee arrears. Most operators have already paid upto 20 per cent of their outstanding dues. While another 15 per cent must be cleared by August 15, 1999, bank guarantees for the remaining amount must also be furnished. So, over the next 6 months, the industry has to generate Rs 2,239.65 crore-arrears plus penal interest-to stay alive. With banks and financial institutions fighting shy of extending funds, there are bound to be casualties.

Warns Umang Das, 50, Director, Spice Telecom, which has the cellular licences for Punjab and Karnataka: ''Some companies will not be able to mobilise the required funds simply because the banks will refuse to extend the guarantees.'' If the payment of arrears is the stick, there are also plenty of carrots. For both cellular operators in the state-circles and basic services operators, the effective date of the licence has been extended by 6 months. That amounts to a licence-fee waiver of Rs 1,443.60 crore. More importantly, under the revenue-sharing arrangement, the licence-period will stretch to 20 years-up from 10 years for cellular and 15 years for basic services. ''The extension makes projects bankable,'' says Nanda Menon, 31, Director, Jardine Fleming: ''Earlier, the financier had no claim over the profits generated after the tenth year.''

For a cash-strapped industry, the lure of longer licence-periods (and hence, the prospect of financial closure) is so powerful that even operators who would benefit from staying in the fixed licence-fee regime will opt for revenue-sharing. For instance, in 3 of the 4 state-circles in which it holds a cellular licence, Koshika Telecom has opted to fork out the entire licence-fee over a 4-year period ending December, 1999. So, next year onwards, the company does not share any of its revenues with the exchequer. But, right now, Koshika has to cough Rs 332.60 crore of outstanding dues to the DOT. Shrugs Vinay Rai, 49, Managing Director, Koshika Telecom: ''In 20 years, we may end up paying more than what we would have paid in 10 years, but we required the deferment. So, we will migrate.'' Adds a telecom expert: ''Making the migration optional minimises the legal problems. But the deal has been made so sweet for cellular companies that it is unlikely that anyone would choose not to migrate.''

That does not mean that the transition will be smooth. For instance, the cut-off date for the change-over is August 1, 1999. But the Telecom Regulatory Authority of India (TRAI), which has been asked to recommend the revenue-sharing formula, is unlikely to come up with the magic number in less than a month. Confirms S.S. Sodhi, 65, Chairman, TRAI: 'We will not be ready with our recommendations until November, 1999.''

In the interim, operators will have to pay the DOT a yet-to-be specified per cent of their gross revenues. The uncertainty will not necessarily end in November. The TRAI proposals are, after all, merely that-proposals. Nothing prevents the DOT from modifying its recommendations. Counters Anil Kumar, 57, Secretary, DOT: ''The revenue-share percentage will be reasonable. The GOI is not out to create problems for corporates.''

Irrespective of where the actual revenue-share percentage settles, the switch away from fixed licence-fees to revenue-sharing alters the basic economics of the telephony business. First, revenue-sharing transfers some of the business risk to the licensor. When the times are bad, pay-outs to the exchequer are minimised, lowering the load on the business. Second, as the licence-fee payment is now a variable cost, instead of a fixed cost, the break-even point is lower. Koshika, for instance, reckons that it will now break even at 2-2.20 lakh subscribers as compared to 3.50 lakh subscribers under the fixed licence-fee regime. Clearly, migration alters the life-cycle of the licence. BT examines the impact of this on both the cellular and the basic services businesses.

CELLULAR SERVICES: A Question Of Competition

As of now, the country's 22 cellular companies have racked up losses of Rs 7,700 crore. It is normal for a capital-intensive, long-gestation industry to lose money in the first few years of operation, but, thanks to the huge licence-fee commitments, the losses have been abnormally high. For cellular operators in the metros-who have to pay a fixed amount of Rs 6,023 per subscriber-licence-fees consume 30 to 50 per cent of their total revenues.

Manoj Kohli, CEO, Escotel Mobile

"DOT will enter the metros first--the most lucrative circles."
Manoj Kohli
CEO, Escotel Mobile

The situation is even worse in the state-circles, where the license-fee obligations exceed the gross revenues. In fact, a study of the cellular industry conducted by the Bureau of Industrial Costs & Prices (BICP) found that while metro operators were losing money because of low air-time usage by subscribers, operators in the 18 state-circles were bleeding because of heavy licence-fee outflows. Funds from the financial institutions were being used not to fund capital investment, but to pay off the DOT.

Given this dismal performance, any form of revenue-sharing-even if it is pegged at 15 per cent-will offer considerable gains to the operators. But it is not going to translate into immediate profits. Scoffs Richard French, 51, CEO, Tata Communications, the cellular licencee in Andhra Pradesh: ''Worrying about revenue-sharing creating windfall gains is like worrying about artificial respiration making a drowning victim too healthy.''

What could keep the industry afloat in the medium- to long-term is the continuation of the present trends in costs and prices. Improvements in technology, and an expansion in the subscriber-base are pushing down investment costs. From an initial cost of around Rs 80,000 per subscriber in 1995, capital costs in the metros have dropped to Rs 20,000 per subscriber. State circles display a similar trend, but since operators there have to distribute the costs of a larger network over a smaller subscriber-base, the average capital costs exceed those in the metros by Rs 30,000 per subscriber.

If licence and capital costs are falling, so will tariffs. Points out D.K. Sanghal, 69, former Secretary and Director-General, DOT: ''The cellular tariffs notified by the TRAI in its order are cost-based tariffs. If licence-fee costs come down, tariffs will also drop.'' At present, 50 per cent of the licence cost is embedded in the rental; the rest is loaded onto the air-time charges. With the change in the licence regime, air-time charges will come down, resulting in lower revenues per subscriber.

Total revenues will go up, however, for 2 reasons. First, the demand for cellular services tends to be what economists call elastic. A commodity is price-elastic if a fall in price triggers off a more than proportional rise in the demand, resulting in an increase in the total amount spent. Companies are already offering packages with air-time rates lower than those specified by the TRAI. Says Barry Cooney, 57, CEO, Modi Telstra, the cellular licencee in Calcutta: ''With revenue-sharing, we will have greater flexibility to structure tariffs on the basis of demographic and social strata.'' Second, by the end of the year, a Calling Party Pays (CPP) regime will be implemented. Subscribers will now pay only to make-not receive-calls. Air-time usage has been low because most subscribers simply switch off their mobiles to avoid paying for incoming calls.

What do all these changes imply for the operators? Well, the metro licencees will, probably, generate cash profits this year. All the A-grade state-circles along with a few of the B-grade circles (Punjab, Western Uttar Pradesh, and Kerala) should make money in the next 2-3 years. For the rest, it will be a long, hard haul to break even.

It is debatable whether this market size offers room for a third operator, much less a fourth. Sure, the entry-fees will be lower, technology has dramatically reduced capital costs, and spectrum is available, but all these advantages cannot counter the disadvantage of a small market that already has 2 established incumbents.

''Believing that more players will be willing to enter a market where both operators are either making losses or just breaking even displays a touching faith in a lemmings theory of competition,'' says a telecom expert. Echoes Jardine Fleming's Nanda Menon: ''International experience shows that you are asking for trouble if you are No. 3. You are bound to get killed if you are No. 4.''

These equations change if No. 3 happens to be the Mahanagar Telephone Nigam Ltd (MTNL) or the DOT. Predicts Manoj Kohli, 40, CEO, Escotel Mobile Communications, the cellular licencee in Haryana, Kerala, and Western Uttar Pradesh: ''The entry of DOT could be sooner in metro circles.'' For the first time, cellular operators will have to contend with a player who is also a policy-maker. The dual status confers the new entrant with competitive-or rather, anti-competitive-advantages. Entry-fees will be reimbursed; there will be no inter-connection charges since the DOT/MTNL already operates a fixed-line network; and low wireless prices can be cross-subsidised by profits in wireline telephony.

Therefore, if multipoly is to be encouraged, the policy agenda is clear. The policy-making arm of the DOT must be hived off from its service provision function. Since the NTP 99 promises to corporatise the DOT only in 2001, the independent regulator must be immediately strengthened to prevent anti-competitive behaviour by public sector behemoths. ''Otherwise,'' warns Tata Communications' Richard French, ''the MTNL/ DOT will re-nationalise the cellular market in a year or two.''

BASIC SERVICES: A Question Of Viability

Of the 21 circles offered for basic service provision, licence deals were finalised for only 6 circles after 3 protracted rounds of bidding. Of these, 3 have commenced operations: Bharti Telenet in Madhya Pradesh, Hughes Ispat in Maharashtra, and Tata Teleservices in Andhra Pradesh. With the exception of Bharti Telenet and Shyam Telelink, the licence-fee obligations of the basic operators are massive. As a result, though the payment schedule was back-ended, collectively, the basic operators have to pay the goi Rs 900 crore every year for the next 4 years.

Clearly, revenue-sharing will provide immediate relief. There may even be renewed interest in the 15 vacant circles. Predicts Akhil Gupta, 43, Group Director, Bharti Telecom: ''As the entry conditions have changed, there will be more bids for these circles.'' At 2.4 telephones for every 100 people, Indian teledensity rates are amongst the lowest in the world, implying a huge potential market. But don't expect prospective telecorps to queue up; basic telephony is, inherently, a riskier bet than cellular services.

For starters, entrants will have to take on an entrenched public sector monopoly. There is also the skewed pricing-structure. Because of the subsidy on local calls, prices do not cover costs. And for the basic operators, the costs are substantial. A backbone network has to be created, involving massive capital investments. Over the next 3 years, the 6 private sector operators plan to invest Rs 13,180 crore. Even that may not be enough to match the economies of scale reaped by the DOT's network. Argues a telecom analyst: ''All over the world, fixed-line telephony is a numbers game. For it to be viable in India, we need 3 or 4 large regional carriers, not a multiplicity of operators confined to small circles.''

The rapid convergence in communications technology makes nonsense of the rigid policy regimentation of markets and businesses. ''Since Net service-providers and cable operators can now provide last-mile access, the duopoly has already been broken,'' argues Rajiv Mehrotra, 45, Managing Director, Shyam Telelink. There will be more encroachment. Since wireless costs are falling faster than that of fixed-line networks, in the near future, there will be parity between the price of cellular and basic services. Indeed, in developing countries, fixed-line providers are losing out to cellular operators.

Says Ashwini Windlass, 52, Managing Director, Reliance Telecom, which has 7 cellular licences and 1 basic licence: ''Conventional telecom is dead. Globally, people are switching to wireless telephony.'' Recognising the writing on the wall, the MTNL is already aggressively promoting Wireless In Local Loop (WILL) technologies. Private operators must also be allowed the flexibility to span businesses, and offer the customer an integrated solution. Points out Virat Bhatia, 31, Managing Director (Public Affairs), AT&T: ''No licence can be technology-proof.''

Therefore, the value of the licence will diminish. The shift from fixed fees to revenue-sharing does away with duopolies within the basic and cellular businesses; technology is already tearing down the walls between those businesses. Since operators from the entire spectrum of the telecom business will be free to enter, the value of a licencee's business will derive less from the right to use a public resource (the nation's airwaves), and more from the brand the service-provider creates.

Sure, economic theory may tell us that telecom is special because it is a public good, but, in the future, the business of communications is going to be no different than any other service business. In that sense, the convergence is complete.

Additional Reporting by Rajeev Dubey, Rakhi Mazumdar, Ranju Sarkar & R. Sriram


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