The union cabinet has approved the GoM's decision to allow intra-circle mergers between operators. This move has been welcomed by telecom service providers as it gives them more flexibility in their operations. Analysts believe the decision makes "commercial sense" and will help bring consolidation in the sector. We present their views ....

The GoM has in principle allowed intra-circle mergers between operators. How will such a move help telecom service providers?

Usha Rajeev
It will provide an impetus to mergers and acquisitions and help telecom service providers to consolidate their position in the market. However, the success of this move will depend on how the spectrum issue is mandated. If the grant of additional spectrum continues to be linked with subscriber growth, probably one would not see as much activity on this front as would be possible if automatic usage of the spectrum of the acquired company is also allowed.

Mohit Saraf
In June 2003, when the government decided to permit inter circle mergers, the cellular operators had demanded that intra-circle mergers also be allowed. The government had at that point of time itself given indications that it would consider the suggestion favorably. Subsequently, the GoM, after its very first meeting on September 25, 2003, decided to permit intra-circle mergers.

The need for intra-circle mergers arises from two factors. The first is that though there is a good potential for an increase in teledensity in the Indian telecom sector, it will take some time for this growth to actually take place and for a significant sub-scriber base to develop. Moreover, this growth in the market might not take place evenly across all circles. Thus, in places where the subscriber base has not achieved a critical mass, the market might not be able to support the entry of a large number of cellular operators. In such a situation, intra-circle mergers assume critical significance as they allow for consolidation and prevent the market from becoming fragmented. Intra-circle consolidations would thus help in the creation of appropriately sized and viable business entities.

A second factor, which acts as a driver for intra-circle consolidation, is the rapid technological advancement. Change in technology is given in the telecom business. In such an environment, business models that were initially feasible can rapidly become unviable. For instance, GSM technology now faces fierce competition from CDMA technology. Some observers predict that both CDMA and GSM may be upstaged by VoIP. The uncertainty in the policy and regulatory framework in India has further compounded the problem.

In this situation, it is not surprising to find that even industry giants can overnight find themselves grappling with the spectre of financial sickness. Intra-circle mergers give such potentially “Sick” companies an option to turn their businesses over to companies that are in a better position to administer them either due to economies of scale or larger cash reserves or technical advantages. Intra-circle mergers thus allow the smooth transition of business affected by technological obsolescence, thus improving the efficiency of the telecom sector as a whole.

TRAI, in its final recommendations to the government on the unified licensing regime on October 27, stated that it would evolve guidelines for mergers and acquisitions separately. The legal aspects of the process of intra-circle mergers and acquisitions will become clearer only after the TRAI pronouncements are received.

At this stage, the only comment that can be made is that care has to be exercised by the regulator to ensure that the process of consolidation does not result in a monopoly. The stipulation of the GoM that the number of players will not be allowed to fall below three is one step that would help in this regard.

Mahesh Uppal
I think this makes commercial sense. With the overcrowding in the mobile market that results from WLL(M) players providing services identical to GSM players, the earlier restriction on mergers and acquisitions within the circle would have made the much-needed consolidation difficult.

The government has permitted intra-circle licence acquisitions by cellular firms only if they are willing to surrender the spectrum allocated to the acquired company. How important and useful is this caveat?

Usha Rajeev
As mentioned above, the attractiveness of the acquired company would reduce with consequent impact on the valuations.

Mohit Saraf
Spectrum is a precious commodity and the government will have to be very careful in its allocation so as to discourage wasteful usage. Even earlier, the government had mentioned that it would incentives service providers who use spectrum efficiently while penalizing those who use it inefficiently. This was to be achieved through the use of variable licence fees. It is felt that such a policy coupled with auctioning of the fresh spectrum, which is to be released by defence ministry, would be sufficient to achieve the efficient allocation and usage of spectrum.

However, the proposal of the GoM in the case of intra-circle mergers that the acquirer will be able to take only as much of the spectrum as was being utilised by the acquired company might require some reconsideration. Such a policy might attract criticism on the following fronts.

First, the decision to pass on only that portion of the spectrum as is being utilized by the acquired company to the acquirer in effect means that the acquired company is being divested of the spectrum, which it has a right to by virtue of payment of separate charges. The only reason for this divestment is that it is merging with another company. Earlier the argument was that intra-circle mergers and acquisitions could lead to a monopoly if the spectrum was also merged. This argument, however, does not hold water in the present context when the defense ministry has agreed to release additional spectrum. The rationale of the policy is, therefore, not clear with respect to intra-circle mergers. The acquirer will also have to manage his spectrum allocation carefully in a regime that punishes inefficient spectrum usage. This rider could thus place companies positioning themselves for acquisition at a significant disadvantage and thus act as a dampener for intra-circle mergers.

Second, the government should note that companies that position themselves for acquisition are in some cases those whose financial position is already weak. Any move to divest them of a valuable asset such as their spectrum allocation will only drive them more surely towards bankruptcy.

Therefore, in order to be seen to be acting in a fair manner and for the healthy growth of the sector, the government must implement only a disincentive policy towards correcting the present regime of spectrum allocation. This will allow smoother transition to a regime where efficient allocation of spectrum is achieved through market-based mechanisms.

TRAI, in its final recommendations submitted to the GoM on unified licensing, mentioned that it would evolve specific principles to govern the merging of the spectrum during merger of intra-circle operators. It is hoped that the recommendations will ensure that spectrum transfer is allowed to take place on equitable principles and that the service providers are not unfairly deprived of their valuable asset.

Mahesh Uppal
We need to see it in context. All competing operators were given similar spectrum allocation when they started, and resale of spectrum is not currently allowed in India. In view of this, if a merger or acquisition resulted in the spectrum allocation of the two entities being compounded, this would give the new entity a competitive advantage over other existing players. Presumably, this fear is behind the caveat. It may be useful till spectrum is allowed to be traded freely in India.

What impact will this decision have on consolidation in the telecom sector?

Usha Rajeev
The consolidation would be slower than would have been possible if spectrum of the acquired company was allowed to be used.

Mohit Saraf
The decision to allow intra-circle mergers will definitely have a positive impact on the sector and will result in the market consolidating. This consolidation would allow telecom players to improve the quality of service provided to consumers. The decision of the GoM to allow unified licensing will, however, have significant implications for intra-circle mergers in two respects.

One is that the minimum number of service providers in each circle, now pegged at three, needs to be relooked at in light of the proposal permitting WLL operators to offer roaming service. Till now the policy pronouncements have referred to there being a minimum of three cellular players. However, this minimum requirement may have to be expanded include any kind of service providers, be they cellular or WLL. Otherwise it would lead to excessive fragmentation of the market and would deprive customers of the benefits of intra-circle consolidation.

A second aspect of the unified licensing regime is that it implies greater competition from WLL players. This means that the ARPU in the telecom sector as a whole would go down. At the same time, to retain their subscriber base, the existing companies would have to increase their capital expenditure. Thus, the unified licensing regime in tandem with the decision to allow intra-circle mergers is abound to amplify the rate of consolidation in the telecom sector.

However, since the unified licensing dispute might go to the Supreme Court, some of the players may await a final decision on the matter from the apex court before launching their moves. The consolidation process may thus be delayed in the short run.

Mahesh Uppal
It will go some way towards helping consolidation. This is obviously more of an issue in the metros and the more lucrative Category A circles where the market size is relatively large.

What additional reforms are required on the regulatory and policy fronts in order to increase the flow of investment for funding the capital expenditure of operators?

Usha Rajeev
The key requirement to increase the flow of investment for funding into the sector is to provide confidence to the investors that contracts made with the government would not be revised in the future to the detriment of the investor.

The recent moves on the regulatory and policy front have raised concern amongst investors on the long-term view/vision of the policy-makers on this sector.

The availability of other attractive opportunities for investment within the Asia-Pacific region coupled with the very significant uncertainties governing the Indian telecom sector has held back investment interest in Indian telecom, particularly in the last six months.

We believe that the key requirement now is to build confidence among all stakeholders that the changes are not biased towards/against any specific sector/entity and that a level playing field will be ensured. For this, the reforms process undertaken will need to be transparent, ensure adequate due diligence of the impact of planned changes, involve all stakeholders, and provide a roadmap for the future with the degree of certainty required to encourage investment in the telecom sector in India.

Mohit Saraf
A major reform, which could have directly helped the service providers in relation to funding their capital expenditure, was the proposal to raise the foreign investment cap from 49 per cent to 74 per cent. According to the latest newspaper reports, the cabinet has apparently left it to the finance ministry to decide on the issue relating to raising the foreign investment ceiling. A positive decision on this front by the finance ministry may help in increasing the flow of investment for funding capital expenditure of the operators.

Mahesh Uppal
Removal of inconsistencies in the licensing regime is critical. The scope and terms of the licences of BSNL and its private sector competitors are vastly different. BSNL is not confined to circles, and is allowed to provide all service including fixed, mobile and long distance under the same licence throughout India. Its competitors need separate licenses. TRAI’s interconnect regime still does not treat market power effectively, since it hardly distinguishes between new players and the incumbent. TRAI has a long way to go on effective economic regulation. A more nuanced and robust treatment of competition issues will not only benefit consumers, it is also necessary because India needs greater investments, especially those of higher quality, whether Indian or foreign.