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Reliance Jio sparks Indian M&A, but may not emerge the victor

Vodafone India confirms talks to merge with Idea to create new market leader, but Jio has to invest to move on from price wars to high value services

Reliance Jio, India’s newest mobile operator, has not had quite the disruptive impact of Free Mobile in France, with which it is often compared. Not yet anyway. But it has initiated a price war in a country whose operators make razor-thin margins as it is, and now the domino effect is setting in, as it did in France, sparking a wave of mergers and acquisitions in anticipation of further competitive pressures from Jio.

Vodafone India confirmed this week that it is in talks regarding a mega-merger with Idea Cellular, following days of media rumors. Meanwhile, Telenor is said to be in talks with both Reliance Communications (RCOM) and Bharti Airtel about the future of its Indian subsidiary. RCOM has already acquired SSTL and is in the process of merging with Aircel, while Tata Teleservices is also said to be looking for a buyer. There have also been many smaller acquisitions, like Airtel’s of Videocon and Augere.

If the Vodafone deal progresses, it would merge India’s second and third largest MNOs to create a new market leader, overtaking Bharti Airtel, and would be one of the largest transactions India has seen. The merged company would serve 42% of the market by subscribers (387m mobile users), dwarfing Airtel’s 33% (262m). The two companies are complementary too – Vodafone is strong in the enterprise and higher value subscribers while Idea is a leader among rural markets, which have strong growth potential.

However, the combined entity would almost certainly have to divest assets, including spectrum. Indian competition rules say that no telco can have more than a 50% share of subscribers and revenue in any one operating circle. They are also limited to 25% of available spectrum nationwide, and 50% in any one circle.

“Vodafone confirms that it is in discussions with the Aditya Birla Group about an all-share merger of Vodafone India (excluding Vodafone’s 42% stake in Indus Towers) and Idea,” said Vodafone in a statement on Monday. “Any merger would be effected through the issue of new shares in Idea to Vodafone and would result in Vodafone deconsolidating Vodafone India. There is no certainty that any transaction will be agreed, nor as to the terms or timing of any transaction.”

The immediate trigger for such a deal is clearly the growing need for scale in a market which has always been over-competitive. The operators which gained 3G and 4G spectrum were able to haul themselves out of India’s overcrowded, ultra-low ARPU mobile game to some extent with data and value added services, but margins remain tight, at a time when huge capex investments will be needed to improve network coverage and quality. Jio, then, came at just the wrong time for these carriers, launching itself with free voice and data offers which forced the leading MNOs to cut their own tariffs.
The effect of that has already been seen in the major MNOs’ financial results. Vodafone wrote down the value of its Indian business by €5bn in November, citing increased competition and prompting the reports that it wanted to acquire Jio (which it denied). And earlier this month, Airtel announced that its third quarter profit had fallen 55% year-on-year, blaming the “predatory pricing” of the new entrant.

But a merger on the scale of Vodafone-Idea would have to deliver more strategic value than just huddling together for warmth in the face of harsh competitive winds. The leading operators are steadily snapping up the small players, finally addressing the damaging fragmentation which held India back in the 2G era. As in the US and other developed economies in the past, consolidation became inevitable and Jio has just been a catalyst. But consolidation and its efficiencies and market share only drive value for so long. There must also be a plan to harness the enlarged revenue base to drive overall transformation – to modern network architectures and new delivery models, so that permanent competitive advantage can be achieved, not just in economies of scale and price wars, but in high value services.

Some Indian MNOs are already showing a deep interest in moving towards 4G with new approaches to the network, which can improve capacity, flexibility and cost-efficiency, as well as addressing the country’s long-running battles to improve quality of service. Jio itself is driving a major densification program around small cells and WiFi, while Airtel and others are experimenting with virtualized networks.

All this is coming at a time when the operators will have to invest heavily to grow their market share, especially in the high value user segments. According to forecasts by researchers at IHS Market, India and China will be the biggest capex investors in telecoms networks this year, while operators in north America, western Europe and Japan will reduce their spending as their major 4G and fiber roll-outs come to an end. By contrast, Indian operators will be pushing 4G out beyond the metro areas and trying to address issues such as poor call quality. They are also expected to invest significantly in improved backhaul, shifting the balance away from microwave and towards fiber.

This spending, combined with high spectrum prices, will continue to weigh on margins and encourage consolidation in India. But none of this means Jio has accomplished its aims, or will necessarily emerge a winner from the coming wave of change.

It is seeking to shake up a market where ARPUs are tiny and regulatory barriers are high and slow to change. It has assets, such as national spectrum and a growing fiber network, but lacks the established wireline user base which helped Free, via its parent Iliad, acquire customers quickly and operate its networks at low cost.

It has made its mark with its free data, but the impact of the price disruption may be shortlived. The three leading MNOs are also all investing in their networks in order to improve data rates and overall QoE, and shift the fight for subscribers away from price alone and towards higher margins, which means addressing quality, enterprise uptake, high value services and the Internet of Things. For instance, Airtel is spending $9bn on Project Leap, to expand and upgrade its mobile network, and is also deploying large amounts of fiber for access and backhaul.

So Jio will have to play that game if it is not to be relegated to a price-driven dogfight with the second tier operators – the surviving non-4G cellcos, the WISPs and the state-owned companies, BSNL and MTNL.  In announcing that its free data offers would end in March, it said it now had to start making revenue.

And, only four months after launch, RJio has already revealed plans to spend a further $4.4bn on expanding and upgrading its network, even though its decision to attract customers by offering free data means it has very little revenue so far. Parent company RIL announced the plan in a filing with Indian authorities earlier this month, saying it would raise the money via a rights offer to existing shareholders.

The new investment will bring Jio’s total network spending to date to almost $30bn. RIL was putting a brave face on it, saying that the additional investment was needed because of the “unprecedented customer response to RJio’s services as well as to address the anticipated growth in demand for digital services”.

In reality, though, the additional funds are likely to be spent on improving basic quality of service, especially data speeds. Despite the newness of its network, TRAI’s data from November 2016 shows that Jio delivered one of the slowest 4G connection speeds in the country.

And the claims of massive uptake of its services are exaggerated too. Jio missed its target of signing up 100m subscribers by the end of last year. It now claims to have signed 72m customers in its first four months of service, from September.

The extra $4.4bn, and the missing of subscriber targets, shows that mere undercutting on price has failed to deliver the volumes it needs, even in this land of price wars. Ironically, Jio may have unleashed the latest of those price wars just as India’s mobile data users are starting to prioritize QoE over price alone, and so it now needs to spend more, in order to participate in a different battle, one for the customer experience.

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