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Can Vodafone Idea Survive Even With A Favourable AGR Case Outcome

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The verdict of a 15-year-old legal battle between India’s mobile operators and the Government of India, has raised serious concerns around the survival of Vodafone Idea Ltd. Even with the best possible/most favourable payment term – which now looks quite possible – the Vodafone Plc and Kumar Mangalam Birla controlled entity will have to revisit its survival plan.

In the recent Adjusted Gross Revenue (AGR) hearing, the Supreme Court asked Vodafone Idea to submit not only its audited financials for the last 10 years, but to also make a reasonable payment related to AGR dues before the next date of hearing. This is after the lawyer representing the company said in the court that its financial state is “precarious” and it is “not in a position to give any more guarantees”.

The court will hear further arguments related to the case in the third week of July.

What Was The Legal Battle On?

The legal battle was regarding the definition of adjusted gross revenue (AGR) – which is used by the Department of Telecommunications to calculate the charges payable by the telecom operator. Adjusted gross revenue means gross revenue adjusted for interconnect usage charges and other deductions.

Telecom operators are liable to pay around 4% and 8% of the AGR as spectrum usage charges and licence fees, respectively, to DoT. The operators were arguing that AGR should comprise revenue from telecom services, but DoT insisted that AGR should include all revenue earned by an operator, including that from non-core telecom operations – rent, profit on the sale of fixed assets, dividend, interest income, etc.

The battle started when the telecom companies migrated to new system offered by the government in 1999 under which operators agreed to share certain percentage of revenue with the government.

 

Can Vodafone Idea Survive Even With A Favourable AGR Case Outcome

The Outcome

The final ruling was announced in October 2019, where the telecom operators were asked to pay the past dues. However, the parties failed to comply with the Supreme Court order and the matter prolonged for another 8 months due to issues regarding the final amount to be paid and on concerns regarding viability of a telecom operator.

Earlier the operators were given 3-months time to pay the entire dues. The asked dues were so huge and with no provisions, the telecom operators took it upon themselves to verify the correctness of the amount. The reassessment of dues done by the telecom operators resulted into an amount much lower than what the DoT had claimed. However, the Supreme Court later disallowed any reassessment and asked the companies to pay the amount mentioned in the petition.

In meantime, Kumar Mangalam Birla – chairman of Vodafone Idea Ltd. – said that the company will shut down its operations if there would be no help from the government. The telecom operator was incapable of paying thousands of crores as dues and penalties at one go as back then they continued to bleed from a tariff war unleashed by Mukesh Ambani’s Reliance Jio Infocomm Ltd. The shutdown would have hurt the Government of India the most.

Can Vodafone Idea Survive Even With A Favourable AGR Case Outcome

Vodafone Idea owes more than 80% of its debt to the Government of India in form of deferred spectrum liabilities. Usually telecom companies pay half of the spectrum cost upfront, post which there is two-year moratorium period. The remaining 50% is to be paid in equal installments over the next 16 years. This amount is reported as the deferred spectrum liability.

Given the inability to pay the entire dues in one go, the government proposed staggered payout of 20 years with an interest rate of 8%. A favourable outcome at this stage looks quite possible, but will that be enough for the debt-laden Vodafone Idea to survive in the telecom market?

Survival Issues

The staggered payout if allowed by the Supreme Court will definitely ease the cashflow situation of the telecom operators and might remove the possibility of a telecom operator – Vodafone Idea – from shutting down at this moment, but will that resolve the existential crises that the company is facing?

The answer is No, because of several reasons. To list out some…

  • Low cash generation
  • Hefty pending payouts
  • Unwillingness of promoters to infuse cash
  • Massive subscriber loss
  • Weak balance sheet and network
  • Insufficient tariff hike
  • Significant 4G capex requirement

The past AGR dues for Vodafone Idea are so high that even a staggered payment for 20 years with 8% interest rate would lead to an annual payout of ₹ 4,899 crore for Vodafone Idea. This is for a company which has been generating negative free cash flow since the time of merger completion and has been struggling to repay its debt. For Bharti Airtel, the annual payout wouldn’t hurt much, as the amount to be paid is much less than the free cash flow it generates.

Can Vodafone Idea Survive Even With A Favourable AGR Case Outcome

According to the merger agreement between Vodafone Plc and Idea Cellular, Vodafone Group had agreed to take upon a part of AGR liability limited to ₹ 8,400 crore. Of this, the Group has already paid ₹ 1,680 crore to Vodafone Idea. The balance of ₹ 6,720 crore if paid over a period of 20 years would translate to ₹ 336 crore of annual payout.

Vodafone Idea in FY21 and FY22, is expected to generate free cash flow on the back of merger synergies and recently announced tariff hike. But the annual AGR payout will consume nearly 94% and 61% of the free cash flow generated in FY21 and FY22, respectively.

The Supreme Court has asked the company to make a “reasonable payment” of past AGR dues upfront to consider the staggered payout option.

The Court has not defined what is reasonable, but considering what other telecom companies have paid, Vodafone Idea might have to shell out additional ₹ 7,700-17,000 crore. Currently, Vodafone Idea has paid only 12% of its AGR dues, while Bharti Airtel and Tata Group have deposited 41% and 25% of their respective dues.

Can Vodafone Idea Survive Even With A Favourable AGR Case Outcome

At this moment, we believe, Vodafone Idea has only two external source of funds – promoter Vodafone Plc. and Bharti Infratel Ltd. The company can make a payment of ₹ 10,448 crore – ₹ 6,720 crore from Vodafone Plc and ₹ 3,728 crore from Bharti Infratel – assuming that it does not take more debt and use it current cash balance.

The promoter – Vodafone Plc. – can advance its share of AGR liability and from Bharti Infratel, it can do so by selling its stake in Indus Towers Ltd. As per the merger agreement of Bharti Infratel and Indus Towers, the company can sell its 11.15% stake based on the agreed formula, which consider 60 days’ volume-weighted average price of Bharti Infratel.

So, if the company makes an upfront payment of ₹ 10,448 crore, then the annual payment for the next 20 years at 8% interest rate would turn out to be ₹ 4,171 crore. In both the possible scenarios, given the positive cash flow, the company might still sustain for two years. However, beyond that things look bleak as the company will have to start making annual spectrum payments.

Earlier, given the stress in the telecom sector, the Government of India had given a two-year moratorium period for paying annual spectrum liabilities to the operators. This moratorium ends in FY22. From FY23 onwards, the company will have to start paying around ₹ 16,000-17,000 crore annually towards deferred spectrum liability. This means that the company’s annual free cash flow in FY23 has to be atleast 2.4 times of what it is expected to generate in the previous year.

Can the company do so?

Looks like a tall task. By increasing tariffs, getting more subscribers on its network and/or by upgrading its low paying subscribers to higher tariff plans it can manage to meet its requirements.

Recently Idea announced a tariff hike of around 30%, but it will still fall short of meeting its expenses and managing significant improvement in its balance sheet. The company needs its average revenue per user higher by atleast 70-75% from the levels of ₹ 109 to meet its expenses. The tariff hikes were announced in December 2019 and the actual benefits of the same will be reflected in the Q4FY20 earnings which are yet to be announced by Vodafone Idea.

Bharti Airtel which reported an ARPU of ₹ 154 – highest in the last 12 quarters because of tariff hike – said the same was inadequate to generate a reasonable return on capital. Gopal Vittal, CEO of Bharti Airtel, expects the ARPUs to get to ₹ 200 in the short term and eventually to ₹ 300 which is where it should be for a telecom business.

The telecom regulator is also mulling to introduce floor tariffs – price below which no telecom operator can offer its services. Thus, a second round of tariff hike either directly or indirectly is imminent. But given the Covid-19 pandemic and the economic slowdown in the country, it is unlikely to happen anytime soon.

But Will That Be All?

Increasing tariffs is not the only solution as Vodafone Idea also needs to restrict its massive subscriber loss. The company has been losing active subscribers for 21 consecutive months. Along with this, the broadband subscriber addition for Vodafone Idea has also been lower compared to its peer.

Can Vodafone Idea Survive Even With A Favourable AGR Case Outcome

A higher number of subscribers actively using an operator’s services doesn’t necessarily mean better revenue. But it at least means the customer is frequently using the service and the risk of losing that user is low. Broadband users or the customers which predominantly use data are high revenue generating as voice service is now free in India.

Over the past 21 months, Vodafone Idea has lost more than 122 million subscribers on its network. Reversing this subscriber loss will be difficult for Vodafone Idea given their underinvestment on network over last one and half years. This is evident by meaningfully lower capital expenditure than Bharti Airtel. Moreover, given the hefty statutory payouts in future, Vodafone Idea’s investment on its network could continue to be lower.

Can Vodafone Idea Survive Even With A Favourable AGR Case Outcome

Bottomline

Vodafone Idea is and will continue to face a severe cash crunch. Its survivability will always be under cloud. Along with payment of AGR dues and spectrum liability, the company will also have to continue to invest on its network. If the company choses to underinvest on its network, then it will lead to an adverse impact on the already shrinking subscriber base.

A combination of tariff hike, government relief measures, an equity infusion by promoters or a strategic investor and any potential surrender of unused spectrum to reduce future liability seems to be the only route to ensure survival for Vodafone Idea.

With promoters unwilling to infuse funds, it could be challenging to obtain a strategic investment, even after clarity on AGR overhang, due to continued market share and sustained cash loss. Also, a sizeable investment by a strategic investor could lead to extensive equity dilution.

Telecom in India could well end up becoming a duopoly, especially given the recent moves by Reliance to raise cash to become net debt free. How Reliance plans to get “Net Debt-Free” [Premium Access]


Disclaimer: At the time of writing this article, Capitalmind, as part of its LongTerm MultiCap Portfolio, has positions in one or more of the stocks mentioned.

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