Airtel, Idea face double whammy if Trai cuts interconnection usage charge

The Telecom Regulatory Authority of India (Trai) is set to cut the interconnection usage charge (IUC) levied by telecom companies, according to a 13 August report in The Times of India. Trai chairman R.S. Sharma has said IUC recommendations will be framed by the end of the month, suggesting a final decision is yet to be taken.

But if IUC is indeed cut, it will be a double whammy of sorts for large incumbents.

First, the compensation they earn for terminating calls from competing networks will dwindle. More importantly, the move will result in huge savings for new entrant Reliance Jio Infocomm Ltd, which may well use the opportunity to step up its pricing aggression.

The upshot: companies such as Idea Cellular Ltd will be dragged deeper into the red, while Bharti Airtel Ltd’s India wireless business, too, could start running pre-tax losses.

Net IUC income accounted for roughly 14% and 18%, respectively, of Bharti Airtel and Idea Cellular’s India wireless businesses in the June quarter. If the fee is cut by half, as is being speculated in some quarters, operating profit of the two wireless businesses will fall by 7% and 9%, respectively.

After accounting for its huge interest and depreciation charges, Bharti Airtel’s wireless business will run losses at the PBT (profit before tax) level, all other things remaining the same. Of course, at a company-wide level, the impact on Bharti Airtel will be lower, thanks to large contributions from other business segments.

But there’s no such luck for Idea Cellular, which has already been running losses in the past three quarters.

And as pointed out earlier, that’s not all. The move will also result in substantial savings for Reliance Jio, which accounts for the majority of IUC payable to incumbents. Analysts at Kotak Institutional Equities estimate Reliance Jio to save around Rs25 per subscriber per month if IUC is cut by half. For perspective, the average revenue per user based on its flagship Rs399 plan is around Rs120/month.

Kotak’s analysts say in a note to clients that a cut in IUC could well result in more pricing aggression from Reliance Jio, which can have a larger impact than the one-time hit on Ebitda (earnings before interest, tax, depreciation and amortization).

Most of the above calculations (except Kotak’s) are based on data presented by incumbents to Trai last month. For instance, they point out that the ratio of incoming-outgoing traffic when it comes to Reliance Jio is as high as 9:1. And based on the current IUC fee of 14 paise per minute, Bharti Airtel is estimated to have received net interconnect charges of around Rs500 crore from Reliance Jio in the April-June quarter. Idea Cellular would have received close to Rs350 crore, based on data it shared with the regulator for the month of May. Net incoming calls from other operators added about Rs200 crore to Bharti Airtel’s kitty and about Rs25 crore to Idea Cellular’s.

Even after adjusting for regulatory levies of around 12% that telcos pay on net revenue, these add substantially to overall profits. If half of this contribution is knocked off on account of a cut in IUC, profit margin will be hit by more than 2 percentage points. Note that margins of the two companies have already fallen by 8-10 percentage points in the past year thanks to a drastic fall in tariffs.

And while tariffs have stabilized in recent months, they may well be headed lower again if the IUC cut drives substantial savings for Reliance Jio. In that event, it’s difficult to say where profit margins will settle.