Sector Pick for 2011 : (3) Telecom : DARK Horse

Telecom has been one of the most debated sector, if not for the right reason.

The telecom industry has witnessed one of its most turbulent years in 2010, with the likes of Bharti Airtel and Reliance Communications (RCom) underperforming in the markets, faced as they were with a decline in Average Revenue Per User and margins.

Barring Idea Cellular, that has outperformed the indices, all the others including Tata Teleservices Maharashtra (TTML) and MTNL have languished at the bourses.

Much of it can be explained by the continued de-rating of telecom stocks which started in late 2009 as a result of the tariff war started by several new entrants and led to erosion in popular metrics. Culminating in 2G allocation scam, the future prospects don't seem to be as weak as it is made out to be.

Besides, other businesses of these companies such as broadband (through 3G and BWA), enterprise services and passive infrastructure (towers) are seeing an increase in contribution to revenues and adding to margins as well.

Declining parameters

For mobile operators such as Bharti, Vodafone, Idea and RCom, the average revenue per user (ARPU) has fallen by 20-25 per cent over the past year to Rs 121-200 levels. ARPUs however may no longer be the best indicator of a telecom player's performance what with the new subscribers increasingly coming from the less lucrative semi-urban and rural regions. As a result revenue growth has lagged subscriber additions by 15-20 percentage points. .

However, the more representative metric, revenue per minute has been stable at around 42-44 paise per minute across operators. Even so, operating margins have slid 2-5 percentage points across operators. The top 7 operators including BSNL, Tata Teleservices and Aircel nonetheless have held their own in terms of subscriber market share. More importantly, they hold an estimated 98 percent revenue market share . Of this Bharti, Vodafone, Idea and RCom together command more than 77 percent of the revenue market share, points at their sustainable leadership.

The likes of MTNL and TTML with loss-making operations and limitations in scalability face serious challenges going forward.

Non-mobile growth

Businesses other than mobile telephony contribute over 15 percent of Bharti's revenues, while for RCom the proportion is nearly 40 percent. The operating margins in this segment have increased over the past year.

Both these companies have won licenses in strategic circles on the 3G front, with Bharti also winning bids in the broadband wireless (BWA) segment.

Unlocking of tower value
The passive infrastructure business could see significant value unlocking too. Indus Towers (co-owned by Bharti, Vodafone and Idea) and RCom's tenancy factor has been on the rise.

Rentals from these towers too are increasing as operators, both captive and several new ones, seek to expand.

Earlier in the year TTML divested its entire stake in its tower subsidiary to Quippo-WTTIL, an independent tower company for an enterprise value of Rs 1,318 crore for its 2535 towers. Clearly Reliance Infratel, expected to make an IPO offering, Indus Towers and Bharti Infratel may look higher valuation and significant value unlocking given their much higher tenancies and larger footprint.