Slash in interconnect is good for consumers, will hurt incumbent telco profits

Nitin Agrawal Moneycontrol Research

After battling the disruptions brought in by Reliance Jio in the Indian telecommunication sector, the incumbents have had to take another blow: the reduction in Interconnect Usage Charges (IUC) or termination charges. The Street had been expecting the reduction in the IUC, widely seen as a consumer-friendly move, but the quantum of the cut surprised some.

The average revenue per user (ARPU), an important metric for telecommunication players, has been on a downward trajectory for a while now, and the entry of Jio (owned by Reliance Industries) has shaken up the industry dynamics with a series of bold offers. Jio’s innovative strategies have been difficult for its competitors to gauge, and few can tell what’s coming next.

The decision

The Telecom Regulatory Authority of India (TRAI) has decided to reduce the IUC from current levels of 14 paise per min to 6 paise per min effective from October 1, 2017 and zero from January 1, 2020.  The chart below indicates the change in IUC over a period of time, and it has always been on the downward trajectory, as one would expect.

Zero-Sum game

Revenues from IUC are a zero-sum game. The loss of one is the profit of other. IUC is a settlement between operators to provide access to the network for completing the calls. Bharti Airtel, the leader in the space with a large network, is a net revenues earner from IUC, whereas the new player Jio shells out money as it uses other networks for completing the call because it is in a nascent stage in terms of network reach.

Entry of Jio – increase in importance of termination charges

The importance of termination charges increased after Jio entered the market. The revenue from termination charges increased by 194 percent (YoY) and 129 percent (YoY) in 1Q18 for Bharti and Idea, respectively. The obvious reason for this is that Jio has a small network and most of its calls fall on incumbents’ network, letting the incumbents earn termination charges.

Impact on incumbents

On a last twelve month (LTM) basis, based on termination charges of Rs 0.14 per minute, the net termination revenues for Bharti Airtel and Idea were Rs 15.9 billion and Rs 12.2 billion, respectively.

On the operating profit levels, termination accounts for 4.1 percent and 11.8 percent of consolidated EBITDA for Bharti Airtel and Idea, respectively. The termination EBITDA contribution for Airtel is less, thanks to its non-wireless businesses, and hence the impact of the reduction in IUC is less.

Calculations, based on termination charges of Rs 0.06 per minute, suggest that Airtel and Idea are expected to have an EBITDA impact of 2.3 percent and 6.7 percent, respectively. Based on zero termination charges, the impact would be 4.1 percent and 11.8 percent, respectively.

 As per the estimates, Jio is the net payer of termination charges as its off-net minute mix is 90:10 and pays close to Rs 50-60 billion annually. The reduction in termination charges can bring in a significant benefit of close to Rs 28-34 billion to Jio.

The moot question is whether the reduction in termination charges will kick in another price war?

At this point it is difficult to answer as it depends on Jio’s actions and whether it decides to pass on the part or full benefit to the customers.

(Disclosure: Reliance Industries Ltd. is the sole beneficiary of Independent Media Trust which controls Network18 Media & Investments Ltd.)

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