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Impact of FDI Hike - Catalyst for telecom growth

March 15, 2005
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The hike in the foreign direct investment (FDI) limit in telecom has finally come about. How will this impact telecom operators –­ both big and small –­ in terms of ownership and control? What are the implications on consolidation, on tariffs and on ARPUs? tele.net brings you the views of industry experts...

The recent hike in FDI in telecom raises the issue of "ownership" versus "control". How will the issue be resolved in the current scenario?

Madhav Rao: The government has approved an increase in the FDI limit in telecom from 49 per cent to 74 per cent. However, some of the conditions imposed vide the approved policy are that the majority of directors on the board, including the chairman, MD and CEO would have to be resident Indian citizens, clearly a sign of unwillingness on the part of the government to hand over complete control to foreign investors. This also highlights the fallacy that a domestic partner in a telecom company could hold management control with a mere 26 per cent stake in a venture.

In the current scenario, this issue could be resolved contractually. Typically, joint venture agreements contain clauses which can ensure that the foreign partner exercises control over major business decisions of the company. Further, though the policy requires the senior management to be Indian residents, there is no bar on the foreign partner appointing such senior personnel, ensuring control to some extent over the affairs of the company.

Rajat Sharma: Telecom companies are more than ecstatic with the increase in the FDI cap as their strategic objectives can now be met, which were earlier restricted due to the lack of funds in the domestic market. At this point, what is important is to realise that the telecom industry, which is growing at over 30 per cent per annum, needed such a step to sustain future growth, especially when India envisions 250 million subscribers by 2007. All this has to come at a cost. No foreign investor will invest until they have a majority stake. Further, the "ownership versus control" issue seems to be evenly balanced with management control of all operators remaining with the Indian partner and operations and finance control with the foreign partner. If one rises above this issue, one can see benefits galore for both the industry and the Indian economy.

Prashant Singhal: The recent FDI hike in telecom and the guidelines therein would ensure that the opaqueness that had crept into ownership patterns of some telecom companies as a result of the circuitous route being followed to circumvent the 49 per cent cap, would no longer be there. It would also ensure that management would actually be controlled by the majority shareholders. The FDI hike will therefore result in greater transparency and ensure that foreign companies can own controlling stakesin an upfront manner.

Having said that, prima facie, there is an issue with the CEO, CFO and directors being Indian citizens, which, in my view, would also encourage more Indians to come back to the country and work here. We are already aware that many Indians are manning key positions in global telcos. Hence, this issue is not likely to impact investment decisions. Moreover, as the foreign partner will have 74 per cent stake, he will have unequivocal and clear voting rights.

Mahesh Uppal: The government seems to derive comfort from stipulating that the senior management, including the CEO and CFO, are resident Indians. This, when coupled with the reserved right to cancel licences of errant operators, seems to be quite a strong safeguard that the 74 per cent foreign ownership does not leave the government without effective recourse if that ownership is abused.

Is there a possibility of greater consolidation in the sector post the FDI hike? What effect will this have on the competition that exists in the sector?

Madhav Rao: Yes, there is a possibility of greater consolidation post the FDI hike, since the new FDI policy will simplify the existing equity structures of limited companies and enable raising of funds for infrastructure development. The consolidation will, however, be limited to certain sectors.

Competition would affect the small players since it may become difficult for them to remain competitive, leading to mergers with the giants. It is likely that the higher FDI ceiling will spur merger and acquisition activities in the sector. It is also possible that as a result, mergers and acquisitions are going to result in fewer companies providing certain telecom services. This could have an adverse impact on competition as this would lead to provision of certain telecom services by a few.

Rajat Sharma: Availability of funds is good news for both serious and non-serious players, as now both have options to operate professionally either by exiting or infusing funds. This could result in consolidation but many small players have already expressed their intention to run as individual players. Already, over a period, consolidation has taken place and, although with added FDI more consolidation is anticipated, only time can tell whether further consolidation does take place or not. Competition will still exist in circles as consolidation cannot take place if it results in less than three players in a circle.

Prashant Singhal: At the industry level, the FDI hike decision will facilitate the inflow of muchneeded capital since the telecom business is growing at more than 30 per cent annually, especially the mobile sector which has doubled in size over the last two years. This will also drive the process of consolidation, especially amongst domestic players. Domestic players will have access to greater international funds than before; this will enable them to build the financial muscle to acquire other domestic players.

Moreover, international telcos which recognise the potential of the Indian market but were constrained by the FDI limit will now look at ways of entering India through the acquisition route. With foreign funds flowing in there is bound to be more capital available for consolidation.

Competition is bound to be fiercer with greater inflow of funds. And even after consolidation, we expect that about five-six strong players will be left in the country, which will be enough to ensure that there is adequate competition in the marketplace.

Mahesh Uppal: Yes. This will offer added opportunity to those international players looking for substantive ownership of companies that they might wish to acquire or use as a vehicle for entry into the market. Thanks to the recent unification of fixed and mobile licences, most major cities in India have more mobile players than any place in the world. The markets will remain fairly competitive, even if a couple of players do exit or sell out.

Will the FDI hike be more beneficial to small players as opposed to bigger players?

Madhav Rao: The FDI hike should be more beneficial to the small players as they stand to gain from the large telecom companies looking to enter the Indian market through mergers and acquisitions. It will benefit big players to the extent that the investment will provide them the funds to expand their services.

More FDI in such a scenario is, therefore, in our view, imperative given the lack of domestic sources for infrastructure development. Also, considering the fact that the telecom industry requires huge investments, the proposals are likely to provide an opportunity to foreign investors to invest large amounts in India.

Rajat Sharma: The FDI hike is good news for both small and big players. Smaller players, if they decide to exit, can expect much higher returns or else join other like-minded standalones and create an alliance where the investors feel comfortable to add funds and technology to match bigger players in the sector. It just depends on how the small players want to leverage this opportunity to either compete against the biggerplayers or make money in the near future. Opportunity exists for all out there.

Prashant Singhal: The FDI hike will benefit both small and big players. It will allow small players the opportunity to access international funds and the long-pending acquisitions will get rolled out through mergers or acquisitions.

At the same time, bigger players will now be able to tap funds to strengthen and expand their operations. Several foreign telecom companies, particularly from Asia-Pacific, which recognised the potential of the Indian market and have made some investments in the past but were reluctant to invest whole hog in the country as they were not allowed direct majority control, could also firm up their India plans. Significantly, the FDI ceiling comes at a time when the government has allowed intra-circle mergers. To meet the target of 250 million subscribers by 2007, the sector needs $20 billion annually.

However, the biggest beneficiaries would be the companies where foreign investors already reside and would be looking to increase their stake.

Mahesh Uppal: Yes, since one would assume that the larger players may not need, or be comfortable with, too small a stake in their companies.

Is increased investment in the industry likely to reduce tariffs further? What effect will this have on ARPUs?

Madhav Rao: Yes, increased investment in the industry could reduce tariffs further as there will be free flow of funds in the sector, leading to competition. The same would increase teledensity, which would make the services affordable.

Rajat Sharma: Increased investments are needed to meet the future vision of achieving 250 million connections by 2007. This needs us to bridge the urban-rural digital divide which cannot be possible without commoditising phone usage. Also, such commoditisation can only be achieved by companies with deep pockets. As tariffs fall, more connections are pocketed. So, at the end of the day, the bottomline will still reflect healthy figures. Also, with improved technology and more valueadded services, ARPUs can be segregated into one with value-added services (urban) and the other with plain vanilla voice (rural). Hence, in one case the ARPU will be low while in the other, the ARPU will definitely be high. So, again, we see a balancing act here.

Prashant Singhal: Any increase in the capital outlay should easily expand the networks and increase mobile penetration, subscriber growth and importantly, would lead to upgrading the quality of networks and providing cheaper value-added services. Mobile tariffs standing at less than a cent per minute are the lowest in the world and we don't see that dropping further. However, there is potential to see international and national long distance tariffs reduce.

As mentioned above, with a flush of foreign investments, networks would expand and penetration would go up, resulting in lower ARPU customer acquisitions. However, with the improvement in networks and more value-added services being offered, this fall is likely to get offset by the increase. The ARPUs are already at a low of $7$8 per month per subscriber and any significant fall from here could make the industry unviable. Hence, we don't foresee a significant drop in ARPUs with the increased investments.

Mahesh Uppal: The new FDI rules may not impact tariffs directly. With current levels of competition, one would expect prices to continue being consumer friendly. ARPUs will depend on how successful the companies are in stimulating usage. If they are, ARPUs will increase. Otherwise, the operators will bank on increased revenues from a larger user base, which would not necessarily increase their operating costs to the same extent.

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