Telecom companies (telcos) have a compelling reason to push average revenue per user (ARPU) up by ~25% over the next 6-12 months to achieve a sustainable return on capital employed (RoCE) of ~10%, given their abysmally low returns at present and increased liability on account of adjusted gross revenue (AGR) dues.

Though operators did go for a significant tariff hike in December 2019, intense competition over the past three years, heavy capital expenditure (capex) to roll out 4G networks, and pending AGR liabilities have weakened their balance sheets. Therefore, increase in ARPU will be essential to strengthen credit profiles.

Tariff hikes, rising 4G adoption and increasing data consumption by adopting content-led bundled pricing strategies could help boost ARPU growth. That could, in turn, beam up profitability, which will also help telcos invest in 5G networks over the medium term.

Had the AGR liability not panned out as it did, the tariff hikes undertaken in December 2019 could have improved the industry’s RoCE to ~7% in fiscal 2021 and to ~9% in fiscal 2022, from lows of ~3% in fiscal 2020.

Now, with the Supreme Court’s final judgement on the AGR case in place, telcos have to bear AGR liabilities of ~Rs 1.15 lakh crore, which is expected to erode the benefits of the tariff hikes implemented last fiscal and bring the RoCE back to 4-5% this fiscal (see chart 1 in annexure), a CRISIL estimate shows.

Says Sachin Gupta, Senior Director, CRISIL Ratings, “Our base case assumes monthly ARPU reaching Rs 175-180 by next fiscal from ~Rs 140 in the first half of the current fiscal so as to generate a sustainable RoCE of ~10%. Of course, this will depend on competitive intensity, but it can crank up industry revenue to over ~Rs 2 lakh crore next fiscal, or a third more than the Rs 1.5 lakh crore seen in fiscal 2020, despite muted subscriber growth.”

Apart from tariff hikes, the ARPU will also benefit from the increasing data consumption due to proliferation of work from home, video conferencing and other forms of online business communications, along with a big uptick in over-the-top streaming services amid the pandemic. Consequently, data usage per subscriber per month is expected to grow 28-30% to ~15 gigabyte by the end of this fiscal. Sustenance of these drivers over the medium term will however need to be monitored.

ARPU growth will lead to non-linear growth in profitability due to the high operating leverage of the telecom business. Our analysis indicates that a Re 1 increase in ARPU adds about Rs 1,000 crore to the industry’s earnings before interest, tax, depreciation and amortisation (Ebitda), indicating high operating leverage of the industry. Thus, the industry’s Ebitda under our base-case is expected to double to ~Rs 79,000 crore in fiscal 2022 compared with Rs 38,500 crore in fiscal 2020.

Improvement in profitability, coupled with sizeable equity infusion of about Rs 1.7 lakh crore in fiscal 2020 had helped reduce the debt level to ~Rs 2.8 lakh crore as on March 31, 2020, from Rs 3.4 lakh crore a year ago. Debt protection metrics, though weak, improved with debt-to-Ebitda ratio at 4.7 times in fiscal 2020 compared with 7.3 times in fiscal 2019 (see chart 2 in annexure).

Says Nitesh Jain, Director, CRISIL Ratings, “The debt-to-Ebitda ratio will remain high at above 4 times in fiscal 2021 as the sizeable AGR liabilities will continue to weigh on the credit profiles of telcos. But, it is pertinent to note that despite getting relief in AGR payment terms, at this juncture, sponsor support, sizeable tariff hikes, and prudent capex would remain crucial to support the credit profile of telcos.”

Capex is expected to moderate to Rs 62,000-65,000 crore per annum over fiscal 2021 and 2022, compared with Rs 83,000 crore in fiscal 2020, due to frontloading of network capex by telcos in the past four years for 4G rollout. We expect no major capex towards fifth generation or 5G mobile services over the next 1-1.5 years.