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Corporate Jul 13, 2012

Telecom Spectrum: Why the 31 Aug SC deadline will be missed

By Aditi Roy Ghatak and Paranjoy Guha Thakurta

The most contentious issue that will have to be resolved by the Empowered Group of Ministers (eGoM) on telecommunications headed by Home Minister Palaniappan Chidambaram is the levy of a "one-time" fee on excess spectrum held by telecom companies. None of the three options suggested by the Department of Telecommunications (DoT) seem feasible and considerable confusion is currently prevailing.

Whatever decision is taken by the eGoM will have major financial implications for the incumbent operators. The total amount involved could be as much as the equivalent of $ 42 billion, or over Rs 2,30,000 crore, a recent report prepared by two researchers at the institutional equities research desk of India Infoline Ltd (IIFL) has claimed.

This staggering amount is virtually identical to the present value of the maximum "presumptive" or "notional" loss to the exchequer of Rs 1,76,000 crore on account of the misallocation and undervaluation of second generation (2G) spectrum that had been estimated by the Comptroller and Auditor General of India in November 2010.

Before this report by GV Giri and Balaji Subramanian of India Infoline is disclosed in Firstpost, a bit of background information is provided. (See also the earlier part of the story here)

Given the nexus between business and politics and the deep divisions within the Indian telecom industry, there are concerted efforts to delay auctions till as late as possible. AFP

On 29 January 2011, after assuming office as Union Minister for Communications and Information Technology and replacing Andimuthu Raja, Kapil Sibal announced that all future spectrum beyond the start-up spectrum with incumbent operators - 2x4.4 megahertz (Mhz) for users of GSM (global system of mobile communications) technology and 2x2.5 Mhz for users of the competing CDMA (code division multiple access) technology - would be assigned at a price that would be determined under a new telecom policy.

Whereas this assignment of spectrum can be contested (see the five-part series of articles by the authors in Firstpost starting 29 May 2012 here, here, here, here, and here), after the 2 February decision of the Supreme Court cancelling 122 telecom licences and ordering public auctions of spectrum, Sibal stated that the prices of spectrum would be auction-determined.

The rationale was to create a level playing-field for the relatively new operators such as Reliance Communications and Tata Teleservices (with spectrum prices emanating from the auction process) vis--vis the old operators, notably Airtel, Idea and Vodafone, who had been assigned spectrum at the administered rate.

A Cabinet note was prepared with this proposal and circulated for inter-ministerial consultations. The Planning Commission and the Prime Minister's Office then wondered if it would be fair to charge everyone the new auction-determined price of spectrum because that would amount to changing the rules in the middle of the game and would dampen investor confidence.

The DoT pointed out that existing licence contracts between the department and different operators are only for the quantity of spectrum and not its price. In other words, the DoT argued that the contracts it had signed with operators were open and flexible and gave the department the right to decide on the pricing of spectrum at a later date and that no terms of the licence agreements would be violated by changing the spectrum pricing structure.

Still, the Planning Commission and the PMO prevailed on the DoT to modify the Cabinet note to include two additional options. Thus, the following three options were presented by the DoT:

Option One: Payment for all spectrum to be made by operators for the remaining lives of licences issued;

Option Two: Payment for excess spectrum held over 2x4.4 Mhz (for GSM operations) and 2x2.5 Mhz (for CDMA operations); and

Option Three: Charging for excess spectrum held above 2x6.25 Mhz/2x5 Mhz (GSM/CDMA) but not both GSM and CDMA.

While formulating these options, the DoT raised concerns about the difficulties in dealing with situations where an existing player demands free spectrum up to the set limit laid down in the last two options. It referred to recent Telecom Disputes Settlement and Appellate Tribunal (TDSAT) filings by Reliance, Tata and Aircel, demanding additional 2x1.8 Mhz of spectrum (over and above the already assigned 2x4.4 Mhz) before deciding on the total quantum of spectrum that would be auctioned.

Lest one presumes that should the Cabinet decide to charge for spectrum beyond 2x6.2/2x5 Mhz, dual-technology operators like Reliance and Tata would get away paying nothing, the DoT sought to plug that possibility by proposing Option Three, namely, that dual technology operators would only be allowed to retain one of the two slots free (either the 2x6.2 Mhz slot for GSM operations or the 2x5 Mhz slot for CDMA operations) and pay for the other slot at the price decided by the auctions. Thus, DoT said that dual technology operators would not "escape" without paying for excess spectrum, even if the cut-off levels were 2x6.2 Mhz/2x5 Mhz.

It may be recalled that dual-technology players had lobbied to define the contractual spectrum benchmark at 2x6.2 Mhz to counter the advantage of the old incumbent operators (Bharti, Vodafone and Idea). The other issue that the dual technology operators lobbied for was to get the old incumbent operators (Bharti, Vodafone, Idea and Bharat Sanchar Nigam Limited, or BSNL) with more than 2x6.2 Mhz of spectrum to pay up for the excess spectrum retrospectively, as the licence allowed them to have up to only 2x6.2 Mhz.

The DoT said it would rather leave the issue of charging for spectrum with retrospective effect to the Supreme Court, especially since the levy of retrospective charges has become controversial of late after the Vodafone capital gains tax case.

Given these complex sets of circumstances - which are the outcome of ambiguous positions taken in the past - the Cabinet might choose to charge all operators for administered spectrum starting from zero, lest operators with less than the contractual spectrum demand additional spectrum free till the contractual limit, which would be seen to go against the spirit of the apex court's judgment.

However, there will be strong resistance to such a proposal with operators expressing their inability to pay upfront, especially due to the high debt to earnings before interest, taxes, depreciation and amortisation (EBITDA) ratio, in case the decision to charge for all spectrum starting from zero Mhz is made.

The India Infoline researchers, in their report dated 9 July, contend that "we expect the government to become increasingly defensive and incapable of enforcing punitive regulation (high payouts only for GSM incumbents and refarming)" and add: "Decision- making around auctions and excess spectrum seems set for more delays, and this should act against cancelled licensees."

Arguing why all three options for charging for excess spectrum seem unworkable, the researchers make the following calculations on the basis of the prices suggested by the Telecom Regulatory Authority of India (Trai) and on the assumption that auction prices "should" be 30 percent lower. Under the three options, Bharti Airtel would pay Rs 11,100 crore, Rs 5,700 crore and Rs 3,200 crore respectively, while the corresponding numbers for Idea would be Rs 10,500 crore, Rs 2,800 crore and Rs 1,200 crore.

As already stated, Option Two results in zero payout for dual-technology companies, Reliance and Tata, if they surrender CDMA spectrum above the cut-off levels, which, contend Giri and Subramanian, "they can easily manage, in our opinion, and hence this is potentially equally unacceptable, unfeasible".

That this option allows dual-technology companies like Reliance and Tata to avoid large payments (equivalent to $1.2 billion and $ 900 million respectively) by returning excess CDMA spectrum held over 2.5 Mhz, is described by the researchers as "a problem in an environment of bloodlust". The report claims that these two companies could easily carry on their "dongles" business - dongles is a device that is connected to a computer to allow access to wireless broadband or use of protected software -- for high speed data on the 2.5 Mhz spectrum band and transfer (the) voice business over to GSM spectrum.

It adds that a migration of 50 million CDMA voice subscribers with full subsidy on GSM handsets priced at $5 each would result in a total cost of "merely" $ 250 million, "an easy choice in our view". Further, the report states that for GSM operations, the holdings of spectrum "would largely be under (the) cut-off (level)". Hence, Option Two "would entail almost no spectrum outgo for dual-technology companies", the report states, adding: "This seems politically unfeasible, given that free spectrum is the genesis of the 2G scam."

Option Three, the report suggests is "very brave in a scam-charged environment". This option seems "to imply a twist - if one pays for GSM, CDMA spectrum becomes free (which again favours dual-technology companies)". The researchers add: "Anything free will certainly attract controversy, especially if it is the CDMA spectrum which until now was being priced at 2x1,800 (Mhz for) GSM (players)." Hence, the report contends that "all options seem unworkable".

The Indian Infoline report argues for a "complete reset" of licence periods and "lower reserve prices" as the "best option".

It states: "Full immediate payment for 20 years would be a more feasible option. This would ensure a 'level-playing field', eliminate scam allegations and would be revenue generating for the government. At our assumed price, industry would see $42 bn (being paid out for excess spectrum) and deferred payment/spectrum trading/mortgaging could help with financing. This clean solution is, however, dependent on successful auctions and that needs lower reserve prices. We are beginning to believe that this is inevitable."

What is particularly interesting is that this figure of the total value of excess spectrum held by the Indian telecom sector that has been arrived at by the two "independent" researchers - $ 42 billion works out to Rs 2,31,000 crore assuming an exchange rate of Rs 55 to a dollar - more or less matches the present value of the maximum "presumptive" loss of Rs 1,76,000 crore estimated by the CAG in its November 2010 report presented in Parliament.

The India Infoline researchers argue that since BSNL and MTNL (Mahanagar Telephone Nigam Ltd) "would need to pay but cannot, we presume they will surrender spectrum, which means that a good chunk of spectrum will come into the market over time".

"This option will also entail fairly low returns to the government - excluding BSNL/MTNL, assuming (the final spectrum prices are) 30 percent (lower)... than Trai (recommended) prices, the government may net less than Rs 150 bn (or Rs 15,000 crore). This plan too looks weak as there may be no takers within the government".

The researchers conclude with the suggestion that a lower base price for spectrum auctions with simultaneous reset of licence periods constitute "the best option". This is what they have written:

"According to an earlier DoT proposal, all operators must pay an auction determined price for the next 20 years, regardless of the remaining years in the current licence. While media reports indicate that this is not being actively explored, this is the best way forward in our view. All licences will be reset and become coterminus ensuring (a) 'level-playing field' in unambiguous terms, and (will) leave little room for complaints by anyone.

"This proposal would substantially eliminate regulatory controversy, be viewed as revenue generating for the government. This would also liberalise all spectrum allowing telcos (telecom companies) to deploy any technology of their choice in the future. This would also obviate the need for refarming as 900 Mhz spectrum would have been paid (for) at (a) market (determined) price."

The researchers are, however, sceptical about whether or not spectrum auctions will at all take place during the current fiscal year. "The biggest obstacle ... is the reluctance of the government to fix lower reserve prices fearing future scam charges," they claim, adding the longer the impasse continues the better for older incumbents like Airtel and Idea.

Two critical details still remain unaddressed: identifying the auctioneer and determining the guidelines. The DoT issued a request for proposals (RFP) for identifying the auctioneer on 3 May. An open house session was subsequently held on 15 June during which clarifications were sought and responded to by DoT officials. Another notification has been issued to extend the bid submission date to 20 July.

The point is that the DoT can go on extending the deadline but may not get a response till the reserve price is determined. The reason is obvious. No bidder will like to bid unless there is certainty about the reserve price as the payment for auctioneer is a percentage of the difference between the final price and the reserve price.

With the reserve price already set at a "high" level, should the auction fail or close at the reserve price, as per the current payment terms, the auctioneer could end up getting a "meagre" Rs 10 lakh or thereabouts. No auctioneer would want to venture into such uncertain territory at this juncture.

It will be reasonable to expect bids from auctioneers once the base price is set. If the base price is lowered, the chances of getting a credible auctioneer become brighter. The guidelines for conducting auctions can only follow after the resolution of these issues. Till then spectrum auctions can remain in a state of limbo.

There are important lessons to be drawn from the current chaotic situation that is prevailing. The government as well as industry players are today paying a stiff price for having turned a blind eye to the 2G spectrum scam during Raja's tenure as Telecom Minister.

Given the nexus between business and politics and the deep divisions within the Indian telecom industry, there are concerted efforts to delay auctions till as late as possible. By postponing the inevitable, our netas and babus as well as our corporate captains are merely buying time.

As to who will end up being the biggest loser, the answer is clear: the consumer, of course. She or he will eventually have to pay more for telecom services with little improvement in quality. Hello!

View the IIFL report below:
IIFL Telecom Spectrum Payout

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