India's tortuous path to 3G

It's hard not to see parallels between New Delhi's preparations for the 2010 Commonwealth Games and the government's attempts to auction off 3G spectrum. Both are controversy-cloaked events that are well behind schedule.

After re-starting the auction process that had been delayed eight months until September, the Department of Telecom (DoT) again had to stall proceedings, with Communications and IT Minister A Raja saying the Defense Ministry had not vacated key 3G spectrum required for the auction scheduled for December 7. The Defense Ministry was to have handed over 20 MHz of spectrum by December, as per a memorandum of understanding signed between the ministries this summer.

What followed was a well-publicized exchange of letters between the Finance Minister Pranab Mukherjee and Raja, with the latter saying it was up to the telecom minister to ensure the auction goes off on schedule. In India, "on schedule" is an expansive term, and while the finance minister's words have wei ght, the auction has now been postponed to January 14.

The DoT's fix has been to trim the auction. Instead of selling four licenses in all 22 telecom circles, it will sell four blocks of two times 5 MHz spectrum, with one block reserved for state operators BSNL and MTNL, in 20 of the country's 22 telecom zones. There isn't spectrum available for the remaining two zones. It will also sell three broadband wireless access licenses in these zones.

"Interested foreign entities are allowed to participate in the auctions directly and apply for a licence subsequently," the DoT has said. But non-Indian players will need to find a local partner to operate here because foreign ownership in telecom is capped at 74%.

The government wants to finish the process before the end of this fiscal year. The reserve price for a pan-India license is set at Rs35 billion ($751 million), up from an earlier price of Rs20.2 billion.

The biggest local businesses, such as Bharti Airtel, Vodafone Essar and Reliance Communications, have made no secret of their desire to bid for 3G frequencies, which will add capacity to congested 2G networks and enable them to offer fresh services like gaming, videos and internet access.

The tussle over spectrum has been going on for years in one of the world's most attractive telecom markets, with Defense Ministry officials unwilling to release bandwidth until the DoT funds an alternative. Under the agreement signed in May, BSNL was commissioned to build an optic-fiber cable for the armed forces, enabling them to vacate commercially-viable spectrum.

"The FM's words carry weight and it is likely the auction will now take place, in January at least," says telecom expert Satya N Gupta, who worked with the Telecom Regulatory Authority of India between 2000 and 2006. "The government needs the money to balance its budget commitments."

Further darkening the 3G skies is an emerging scandal over Raja's issue of 2G licenses in January 2008.

Instead of an auction, the ministry sold licenses on a "first come, first serve basis," which resulted in new entrants like real estate giant Unitech getting licenses at low prices and then selling stakes to foreign telecom operators keen to enter the market.

Analysts say the government lost out on billions of rupees of revenues by not holding an auction. The Central Bureau of Investigation (CBI) raided the DoT offices in New Delhi on October 23 and is probing a possible "criminal conspiracy" between officials and private companies. Raja has denied any wrong doing.

But handing out licenses to players without telecom experience ended up further crowding an already congested market, says Mahesh Uppal, director at the telecom consultancy Com First. Uppal says India has among the largest number of players in a single market. There were six operators in most of the 22 circles before the last spectrum sale, and now that has risen to about 10.

Sheer size

Delays and scandals notwithstanding, the 3G auction holds huge appeal because of its sheer size.

New entrants are eager to find a foothold - in September Bharti, the market leader, and Vodafone saw subscriber growth slow amid intense price competition from smaller players. For instance, Tata Teleservices' introduction of a pay-per-second plan helped it add a record 3.4 million users in August.

"India is the last frontier in telecom, so I wouldn't be surprised to see huge interest in the 3G auction from foreign operators," says TV Ramachandran, head of the Cellular Operators Association of India (COA). The country has the world's largest mobile subscriber growth numbers, he points out.

According to the regulator TRAI, India has 457 million wireless users. Operators added 15 million new subs in September and an average 13 million every month this year since January - far and away more than any other market in the world.  China, the world's biggest market by customer numbers, has 697 million mobile subs, adding nine million in September.

"In the West, countries were wired extensively by the time cellular networks came in. In India, there is hardly any wiring. This represents a huge opportunity for mobile broadband," says Ramachandran. By 2013, the country will have an estimated one billion mobile connections.

If the auction goes ahead in January, 3G networks could be up and running by the end of 2010 since most operators will only need to upgrade their existing 2G networks. Within three years, 10% of the mobile base, or about 100 million subscribers, could be converted to 3G, Ramachandran predicts.

And India will deal with 3G differently from other markets. As with 2G, competition and price wars will result in it becoming a mass market, thereby ensuring its appeal. In addition, in a technology services hub like India, there is already a huge market for mobile broadband and related VAS.

Initially it is likely operators will use additional spectrum to offset congestion in existing networks.

"In the Indian market, content and value-added applications aren't that great. The crying need is 'I hope my call doesn't drop when talking to you'," says Romal Shetty, head of telecom at KPMG. "The bidding may be for 3G, but the priority for operators is to get additional spectrum."

Indian mobile operators saw rapid growth rates in the last few years. But "they face two challenges to maintain that momentum - increasing capacity to support rapid subscriber growth and countering declining ARPUs by launching high-speed data services," says a report by consultancy Ovum. And there isn't much 2G spectrum available for operators looking to expand.

Defensive play

"In India, 3G is a defensive asset for companies. There will not be a huge revenue upside, but they need it to address capacity issues and provide tech services," says Amit Gupta, principal analyst for emerging markets at Ovum. "And if market leaders are not part of the auction it sends the wrong signal to subscribers. No leading player in any market has kept away from 3G and been successful."

While most operators declined to discuss the auction on the record, Idea Cellular's spokesperson Rajat Mukherjee said: "Demand for additional spectrum by all large operators is the critical need of the hour, and even if the 2100-MHz spectrum auction does take place, albeit delayed, the operators are more likely to use it to augment much-needed voice services, and the true greater bandwidth opportunity will be considered later. With it being the only spectrum likely to be available for some time to come, every operator may consider a bid." 

As for the foreign players - whom Telecom Minister Raja said had shown a strong interest - those that are already in the market are likely to attempt to augment their network. Since 2008 Etisalat from the UAE, Norway's Telenor and Japan's NTT DocoMo have bought into Indian operators. A Telenor spokesperson said it would "carefully evaluate different 3G opportunities" in India but not bid for a pan-India license this time round. Other foreign operators declined comment.

But taking part in the auction to break into India doesn't make sense financially, according to Ovum's Gupta. "India is already a very crowded market and if an operator is bidding for 3G, it's likely to be targeting high-end customers. They present a different business opportunity and are operationally far more challenging," he points out. 

The two state-owned operators that have been given a head start with 3G haven't had much success. Both MTNL and BSNL were given 3G spectrum early this year, the only players in the market to get it before the auction. Neither company has seen encouraging subscriber addition for related services. For the June quarter, MTNL reported a net loss of Rs 468.47 million ($10 million) as well as a 22% decline in mobile revenue. In 2G, value added-services account for only 1% of MTNL's revenues, while for market leader Bharti that number is 12%, says KPMG's Shetty.

"If you want to make something a failure, give it to the public sector," quips former TRAI official N Gupta. "They could have marketed 3G services much better, either themselves or through third-party marketers. If you'd given the same chance to a private company we would have seen results."

The state telcos have long been perceived as the poorer cousins of private operators, which tend to have better customer services, branding and in some cases stronger networks. Analysts say that is one reason why 3G hasn't been successful for them. "I don't know of many businesses or high-end customers who have BSNL as their operator of choice," says an analyst.

But industry sources say MTNL and BSNL's experiences needn't be an indication of things to come. For one, they are operating without competition. "You must have competition and then it will take off. Private operators hungry for new business can make it happen," says COAI's Ramachandran.

Given the minimum reserve price for the auction, bidders are likely to be very hungry for revenues. But after charges that the last sale of 2G licenses lost the state money, the government doesn't want to repeat the same mistakes. "The fees seem high because of the financial meltdown. If the auction had happened last year, companies wouldn't have thought twice about it," says Shetty.

The industry isn't as sanguine. "A high reserve price tends to make it less of an auction and more of an administered price. This will keep some interested companies at bay and reduce competition. The market should be allowed to discover the price," says Ramachandran. "Mobile broadband is a desperate need, but to succeed we need to crash prices, like we did with 2G. If you start off the auction with such high prices, companies will be unable to offer cheap 3G services," he says.

At what cost?

With 3G revenues unlikely to materialize initially, profitability for operators that buy into the auction is a concern. India has among the lowest ARPU in the world. And those numbers are declining because of price wars. In the June quarter, ARPU for GSM users fell 10% from the previous quarter to Rs185 ($3.92) while for CDMA they declined to Rs92, according to TRAI.

Among the likely Indian contenders, "Reliance Communications has prepared for a qualified institutional placement for Rs150 billion, and additionally/alternatively may raise money through an IPO of Reliance Infratel, and the amounts may not be trivial," IIFL analyst GV Giri said in a note.

"Tata DoCoMo has displayed unbridled aggression in its brief time (until now) as a GSM operator, and some of this may spill over to the 3G auctions, especially plausible if one remembers that DoCoMo invested in Tata Tele at very high valuations."  With the MTN acquisition off the table for now, Bharti is in a strong spot as well financially. But Vodafone Essar, which reportedly already has a debt of $4 billion, will "be pragmatic rather than reckless" in any bidding war, Giri says.

India's 3G auction has kicked off at a time when even the most profitable telecom businesses are reeling under the impact of intensified competition and declining subscriber additions. But if they want to expand into the market, operators have little option but to fork out the millions needed to acquire additional spectrum. That's once those handing it out decide when to part with it.