Telecom

India

ATTRACTIVE
FEBRUARY 06, 2014 UPDATE BSE-30: 20,311

Auctions day 4 update: War of attrition on 900; rub-off on 1800 likely. Day 4 of the ongoing auctions saw 900 prices stay flat at end-day-3 levels in Mumbai and Kolkata, while moving up 11% in Delhi. Overall 900 prices are now around 72% higher than the reserve price. Selective excess demand in a few circles continued in the 1800 band with pan-India price now 9% above the reserve price. The 900 war of attrition could have a rub-off effect on 1800 auctions we illustrate this aspect in this report.

Day 4 update selective bidding continues Quick summary of day 4 action Delhi, 900 MHz provisional winning price (PWP) at the end of round 28 was 11% higher than day 3, a cumulative increase of 78% over the initial reserve price to `3.6 bn per MHz. As we had discussed in detail in a couple of our earlier notes, demand assessment based on the reported last-round-of-the-day bids (for records, demand of 10 blocks in round 28 in Delhi versus a supply of 16) is futile. The only data point of relevance from the end-of-the-day reports is the end-of-the-day PWP. Mumbai, 900 MHz PWP remained flat at end-day-3 prices, keeping the cumulative increase over reserve price at 72%. Flat PWP only means that there was no excess demand during any round completed on day 4; nothing more, whatsoever. Lack of excess demand in any of the rounds does not mean lack of true excess underlying demand. Kolkata, 900 MHz PWP remained at end-day-3 levels keeping the cumulative increase over reserve price to 54%. Same analysis as Mumbai holds, as far as demand assessment is concerned. 1800 MHz auctions prices in 10 circles ended above the reserve price Assam (79% above reserve price now), Bihar (14%), Delhi (5%), Gujarat (39% above), J&K (18%), MP (4%), Maharashtra (31%), UP East (3%), UP West (36%) and West Bengal (13%). Blended pan-India 1800 price has moved up 9.2% over reserve price levels. Interestingly, 1800 price in Maharashtra has now moved ahead of both Delhi and Mumbai a result of auction dynamics and not necessarily the underlying relative value of 1800 MHz in these circles. The same auction dynamics (1) are perhaps driving some unexpected bidding decisions by the operators, and (2) make 900 auctions a war of attrition and can have a rub-off effect on the 1800 auctions, in our view. We discuss these next. Idea could be bidding aggressively for 1800 MHz spectrum in their upcoming renewal circles This is the last auction where we see non-renewal 1800 MHz spectrum being auctioned. From here, auctions for 900/1800 spectrum will all have renewal spectrum on the block. This places the incumbents, especially Idea with its smaller balance sheet, superior capital discipline and higher dependence on its key 900 circles coming up for renewal next year, in a difficult spot. Vodafone and Bharti, in their renewal circles (Delhi, Kolkata and Mumbai for Voda; the first two for Bharti), can afford to lose 900 MHz spectrum without being forced to get out of business given that they have the option of bidding for and winning 1800 spectrum in these circles in these auctions. Renewal licensees would have no such choice in forthcoming renewals. They can mitigate this business continuity risk (or the risk of seriously overpaying for renewal spectrum) by buying insurance in the form of 1800 spectrum in these auctions. We see the incumbents doing this.

Rohit Chordia
rohit.chordia@kotak.com Mumbai: +91-22-4336-0885

Shyam M.
shyam.m@kotak.com Mumbai: +91-22-4336-0862

Kotak Institutional Equities Research kotak.research@kotak.com Mumbai: +91-22-4336-0000 For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL.

India

Telecom

900 auctions are perhaps a war of attrition already, in our view; we could remain stuck with low price movements for quite some time
Two quick points here (1) these auctions will not see pricing action accelerate once the activity requirement is set to 100% (unlike the 2010 3G/BWA auctions); this is because of a minor, yet significant, change in the auction closing conditions, and (2) we believe the war of attrition on the 900 auctions could have a rub-off effect on the 1800 auctions as players vie for ranking on the 900 side (a player who is not a provisional winning bidder in the 900 auctions in a particular circle may only have this route, i.e. bidding for 1800 spectrum, left to move up on rankings and become a provisional winning bidder on the 900 side). Sounds strange, perhaps; however, as you would already appreciate, the auction design and rules are fairly intricate and hence, nothing really should be seen as strange. Coming to the first point, the change in closing condition that we highlight is that auctions now close only when activity requirement is 100% and there is no bid whatsoever in any of the circles in a particular round. In the 2010 auctions, this condition was no excess demand in any of the circles. This is significant because under the 2010 auction rules, a provisional winner had to necessarily place a bid in every round (after the activity requirement was set to 100%) or risk losing the spectrum if a new player bid in the next round and excess demand still turned out to be negative. There is no such risk in these auctions as any new bid means at least one more round. We tried, but couldnt express it simpler. Broader point is that these auctions may not see the sort of price escalation that the 2010 auctions saw once the activity requirement is set to 100%. Disclaimer: we do not know what the activity requirement is, at this point. It may well already be 100%. The downside of this change in rule is that it could prolong the wait for auctions to close. The second point discussed above, i.e. 900 MHz spectrum auctions having a rub-off effect on 1800 auctions from a 900 ranking perspective (and not from the straightforward if not 900, 1800 perspective) is even more nuanced. Essentially, you could end up in a scenario where a player who is not a provisional winner cannot become one unless (1) one of the extant provisional winners also bids (which the provisional winners have no incentive to) or (2) he moves up on rankings by taking the total value of his bids up by bidding up in the 1800 band. In other words, this player cannot move up the rankings on the 900 side through any action on this side. Happy to discuss this nuance in detail; call us, please. Fiscal collections could be moderately higher than expected According to unconfirmed media reports, the DoT has indicated that as of end of day 4 it had received bids worth `527 bn, which under the deferred payment option would translate to about `156 bn of cash payouts to the exchequer. We had underestimated this number a little as the underlying demand (and not the snapshot of the demand at the end of a particular clock round) is evident only to the auction house.
Exhibit 1: 900 MHz auctions - status update at the end of day 4
Demand > blocks Demand = blocks Demand < blocks Block size: 1 MHz 6-Feb-14 End-round 28 PWP over Provisional Round price over reserve winning price, reserve price (%) PWP (Rs mn) price (%) 79.3 6,392 77.6 55.7 1,927 54.2 73.4 5,631 71.7 73.3 13,950 71.6

Delhi Kolkata Mumbai Total

# of blocks Reserve price per being auctioned block (Rs mn) 16 3,600 14 1,250 16 3,280 8,130

Eligibility points 300 150 300 750

Blocks demand (#) 10 7 5 22

Round price (Rs mn) 6,456 1,946 5,687 14,090

Source: DoT, Kotak Institutional Equities

KOTAK INSTITUTIONAL EQUITIES RESEARCH

Telecom

India

Exhibit 2: 1800 MHz auctions - status update at the end of day 4

Demand > blocks Demand = blocks Demand < blocks # of blocks being auctioned 113 57 12 105 60 82 102 22 123 140 125 96 70 117 125 131 92 95 151 40 12 56 1,926 Reserve price per block (Rs mn) 326 14 74 438 286 54 12 10 310 104 146 86 346 414 14 32 108 52 416 122 124 42 3,530 Block size: 0.2 MHz 6-Feb-14 End-round 28 Round price over reserve price (%) 79.3 15.4 6.1 43.6 18.0 3.7 40.6 3.0 36.4 15.0 10.6 Provisional winning price, PWP (Rs mn) 326 25 85 460 399 54 12 12 310 104 146 89 455 414 14 32 108 52 416 126 169 47 3,854 PWP over reserve price (%) 79.3 14.3 5.0 39.4 18.0 3.7 31.4 3.0 36.4 12.9 9.2

Andhra Pradesh Assam Bihar Delhi Gujarat Haryana Himachal Pradesh J&K Karnataka Kerala Kolkata Madhya Pradesh Maharashtra Mumbai North East Orissa Punjab Rajasthan Tamilnadu UP east UP west West Bengal Total

Eligibility points 55 3 10 55 55 10 3 3 55 22 22 10 55 55 3 10 22 10 55 22 22 10 567

Blocks demand (#) 103 62 5 78 51 25 51 29 119 106 90 97 53 116 81 50 82 53 56 45 14 37 1,403

Round price (Rs mn) 326 25 85 465 411 54 12 12 310 104 146 89 486 414 14 32 108 52 416 126 169 48 3,904

Source: DoT, Kotak Institutional Equities

KOTAK INSTITUTIONAL EQUITIES RESEARCH

Disclosures
"I, Rohit Chordia, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in this report."

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Source: Kotak Institutional Equities

As of December 31, 2013

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