Every now and then, a new player comes along and disrupts an equilibrium. Reliance Jio is repeating the same strategy in the telecom business. With uncertainties all around, what should an investor focus upon? What is the key parameter of a business that defines its true potential?
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1. Analyzing Jio’s promises by the numbers
2. History repeated: What happened to Reliance Telecom after similar grand entry in last decade?
3. Importance of sustainable competitive advantage
4. Strategies of business with and without moats
5. Weather report: the effect of Jio on intra-day performance of competitors, and market movements in past two weeks
Read the Transcript of this Podcast:
Reliance is investing Rs. 150,000 cr. in Jio venture. The Cost of Capital in India is about 12% of the investment. So shareholders of Reliance will benefit only when the company earns more than 12% on this Rs 150,000 cr. investment. Thus Jio needs to earn at least Rs. 18,000 cr. every year.
Comparison with existing players and feasibility of numbers
Bharati Airtel is India’s largest telecom service provider, with a 24% share of total subscribers and a 30% share in the total industry revenue. The operating profit from their Indian operations is around Rs. 12,000 Cr.
Airtel’s domestic mobile business has an operating margin of about 20%. In India Airtel has the highest operating profit margin among all players. Globally, the telecom company’s margins vary between mid-single digits to as high as 30%. Let us be optimistic and assume that Reliance can efficiently manage a 25% operating margin.
At a 25% operating margin, to earn Rs. 18,000 cr. of profit, they will have to generate revenue of Rs. 72,000 Crores per year. Currently the Indian telecom industry’s revenues are around 150,000 cr. So, Jio has to capture 50% of industry’s revenue even though they are starting from scratch.
Assuming that every consumer generates Rs. 150 worth of revenue per month, then in order to generate Rs. 6,000 cr. in revenue per month, Jio will need 40 crore subscribers, which is accounts for nearly almost 40% of the current mobile phone user base.
Now this is a very simplistic view. This ‘Average Revenue per user’ figure can vary, and other mobile companies are not going to sit quietly, as they watch their market share being eaten into. It is going to be a speculative game.
When mobile services were in their nascent stage in India, the prices were exorbitant, and, there used to be a fee in order to receive calls as well. In December 2002, Reliance Communication was launched amid huge fanfare, with a dream to make a phone call at the price of a post card. A price war was triggered, and the other companies in the telecom industry had to match the prices or better the quality of their services in order to retain their market shares. The fight to acquire customers became so fierce, that at one point, there was a company that even paid consumers to receive calls! After a few years of fierce price cuts and brand wars, finally the prices for telecom services settled to a new base. The consumer benefitted the most through this pricing war, and today, India has the lowest telecom tariffs in the world.
However, the story was not the same for the investors. If we compare the last decade’s vital statistics for telecom companies, the numbers tell a different story. Despite being the game-changer that brought in a huge change in the pricing and accessibility of mobile phones to the mass market, the numbers are not in favour of Reliance. A few important parameters for an investor are
- Revenue growth
- Return on Assets and lastly,
- Annualized returns
In all three parameters, Revenue growth, Return on Assets, and annualized returns, Reliance Communication have the lowest numbers when compared to Idea and Bharti Airtel. This goes to show that something that is beneficial to a consumer may not be one-to-one beneficial to an investor.