In recent years, the telecommunications sector has faced the challenge of deteriorating profitability. Sustainability issues haunt all major operators, and a sense of desperation prevails among industry players. Although the industry is watching the regulator, hoping it pulls a rabbit out of the hat, companies must do some soul-searching and innovate to overcome the challenges.
There are, however, a few options at hand for the government and cellular mobile operators (CMOs) to ward off the impending crisis. But how likely are these milestones to materialize?
Now let’s talk about those financial results. Recent financial results announced by the sector paint a rather grim picture of the seriousness of the situation, as industry-wide revenues have taken a toll while high operating costs have put a damper on the profitability. Amir Ibrahim, CEO of Jazz, in a recorded video message, commented on the situation: “This is the first time in our history that revenues have declined, in dollars, for four consecutive quarters compared to the previous year.”
However, Jazz is doing much better than its competitors who are not only experiencing declining revenues but posting huge losses. Ufone, for example, recorded a loss of around PKR 8 billion, turning PTCL’s net income into negative on its own.
Telenor’s situation is also grim. Financial operating results during the second quarter of this year were negative. Earnings before interest, amortization and tax (EBITDA) fell 15% as operating costs rose 30% due to currency devaluation and high energy costs. This triggered an impairment event which led Telenor’s parent company to write down the recoverable amount of assets in Pakistan by $850-600 million. (Read more about this in the Profit article: Telenor Impairment: Has the band lost hope?)
According to Jazz’s investor presentation, an increase in diesel costs of approximately 169% year-over-year (YoY) and 41% in electricity costs year-on-year drove the energy cost of tower operations, a important component of the telecommunications operator’s infrastructure. (Read more about this in the Profit article: Telecom Operators‘ Energy Concerns: Unnecessary Whining or Real Problem?)
“The increase in withholding tax from 10% to 15% on January 16, 2022 and the reduction in mobile termination rates from 0.70 PKR to 0.50 PKR were major headwinds, slowing revenue growth during the quarter,” the presentation adds.
According to the PTA, the mobile termination rate (MTR) is the price that a cellular mobile operator (CMO) charges another mobile operator to terminate out-of-network calls on its network. For example, if a Ufone user calls a Telenor user, then Ufone will pay the Telenor termination fee to facilitate that call.
The net effect of this would be greater for Jazz than for smaller players, as it has a larger customer base, hence more scope to bill other operators.
Moreover, interest rate hikes have also added to Telco’s wishes. For example, Ufone financed its spectrum purchase last year using a long-term debt facility. Additionally, Jazz has also increased its leverage as equity financing is expensive, especially in a country like Pakistan where the risk premium is extremely high.
According to PACRA, “Therefore, in an effort to rein in demand and inflation, a restrictive monetary measure in the form of an annual increase in policy rates of 675 basis points had to be put in place during the exercise 22; The MPR increased from a constant rate of 7% to 13.75% from FY21 to FY22. The new fiscal year (FY23) began with a further 125 basis point increase in the policy rate to 15.00%.
The rating agency estimated that interest rate hikes in the last year alone have created an additional cost of around PKR 19 billion for the telecom sector.
Additionally, the ability of telecom operators to absorb these shocks is compromised due to the fact that revenue growth has historically been slow, growing at an average rate of around 4% over the past five years.
The path to follow
There is consensus within the industry that the average revenue per user (ARPU), which is around $1, must increase significantly for the survival of cellular operators. There might be some relief on that front after recent CMO rate hikes. In India, tariffs were revised upwards in November last year, resulting in an industry-wide ARPU growth.
Yet, this will not be enough to see a turnaround in Pakistan’s telecommunications sector. There is a limit to rate hikes and excessive hikes could undermine future growth potential. Additionally, for Jazz, rate hikes must be pre-approved by the regulator as the company is ranked as a significant market player following the acquisition of Warid.
In addition, a major issue for the sector is spectrum and license fees. There are three aspects that players have sought relief from; with spectrum being priced in dollars, high spectrum pricing (nearly doubled from 2004) and a small five-year window to pay fees.
Comparable economies in the East and in India are some of the examples cited when making the case for spectrum fees in PKR. In addition, the industry requested to extend the license payment period from 5 to 10 years.
Irfan Wahab, CEO of Telenor, in an interview with Profit, earlier this year, said: “If we look at the sustainability of the business, our main cost elements are in US dollars, which is insane for a country like ours. It made sense in 2004 when we entered the market as an international investor, but now we are a player here. We win here. Our customers pay us in rupees.
“You cannot pay your annual license fees and spectrum fees in dollars, especially in an environment where the dollar has rapidly devalued.” He added.
However, the demand for a significant spectrum price reduction and pricing change in PKR is unlikely to be met. The reason is simple, Pakistan, like many other border markets, relies on these one-time dollar payments to bridge the balance of payments gap. Moreover, in the current economic situation, the government is likely to prioritize short-term funding objectives over long-term growth.
Yet one demand from the sector that the government can possibly respond to is the suspension of the USF and Ignite contribution. In accordance with the regulations, all CMOs contribute 1.5% of their gross income to the Universal Development Fund and 0.5% to the Ignite fund. According to officials associated with the sector, the suspension of contributions for two to three years will not affect the activities of the aforementioned funds as sufficient reserves are available. However, this will have a positive effect on the bottom line of telecom operators. For example, a contribution holiday can improve Jazz’s EBITDA by approximately 4%.
However, telecom operators also need to do some soul-searching. They have been slow to innovate, which now comes down to biting them. But, belatedly, the big players have recognized the need to be dynamic and pursue a 4G multi-play strategy, meaning that an operator must not only remain a pipeline, but also a destination for its customers. Users are expected to spend more time on the network using its digital applications, thereby generating additional revenue.
Source: VEON (parent of Jazz) results presentation
“In our quest to become a platform player, we have launched the Mini App program and Open APIs to further develop the digital ecosystem in the country. We want to position ourselves as a platform where other parties can integrate with us and create new value with a transparent payment layer available on our platform.With strong payment capabilities at its core, we aspire to leverage the platform’s business model approach and be The Lifestyle Companion App / Super App Mr. Mudassar Aqil, CEO, Telenor Microfinance Bank/Easypaisa.
Also, there needs to be some serious thinking about consolidation in the sector. Jazz has consistently outperformed other players and managed to be profitable even in times of crisis, as it moved at the right time by acquiring Warid.
“There is an enormous degree of mergers and consolidation that has occurred in all major markets. When I worked in the US there were 15-16 GSM carriers and now there are only three. Also look at our neighboring countries like China, a market that has so many resources. They are adamant about deploying no more than 2 networks on 5G. So you need scale in this industry and that’s why I think consolidation is important for any healthy market. Irfan Wahab told Profit in an interview.
Still, it all depends on the user base. Growing the subscriber base should be the main focus as it will be the driving factor for everything mentioned in this article. However, the regulatory framework prevented this from happening. Import restrictions on key raw materials for smartphone manufacturing and high taxation have kept smartphone penetration low, posing a serious threat to the telecom industry‘s 4G multiplayer strategy,
Pakistan is already in the lower rungs when it comes to digital inclusion. The current situation threatens to aggravate this problem and tip the country into the age of digital darkness.