How did they get into this mess?

The Supreme Court's ruling on the long-standing dispute on the definition of adjusted gross revenue (AGR) between the Department of Telecommunications (DoT) and telecom operators is the foremost cause for this.

Telecom operators are required to pay a part of their revenue from telecom services to the government. As per the new definition, the revenues from non-core activities too need to be included, as was demanded by the DoT.

Accordingly, the operators now have to pay past dues which include penalty, interest, and interest on penalty amounting to Rs 92,641 crore (by operational and non-operational players). The huge quarterly loss was on account of Rs 28,450 crore provision by Bharti Airtel and Rs 25,677 crore provision by Vodafone Idea for AGR payments. Reliance Jio being a new entrant does not owe much to the government.

Vodafone Idea and Bharti Airtel do not have sufficient cash flows in their books to cover the dues. On the other hand, given the huge amount, financing option will not be easily available to them.

Vodafone's UK-based parent company has refused to infuse more money into the India operation, while Bharti Airtel has said that there can be no assurance of success in the management's plans to raise funds.

Graph 1: Service provider-wise market share

Data as on August 31, 2019
(Source: TRAI)

This has raised a serious concern of the two telecom giants facing liquidation. The only relief measure in sight will be if the government intervenes.

Why it is important for telecom sector to flourish...

If one or more incumbents collapse, the sector will lack competition. This could pose a threat to the sector's ability to handle the subscribers who will need to port to other operators and impact the quality of services operators provide. The impact will also be seen in allied industries such as towers and storage batteries. Its effect on the future capex plans of the operators and potential job cuts cannot be ignored.

Graph 2: Subscriber addition in the month of August 2019

Data as on August 31, 2019
(Source: TRAI)

The financial sector may see a significant impact if the troubles in the sector continues. As per media reports, big names in the banking sector such as SBI, HDFC Bank, and Axis Bank have substantial exposures to Vodafone Idea and Bharti Airtel.

The troubles in the sector could also rub off on mutual funds with aggregate debt exposure of Rs 5,959 crore and aggregate equity exposure of Rs 17,458 crore to Vodafone Idea and Bharti Airtel.

Table 1: Mutual fund exposure to Vodafone Idea and Bharti Airtel

Company Name	Market Value (Cr.)
	Debt	Equity
Bharti Airtel	2,583	16,815
Vodafone Idea	3,376	643

Data as on October 31, 2019
(Source: ACE MF)

Franklin Templeton Asset Management India, ICICI Prudential Asset Management Company, SBI Funds Management are some of the fund houses that have high equity and debt exposure to Vodafone Idea and Bharti Airtel.

In the recent past, debt mutual funds have had exposure to troubled firms such as IL&FS, DHFL, Reliance ADAG group firms, and Essel group firms.

[Read: Are You Holding Debt Mutual Funds With Stressed Assets?]

Table 2: Fund houses with highest exposure to Vodafone Idea and Bharti Airtel

Data as on October 31, 2019
(Source: ACE MF)

The road ahead...

The Cellular Operators Association of India (COAI) has sought the government's intervention to provide relief to these financially troubled companies. It has requested a waiver on interest, penalty and interest on penalty along with a longer period for the payment of the principal amount. Further, it has sought a two-year moratorium on spectrum payment and reduction in licence fee from 8% to 3% of annual revenue.

It is unlikely that the government will let major telecom companies go bust in the interest of the sector as well as the economy.

Finance Minister, Ms Nirmala Sitharaman has said that they do not want any company to shut operations, but their decision on including the dues arising out of the Supreme Court judgment into its own accounts is still in the pipeline.

The government has set up a panel headed by Cabinet Secretary Rajiv Gauba to understand and ease the financial burden in the sector.

Therefore, relief measure such as waiver of dues, deferred payment, bringing down the applicable levies, etc. may be expected soon. It may also consider steps to ensure better competition in the sector such as setting of floor price on voice and data services.

What should investors do?

It is likely that debt papers of Vodafone Idea and Bharti Airtel will be downgraded. Mutual funds with equity exposure may offload their holdings in the troubled firms.

If your fund has exposure to these firms, review and evaluate its performance based on qualitative and quantitative parameters. If the fund has performed consistently well over a period of time and has robust investment strategy and adequate risk management system in place, you need not worry.

Credit risk can crop up anytime and avoiding it is almost impossible -- even for a seasoned fund manager. However, if you invest in process-driven fund that avoids taking concentrated bets and focuses on portfolio characteristics, the risk involved can be reduced.

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