Will the spectrum auction be a flop show?

Nov 12, 2012

In this issue:
» Infra firms continue to languish
» 'FM has inherited a huge fiscal mess'
» Can the US fiscal cliff be a good thing?
» Japanese economy shrinks by 3%
» ...and more!

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    A very important event is supposed to take place today. There are two parties who are equally interested in this event. One for filling its own pockets. The other because this event will be defining their financial health. The event we are referring to is the telecom spectrum auction that is supposed to commence from today. The interested parties are the government and the telecom operators.

    Just to understand the event let us take a step back into history. Earlier this year the Supreme Court cancelled the 122 telecom licenses that were issued by the erstwhile telecom minister. It further directed the regulator to auction these licenses and the attached spectrum. The government and the regulator decided to auction only a portion of this spectrum thus creating an artificial scarcity. Furthermore it decided to keep the reserve price for the auction at a level similar to the price identified under the 3G auction held in 2010. Now this part is extremely crucial because one has to keep in mind that the 3G spectrum is premium to the 2G one. So ideally the latter should be priced at a much lower level. Nevertheless the government needs money to bridge its fiscal gap so the price has been set at what it is. Another thing that will be decided by this auction would be the fee at which the existing licenses would be renewed for the operators. Also the fee payable by them for holding spectrum beyond the capped limits.

    Going by this these auctions are extremely crucial both for the government as well as the industry. If the auction is successful then the government stands to gain a minimum of Rs 140 bn from it. But on the other hand is the industry. Things are a bit dicey on this front. There are two set of participants here - the new entrants and the incumbents. The new entrants looking to participate in these auctions are already cash strapped. Their operations were not really value accretive given the intense competition that has gripped the sector since 2008. As a result these operators are not looking to bid aggressively given the huge costs involved.

    The incumbents on the other hand have very little incentive to participate in the auction. They have been told that in the refarming that will ensue when their current licenses expire, they will be given the spectrum to the extent they already hold. And that this would be given at the price identified post these auctions. Therefore incumbent operators would already get the same quantum of spectrum that they current have but at the higher costs, why would they wish to bid aggressively in the current auction? Does not make any sense. Furthermore, if they end up with more spectrum as compared to the capped limits, they would end up paying a bomb in the form of the fees. So the incumbents do not have much interest in bidding aggressively either.

    So who will bid aggressively in these auctions? Our view is no one. In that event, the government would be left red faced. If the operators get adventurous and bid get aggressively despite all the concerns, the auction would be success. But we doubt this would happen.

    Do you think the 2G auctions would be as big a success as the 3G auctions in 2010? Do share your comments with us or post your views on our Facebook page / Google+ page

     Chart of the day
    A common belief amongst managers and investors alike is that the unlisted companies grow better than the listed one. However a study carried out by the leading daily, Business Line states otherwise. As per the study listed companies have outperformed their unlisted peers in the term period from 2005 to 2012. The listed set of companies saw their sales and operating profits rise by 17.9% and 133% n an annual basis over this period. On the other hand, the unlisted set saw their sales and operating profits go up by 14.2% and 3.7% over the same period. Even on the margin front, the listed companies have done better. The unlisted companies have seen their net margins dip to 0.2% in 2012 as compared to 6.9% seen in 2005. The same numbers for their listed counterparts stood at 4.8% and 7.5% respectively.

    Data source: Hindu Business Line

    Quarter after quarter hopes of revival are penned down. But every time the sorry tale continues. The tale relates to declining profits for infrastructure companies. Rising interest costs and execution issues have again hit the bottomline of frontline infrastructure companies, in 2QFY13. For instance, Lanco Infratech reported a decline in profits for the quarter. So, is the case with Nagarjuna Constructions (NCC). In fact, some like GVK Power and Infrastructure have reported a loss, all together, for the quarter.

    Over leveraged balance sheets had increased the interest burden of infrastructure companies. And with execution not up to the mark bottomline came under pressure. Shortage of fuel supply also made life difficult for them. If Reserve Bank of India (RBI) cuts lending rates the situation might improve. That's because the borrowing cost will decline after that. However, we feel that apart from interest rates measures to eliminate policy roadblocks is equally important. Unless, that happens infrastructure companies will continue to bleed.

    Were it not for Mr Raghuram Rajan, a certain Mr Ajay Chhibber would have been the country's Chief Economic Advisor. Nevertheless, in a recent interview, Mr Chhibber did give some hint of how he would have gone about his job that he narrowly missed out on. Reform oriented yet pragmatic, Chhibber is of the view that prospects of the global economy over a period of as long as 10 years are not that positive.

    Thus, for India to grow at 8%-9%, a lot more will have to be done internally. So, is he satisfied with the recent steps towards reforms that India has taken? Certainly not. But he does believe that recent threats of a downgrade in India's ratings have woken up the Government. It has focused the minds enough to be able to think in the direction of reforms. He has also acknowledged that the FM's hands are tied due to the huge fiscal mess that he has inherited. Besides, with elections barely two years away, it will be difficult to have a very aggressive fiscal plan as per him. And there is every possibility that the forthcoming budget would be more populist in nature even though an exactly opposite approach would be needed. Some very wise words we should say.

    Reality has hit the global economy big time. That too soon after the feel-good factor of the US elections died down. On one hand concerns over the impending US fiscal cliff is making investors jittery. On the other, economic data from Japan confirms all fears of futility of low interest rates. The Japanese economy contracted by 3.5% in the September quarter. Another fall in GDP in the quarter ending December 2002 will officially put Japan in recession. Japanese policy makers have struggled to revive the economy for nearly two decades. The easy monetary policy all this while has proven futile. It has hardly helped the economy to break out of its deflationary trend. Meanwhile, the Japanese yen remains stubbornly high. The currency has discouraged capital investments. It has also undermined Japan's export competitiveness. Especially against rivals Germany and South Korea. Meanwhile the Japanese government has been borrowing overtime by issuing bonds. Its own version of fiscal cliff seems as scary as that in the US.

    In the recent past, the US 'fiscal cliff' has been one of the most debated topics in the global financial media. Before we go any further, let us tell what the term 'fiscal cliff' means. The term refers to expiration of tax cuts and reduction in government spending that are set to become effective from December 31, 2012. It must be recalled that the tax cuts implemented during the Bush administration were set to expire in 2010. However, the expiry was delayed by the Congress on account of the US presidential elections in the current year. Now, if the Bush tax cuts are allowed to expire, the tax burden on all Americans would go up. Moreover, starting January 2013, about 26 million American households will again be subject to alternative minimum tax. All in all, an average American would have to shell out US$ 2,000 to 3,000 more in taxes each year. That's one part of the story. On the other hand, the US government spending is also set to undergo sudden and immediate cut starting January 2013. Now, this seems like a perfect recipe to ensure a 100% recession in an already ailing economy.

    It goes without saying that policy makers and investors alike are terrified about the impending fiscal cliff. But surprisingly, one money manager is pretty optimistic about it. He thinks that the crisis-like situation will force both Democrats and Republicans to compromise and come to a consensus. It is typical of political parties to drag on disagreements until the proverbial waters reach the neck. So hopefully the policy makers will stop playing their petty political games and focus more on real economics.

    In the meanwhile, after opening the day on a positive note, the Indian equity markets are currently trading below the dotted line. At the time of writing, Sensex was down by 25 points (0.1%). Other major Asian stock markets have closed the day on a mixed note with China and Hong Kong closing in the green while markets in Japan and Taiwan closed in the red.

     Today's Investing Mantra
    "When you locate a bargain, you must ask, 'Why me, God? Why am I the only one who could find this bargain?" - Charlie Munger

    Click here to read our series on 'Lessons from Charlie Munger'

    Please note that there would be no edition of The 5 Minute Wrapup on November 13th, 2012 and November 14th, 2012 on account of Diwali.

    We wish all our readers a very Happy Diwali!

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