ICRA RATING FEATURE

I&B MINISTRYS APPROVAL OF TRAIS RECOMMENDATIONS FOR DIGITISATION OF CABLE TV SYSTEMS IN INDIA: IMPACT & OUTLOOK
Contacts
Anjan Ghosh aghosh@icraindia.com (+91-22-30470006) Subrata Ray subrata@icraindia.com (+91-22-30470027) Jitin Makkar jitinm@icraindia.com (+91-124-4545368)

Overview
The Information and Broadcasting (I&B) Ministry has accepted the recommendations of the Telecom Regulatory Authority of India (TRAI) for implementation of digital addressable cable television systems in India, to transition from the existing analog cable network. Although the I&B Ministry has deferred the timelines proposed by TRAI and pushed the proposed sunset date for analog cable distribution from December 2013 to March 2015, in ICRAs view, the approval of TRAIs other recommendations by the Ministry is a significant positive development for the Indian TV distribution space as digitization would pave the way for the cable distribution sector to become more organized, attract greater institutional funding and improve profitability. In addition, other stakeholders in the value chain would also potentially benefit broadcasters by way of increase in subscription revenues, government via increase in service tax collections and customers from an enhanced television viewing experience. In August 2010, TRAI had worked out a framework for implementation of digitization enumerating several measures such as fiscal incentives, right of way etc and had given its recommendations to implement digitization of cable systems pan-India by December 2013 in a phased manner. Even as TRAIs proposed timelines were considered to be ambitious, in view of various sensitive issues involved such as eventual displacement of small Multi System Operators (MSOs) and marginalization of a vast majority of Local Cable Operators (LCOs), besides the enormity of grassroot preparation and investments required for putting in place digital infrastructure, the recommendations were a pointer to the strengthening regulatory push for digitization of cable distribution network in India. The recent approval of TRAIs recommendations by the I&B Ministry is expected to reinforce the cable digitization process. Having accorded its approval, the Ministry has now sent back its proposal containing revised timelines to TRAI for comments before it could table the same before the Union Cabinet for final approval. The legacy analog cable distribution in India is currently replete with several maladies such as the practice of under-reporting of true subscriber base by LCOs which results in inequitable distribution of value amongst the key participants in the media value chain; near monopoly status of LCOs and MSOs in various regions depriving the customers of alternatives; lack of standardization on pricing and capacity constraints curtailing the number of channels that could be carried. The onset of digitisation would mark a paradigm shift in the cable distribution landscape overcoming the limitations in the analog cable systems. While digitization would structurally shift the balance of power away from LCOs and reduce industry fragmentation (which has already witnessed substantial consolidation over the last two years), the process would involve large investments across distribution platforms including cable, Directto-Home (DTH) and Internet Protocol Television (IPTV).

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Already, aggregate investments worth around Rs. 2,000 Crore have been incurred by large national MSOs towards acquisition of smaller regional MSOs and LCOs; and investments worth Rs. 13,000 Crore have been incurred by DTH players towards customer acquisition. As per ICRAs estimates, to achieve complete digitization by March 2015, additional investments of around Rs. 15,000 Crore would be required. While from the industry standpoint, this would imply the need for large fresh capital mobilization; from customers perspective, this could lead to gradual increase in subscriptions costs over the medium term although in exchange for better service value. Considering the capital intensive nature of the industry, ICRA believes further consolidation would become imperative for the industry players to remain viable given the compelling need to achieve scale. Assuming the Ministrys proposed timeline for transition to digital cable by March 2015 gets final approval, the key risks to the pace of digitization process could be (a) the ability of distribution players to successfully raise incremental funds; (b) customers response and acceptability of the value proposition offered by digitization; and (c) the level of competitive intensity in the industry which may impair industry profitability. TRAIs recommendations on implementation of Digital Addressable Cable TV Systems In August 2010, TRAI had come out with its recommendations giving the roadmap for implementation of digital cable systems in India. Some of the key recommendations are enumerated below: Migration to a digital addressable cable TV system to be implemented in four phases with sunset date for analog cable TV services as December 31, 2013: o Phase-I: In four metros by March 31, 2011 o Phase-II: In all cities having a population of over one million, by December 31, 2011 o Phase-III: In all other urban areas (municipal corporations/ municipalities) by December 31, 2012 o Phase-IV: In the rest of India by December 31, 2013 All service providers who have set-up a digital addressable distribution network before the sunset date to be treated similar to telecom providers and be eligible for income tax holiday for the period from the date of setting up of the network or April 1, 2011, whichever is later, till March 31, 2019 Basic custom duty on digital head-end equipment and STBs to be reduced to NIL for three years (from 5% currently) MSOs/ LCOs to be eligible for seeking Right of Way on non-exclusive basis for laying optical fibre/ cable network Recently, the I&B Ministry has approved the recommendations given by TRAI, except the one related to the phased implementation roadmap for digitization. As per the Ministry, the timeline proposed by TRAI was optimistic considering (a) the paucity of set-top-boxes (STBs) required to be seeded at customer premises - a tall order in view of the large volumes of around 75 million involved1; (b) inadequate local manufacturing capacity of STBs at present; and (c) investments required to be made by MSOs towards setting-up of other digital infrastructure such as head-ends and related network equipment. Accordingly, the Ministry has revised the timelines for implementation of digital cable systems as given below: o Phase-I: In four metros by March 31, 2012 o Phase-II: In all cities having a population of over one million, by March 31, 2013 o Phase-III: In all other urban areas (municipal corporations/ municipalities) by November 30, 2014 o Phase-IV: In the rest of India by March 31, 2015 ICRAs interaction with industry players suggests that even though the timelines have been pushed back by a period of more than a year, the revised timelines proposed by the Ministry seem realistic and would stimulate the cable digitization drive in India. In fact, over the last two years, some of the large national MSOs like DEN, Hathway and Digicable have been focusing more on acquisition of smaller MSOs and LCOs to gain control over the last mile rather than push digitization. Now with the regulatory support behind them, ICRA expects the large MSOs efforts and resource deployment towards digitization to gain traction. With this, the digital addressable distribution system in India, which at present is being

Many of the MSOs are currently sourcing the STBs from China and Korea
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spearheaded by the seven DTH players, would see a far greater participation from the cable MSOs who are expected to have relatively better revenue and profit growth opportunities. INDUSTRY STRUCTURE The distribution side of the value chain remains highly fragmented - though market structure changing rapidly with a thrust on consolidation The cable & satellite television market in India had emerged in the 1990s and has since then experienced a strong growth in terms of number of subscribers having grown from mere 400,000 in 1992 to around 90 million today, representing a CAGR of 35% for the last 18 years. With a share of roughly 40%, the television industry accounts for the largest share in the roughly Rs. 70,000 Crore Indian Entertainment & Media industry - followed by Print, Film, Radio and other media. The value chain of Indian television comprises of broadcasters, content syndicators2, multi system operators (MSOs) and local cable operators (LCOs) involved in bringing channels/ content to the television (TV) sets of consumers. Broadcaster Content Syndicator MSO LCO Consumer

The channels seen on TV (pay channels or free to air (FTA) channels) are created by different broadcasters and transmitted from satellite to receiving stations (head-ends) owned by MSOs. The MSOs in turn re-transmit these signals through cables to the LCOs, who have their own last mile cable network to individual homes. Currently, the television distribution network in India - catering to around 140 million television homes is predominantly of analog type with over 60% subscribers belonging to this category while the digital cable subscriber base remains low at around 4.5 million television homes3. The market overall is highly fragmented with some 50,000 LCOs and 1,000 MSOs, including around 10 major MSOs. Nevertheless, the market structure has changed significantly over the last two years with increasing trend towards last mile consolidation. This has been driven by the series of acquisitions of primary (i.e. LCOs) and secondary points (i.e. smaller MSOs) carried by large MSOs with investments of around Rs. 1,000 Crore funded through private equity and public issues. With this, the estimated market share of the few large organized MSOs has increased to around 60% currently from around 25% in 2007-08. The entry of large corporate players in the cable space not only offers strong growth potential but also bodes well for value unlocking in the distribution chain which in turn is likely to have a favourable impact across the media value chain. INDUSTRY CHALLENGES Under-reporting of subscriber base by LCOs leading to inequitable distribution of value In the absence of an addressable system, the subscription revenue transaction between the broadcasters, MSOs and LCOs is currently undertaken either on a fixed-fee basis or on the basis of a negotiated subscriber base. Considering the strong bargaining power enjoyed by LCOs who own the last mile, the distribution of subscription revenue in effect remains heavily skewed in their favour. As per industry estimates, LCOs declare only around 15% of their paid connectivity to MSOs and broadcasters. This not only deprives the MSOs and broadcasters of their fair share of value, but also results in service tax leakage for the government. The lack of trust and transparency in the business models of the industry has also led to frequent disputes between stakeholders and increased litigation incidences.

Content syndicators bundle and create packages of television channels and sell these packages to distributors of television channels. Some of the players engaged in this business include Zee Turner, Star DEN, Sony One Alliance, Sun18 and Media Network and Distribution. 3 The remaining households are served by DTH and terrestrial television (Doordarshan)
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Non-standard pricing and local monopoly status of LCOs leading to sub-optimal customer service In a market survey commissioned by TRAI, it had observed that the average monthly cable bill for a subscriber varied widely from Rs. 149 in Kochi to Rs. 322 in Shillong, even though services being provided did not warrant such variation4. This apart, there are instances where the cable charges are increased by LCOs for a locality arbitrarily. These shortcomings are the natural fallout of the local monopoly status enjoyed by most LCOs and small MSOs who are able to avert competition and thus prevent free market forces to keep prices under check. Capacity constraints in analog cable stifling growth of new channels and introduction of technologically advanced content The number of television channels in India has grown at a rapid pace from two in 1992 to 120 in 2003 to around 600 at present. Arrival of a plethora of new channels in the Indian television space in the backdrop of limited bandwidth of the analog cable system, results in allocation of prime frequencies by MSOs to channels offering higher carriage (or placement) fee. Limited capacity5, coupled with the absence of an addressable system, has also resulted in limited availability of subscription-driven niche content such as science, golf as well as technologically advanced content like high-definition (HD) channels. This trend is further fed by the inordinate dependence of broadcasters revenues on advertising (less on subscription) impacting niche content offerings since focus tends to shift on advertisement friendly genres. INDUSTRY PROSPECTS Since 2004, when the mandate to regulate the sector was given to TRAI, it has been actively pushing the cause of cable digitization. In April 2006, TRAI had announced a plan for digitization (referred to as the Conditional Access System or CAS) of the cable network in Indias 55 cities. As of now, the governmentmandated CAS has been implemented over various stages in Chennai, Kolkata, Delhi and Mumbai. TRAI has also been involved in tariff fixation for CAS mandated areas, laying ground for interconnection agreements between broadcasters, MSOs and LCOs to reduce litigations etc. Notwithstanding TRAIs power to regulate and intervene where necessary, it has not proved to be a deterrent and has not prevented market aberrations even in CAS mandated areas. It is in this context that TRAIs recommendations of August 2010 giving contours of complete transition to digital addressable systems and the I&B Ministrys approval of the key recommendations hold considerable significance for the industry. Implications of I&B Ministrys approval of TRAIs recommendations on various stakeholders Broadcasters: Since digitisation would bring about full addressability, it would eliminate the menace of under-reporting of subscriber base by LCOs. This will aid increase in subscription revenues for broadcasters. Further, the increased capacity of digital distribution channel is likely to spur greater investments by broadcasters towards niche, targeted and HD content and lead to diversification of their revenue streams. The carriage costs paid by broadcasters to distributors, which currently remain high in view of the limited bandwidth of analog cable, may decrease post digitisation. However, the extent of correction would hinge on the growth in the number of channels going forward a high growth is likely to maintain high carriage costs for broadcasters. MSOs: Many of the large MSOs till now have remained heavily focused on inorganic growth (mainly through joint ventures with smaller MSOs) in a bid to acquire control over the last mile6 which is a key competitive advantage. With the threshold subscriber base having been secured, the industry appears set to pursue digitization next. Having indirectly acquired end-customers, the MSOs now face the challenge
4

While there could be a view that the lack of standardized pricing negatively affects consumer interest as some pay more than others for the same service, this could be counter-argued by the fact that it enables flexible pricing to accommodate the paying capacities of different strata of consumers. 5 Analog cable has the capacity to carry around 80 channels. 6 The smaller MSOs have been willing to align with the larger ones under the threat of getting marginalized due to the DTH boom

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with respect to customer retention. For a secondary point acquisition, the industry players face the risk of losing the acquired LCO to another MSO; and for a primary point acquisition, there is the risk of losing the end-customer to alternate technology platforms like DTH and IPTV. Thus, it has become imperative for cable distribution companies (MSOs) to pursue digitization aggressively which could increase acquisition costs for competitors and switching costs for customers. The Ministrys approval of TRAIs recommendations is expected to catalyse the MSOs digitisation thrust. With the necessary investments in digitisation, MSOs get a direct access to the customer end, paving the way for better quality service and transparency in subscriber base. The direct access to customers effectively shifts the bargaining power from LCOs to MSOs. MSOs also benefit from this consolidation eventually leading to a greater bargaining power with broadcasters. The MSO alliance is discussing the possibility of (a) having a two-year lock-in for all LCOs to minimize churn in the industry and curtail the bargaining power of LCOs, and (b) allow MSOs to do the billing function (on the digital side), a function which is currently in the hands of the LCOs. The above measures would be significant in terms of potentially shifting the balance of power with the MSOs. However, in ICRAs opinion, some of the key risks for MSOs would be: (a) The ability to raise timely additional capital for pursuing digitization (purchase of STBs, head-ends and related network equipment): To completely effect switchover from analog to digital cable, the cable distribution players are estimated to require funding in the region of Rs. 15,000 Crore. In the past, the cable industry has been unable to attract the magnitude of funds as has been attracted by the DTH industry which has already expended close to Rs. 13,000 Crore towards capital expenditure, advertisement expenses and funding of financial losses. Availability of funds in the DTH space (and direct access, without depending on intermediaries for last mile access) has been one of the key reasons why growth in subscriber base on DTH platform has outpaced the cable TV platform digitization. Once capital constraints for players in the digital cable space could get addressed, this segment is likely to narrow the gap with DTH in terms of the number of incremental subscriber additions. (b) The ability to protect themselves from the onslaught of alternate technology platforms, particularly DTH: The DTH industry7 has seen a strong surge in its subscriber base which has grown from around 3.5 million subscribers in CY2007 to 10 million subscribers in CY2008 to close to 30 million subscribers currently. Currently, the DTH industry is adding around 2 million subscribers per quarter. However, a large proportion of DTH subscriber base belongs to cable-dark areas (areas with limited or no cable access), which implies that DTH has significantly expanded the market and as such the perceived pace of market share loss for cable distribution companies is relatively lower. However, the strong brand awareness created by DTH players is increasingly expanding their footprint such that customer migration from cable to DTH is gathering momentum. That said, considering the existence of a large market, significantly underpenetrated digital universe and the growing trend of multiple television homes, ICRA believes that multiple technology platforms could co-exist profitably (provided competitive pressures subside and ARPUs increase). LCOs: While the expansion of DTH players in LCO territories means customer loss for the latter, an MSOLCO digitisation partnership ensures that the LCO stays in business albeit with a smaller share of revenues. The larger MSOs may be considered to be more adept at giving competition to DTH players in view of relatively superior financial wherewithal (as compared to small MSOs and LCOs) to invest in infrastructure to provide digital TV over existing cable infrastructure. With the onset of cable digitization, LCOs are likely to experience a diminished role in the distribution chain. Nevertheless, their business interests could still be well served over the long-term with the spread of interactive services, value-added services and broadband services. Customers: Mandatory digitization will result in advantages for customers in terms of quality/ reliability of the signal, increased choice of channels and availability of value-added services. However, customer
7

Currently, there are seven DTH players in India viz., Airtel Digital, DD Direct, Dish TV, Reliance Big TV, Sun TV, Tata Sky and Videocon D2H
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education is likely to play a crucial role in the pursuit of the digitisation objective both in terms of overcoming the inertia of switching over to a new technology as well as the follow-up issues of equipment handling and safety. This is expected to be a long drawn process as there is likely to be a substantial divergence in customer maturity levels in a vast and diverse country like India and a mass acceptance for higher subscriber costs and additional one-time expenses would remain a challenge.

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Analyst Contacts
Delhi Anupama Arora (anupama@icraindia.com, 91 124 4545303); Jitin Makkar (jitinm@icraindia.com, 91 124 4545368); Mumbai Subrata Ray (subrata@icraindia.com, 91 22 30470027) Kinjal Shah (kinjal.shah@icraindia.com, 91 22 30470054)

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