Due to the intense competition, and rising expenses post 3G and MNP, Indian telcos will have to either consolidate or diversify in order to survive, says Fitch

Ratings agency Fitch said, the overcapacity in Indian telecom sector would decline over 2014-15 because some of the weaker, smaller telecom players are likely to be either acquired by larger ones, or to merge with each other to improve their financial and operating position.

"Smaller telcos in India continue to struggle to gain market share or achieve positive EBITDA. Their strategy of relying on the fast-growing data market is no longer working, as they are unable to achieve meaningful scale and generate significant profit from the segment amid competition from larger telcos," the ratings agency said in a research report.

At present, merger and acquisition (M&A) in telecom sector is not allowed. Lack of clarity over the telco M&A regime and, in particular, spectrum acquisitions have prevented any consolidation in India so far. However, Fitch says India would announce relaxation in M&A guidelines in telecom sector by the end of this year.

While it is said that some new entrants are easy prey for bigger, cash-rich players like Bharti Airtel, there are incumbents who may be ready to sell their part or complete business. On the one hand, telecom players are seeking to de-leverage their balance sheet through sale of their non-core assets, on the other some players are also following the footsteps of Bharti Airtel in diversifying their presence in other regions outside India.

According to the note, consolidation in telecom sector should improve operating profitability and cash flow of players, but such transactions could weaken the balance sheets of the acquirers if funded by debt. Consequently, mergers of strugglers may have to be all-equity deals to retain sufficient credit capacity to support ongoing operations, it said.

Fitch expect the consolidation to improve small telcos' declining profitability as cost synergies are realised and voice tariffs benefit from lower competition. It said, "Mergers should also lead to lower capex as network infrastructure investments need not be duplicated. Less intensive price competition in the data segment should benefit all. This is particularly important, as the revenue share of lower-margin data products is increasing - as it cannibalises the more profitable voice and text services."

The Indian market is less profitable and more fragmented, and the top three telcos have relatively weaker balance sheets - which are more likely to be adversely affected by debt-funded acquisitions. "We believe that, in the long run, India can support only six profitable mobile telcos. The market is currently characterised by fierce competition, with eight to 10 operators. Only the top (three to four) operators make a profit, while the rest suffer EBITDA losses and have stretched balance sheets," Fitch added.

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