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Voda-Idea merger rings in new era for Indian telecom

Three mammoth firms will dominate the move to scale up data revenues, grab spectrum, and move into 5g services

Vodafone India and Idea Cellular have decided to merge, creating India's largest telecom operator with nearly 400 million subscribers.

Facing intense competition from cash-rich Reliance Jio, the Aditya Birla Group and British telecom giant Vodafone Plc on March 20 announced the merger of their Indian wireless telephony businesses. As the first step in the merger, Birla-owned Idea Cellular and Vodafone India would merge their operations at a swap ratio of 1:1. Then, Birla's holding companies would buy a 4.9 per cent stake from Vodafone at Rs 110 per share, investing close to Rs 39 billion. This will increase Idea's stake to 26 per cent and bring down Vodafone Plc's stake to 45.1 per cent.

The Birlas would have the right to acquire another 9.5 per cent stake from Vodafone in the next four years, so that both partners eventually hold an equal stake in the company (about 35.5 per cent each). Till the Birlas buy the additional shares, Vodafone Plc would have restricted voting rights on these shares.

The implied enterprise value of Vodafone, as per the Voda-Idea agreement, is Rs 828 billion. Idea Cellular's value is Rs 722 billion excluding its 11.2 per cent stake in Indus Towers. In the next four years the Birlas have the right to acquire an additional 9.5 per cent stake from Vodafone, at Rs 130 per share, implying that the merged entity's equity value would be Rs 946 billion.

"India was earlier the jewel in our crown. Now with this merger, we have got a bigger jewel," Vodafone's Colao said, adding: "This is our Make in India initiative."

The merged entity would have a customer base of 395 million; Bharti Airtel and Reliance Jio have a subscriber base of 320 million and 100 million respectively as of December 2016.

The new company formed will be able to meet the surging demand for data and voice services pan-India due to the availability of 1,850 MHz of spectrum at its disposal. The entity formed by the merger of Vodafone and Idea would have 1,850 MHz; Bharti has 1,489 MHz and disruptive entrant, Jio, has 1,169 MHz.

Vodafone CEO Colao said the pending tax demand would not impact the merger, as it was against the Vodafone group. The firm is embroiled in a $2.5-billion tax dispute with the tax authorities in the country, over its purchase of Hutchison India operations in 2007 for $11.2 billion. The matter is currently under arbitration overseas under international laws.

Before the transaction is completed, Vodafone and Idea plan to sell their standalone tower assets and Idea's 11.15 per cent stake in Indus Towers to reduce leverage in the combined company. Vodafone will explore strategic options for its 42 per cent stake in Indus Towers. Colao said Vodafone would sell its entire stake or a part of it, depending upon offers it gets.

On the management of the merged entity, Birla said he would chair the board of the company. It would have six independent directors and three directors (including the chairman) from each promoter. The CEO and chief operating officer of the merged entity would be decided jointly at a later date, though the chief financial officer would be appointed by Vodafone. The brand names of both Idea and Vodafone would be retained.

The merged entity would save an estimated $2.1 billion a year on operating costs and capital investments after four years. Asked whether or not the merger would result in lay-offs, Birla said the new company would create more opportunities for both companies and there will not be any job cuts.

Although the merged entity might have to sell some of its excess spectrum holdings as per regulatory norms, it will still be able to provide services across all the 22 circles in India.

The new company will be able to bridge the gaps in the network, thanks to the strong presence of Vodafone in urban areas and Idea's in semi-urban and rural areas.

Synergies for long term

The merger is expected to bring in capex and opex synergies in the form of lower infrastructure costs, network consolidation and cost efficiencies in IT. The initial years would entail integration costs, estimated by the management at Rs.133 billion. Total cost synergies of Rs.140 billion on annual basis, are expected to flow only from the fourth year after the merger. Hence, cost savings/synergies, which hold the key to future earnings, are expected to come only in later years.

The October 2016 spectrum auction has left the telecom players saddled with heavy debt. The net debt of the combined entity is pegged at about ₹1070 billion.

The merger could face regulatory challenges on account of excess spectrum and revenue market share of over 50 per cent in some circles.

The litigation cases of the companies involved, particularly the tax struggle of Vodafone, could delay the closure of deal.

Will future fund flow be good?

From having sunk billions of dollars into the Indian market, Vodafone now suddenly looks far less ambitious with its India plans. Besides, without its deep pockets, it will be interesting to see how the merged company fights against the huge resources being deployed by Bharti Airtel Ltd and Reliance Jio Infocomm Ltd.

Vodafone's investors have already been recommending an exit from India. Although the company appears to have chosen the middle path-by retaining a stake (of between 26 and 35%) and raising cash by selling its remaining exposure-investors in the merged company might well view this shrinking interest as a sign of lesser interest in the Indian market's prospects.

The silver lining in all this is that the Birla group has settled on a valuation of Rs130 per share for the possible future transactions in the first three years after the completion of the transaction. If it goes ahead and buys shares from Vodafone at these prices, it should provide investors some assurance that at least one of the partners in the merger is increasing its bet on the Indian market substantially.

It's worthwhile noting here that in the restructuring of Aditya Birla group companies last year, the promoter group effectively cut its stake in the telecom business from about 23.6% to around 20%. It remains to be seen to what extent it actually invests and increases its exposure to Indian telecom.

From Business World, Economic Times, LiveMint, Business Line

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