Will Idea-Vodafone Merger Deal Enhance Shareholder Value?

The merger of Vodafone and Idea was more a question of when than whether. With rising competition from Reliance Jio and deteriorating economics of the telecom industry, the major focus had to be on reducing the number of large players in the industry. This merger will not only reduce the number of large telecom players to 3, but will also help the merged entity to become the largest telecom service provider in India, both in terms of revenues and market capitalization. At this point, the merger makes business sense to both the companies. Vodafone India gets to consolidate its debt under the merged entity while Idea will get tremendous reach on a pan-India basis. But first, how exactly is the merger being structured…

How the merger is being structured?

The merger between Vodafone and Idea will be executed through a stock swap. As part of the deal, idea will issue shares to Vodafone to the extent of 50% of the post-issue capital. Of these, Vodafone India will give a 4.9% stake in the merged entity to the Aditya Birla Group. Thus, Vodafone will effectively hold 45.1% in the merged entity. Post the merger, Vodafone India will hold 45.1% stake in the merged entity while the Aditya Birla Group will hold 26%. The remaining shares will be held by the public. It needs to be remembered that this deal excludes Idea’s holdings in the Indus Towers Business, which it is anyways currently negotiating to sell to ATC of the US. However, the telecom infrastructure company held by Idea will be part of this deal. Aditya Birla Group will have the right to buy an additional 9.5% stake in the company at Rs.130/share over the next 3 years.

How will this merger change the economics of Indian telecom sector?

To begin with, this merger will leave the telecom industry with just 3 large players viz. Idea-Vodafone, Bharti Airtel and Reliance Jio. The combined entity will have a revenue market share of 41% compared to 33% for Bharti Airtel. Of course, in case of Reliance Jio we will have to wait for the services to go priced from April 01st, but it will surely emerge as a formidable player. The Idea-Vodafone combine will have nearly 39.5 crore subscribers compared to 26.5 crore subscribers for Bharti Airtel. Reliance Jio already has 10 crore customers in the first 6 months. The Idea-Vodafone combine will also dominate the spectrum sweepstakes. It will have nearly 1850 MHz of spectrum compared to 1403 MHz for Bharti Airtel and 1107 MHz for Reliance Jio. This will be a big advantage for the merged entity. Lastly, coming to the efficiency of revenue comparison, the merged entity will lag behind Bharti. The combined Idea-Vodafone entity will have combined revenues of Rs. 81,592 crore compared to Rs. 74,714 crore for Bharti Airtel. The irony seems to be that despite the combined entity having a subscriber base that is 50% larger than Bharti Airtel, its revenues are just 10% higher. That clearly shows much better ARPUs and high value business for Airtel. That is something the combined entity will have to focus on.

Why exactly did Idea fall so much after the merger announcement?

It may be a little surprising why Idea fell over 10% on 20th March after the merger announcement. Ironically, the stock of Idea had rallied sharply by over 60% from a level of Rs.65 after the merger news first came in the market. There could be a few key reasons for this reaction. Firstly, the merger ratio implies limited price upsides for the stock. The deal values Idea at Rs.109 per share and the promoters of Idea have the right to buy the stock at 130 at a future date. Secondly, as mentioned earlier the merger may end up creating a merged entity that may still lag behind Bharti in terms of operating efficiency. For example, with a 50% higher subscriber base post-merger, it will have revenues that are just 10% higher than Bharti Airtel. Lastly, as a result of the merger, Vodafone India will transfer Rs. 55,000 crore of debt to the merged entity and will consequently save Rs. 14,000 crore each year. This comes at the cost of Idea’s financials. But the immediate reason seems to be that Idea had already rallied over 60% since the merger talks were first out in the open. Therefore, this seems to be more a case of smart investors “Buying on Rumours and Selling on News”

What is the road ahead for the merger?

There are 6 key points that need to be understood here:

• The merger will have to be approved by the minority shareholders of Idea Cellular and we saw how difficult that was in the case of the Cairn India-Vedanta deal. Also, the CCI will have to approve the merger in India and the EU Anti-Trust Commission will also have to approve the deal.

• Eventually, shareholders will benefit from the merger because this consolidation will reduce the price wars in the industry, as we saw in the case of airlines in India. That should be value accretive for shareholders in the long term.

• This merger has been an obvious reaction to the disruption in telecom triggered by Reliance Jio and therefore, it will be very critical to see how the merged entity takes on competition. It really cannot afford another price war.

• The merged entity will have to work closely on its operating efficiencies and its ARPUs. With ARPUs of under Rs.150, it will be very difficult to grow their bottom-line vis-à-vis Jio, which is going to start off with much higher ARPUs.

• The big challenge for the merged entity will be how they manage the post-merger environment. Most mergers create culture issues and this will be no exception. The added challenge is that a merger of this magnitude will require massive cost cutting, especially in terms of infrastructure and jobs. That will be the big HR challenge for the company.

• Lastly, there is a $2.5 billion dispute tax case under progress against Vodafone over their previous deal with the Essar Group. That could prove to be an impediment to the merger.