How will the Vodafone-Idea merger impact telecom sector?

The merger of Idea and Vodafone was already being discussed for quite some time. When it was announced on 20th March, it was merely a reiteration of the expectation. Strategically, it will position the merged entity as a formidable force in the competitive telecom industry. It will give the merged entity the heft and the dominance to take on the might of Bharti and Reliance Jio. Here is how it could impact the telecom industry in a big way.

How the Vodafone / Idea merger could change the telecom industry in a big way…

  • The merger will reduce the number of large players in the industry to just 3 viz. Idea/Vodafone, Bharti Airtel and Reliance Jio. The merged Idea/Vodafone will be the largest telecom company in terms of revenue, markets share, spectrum holding and in terms of market capitalization.
  • The merger will be executed via stock swap. Idea will issue shares to the tune of 50% of the post-issue capital. Out of this Vodafone will sell 4.9% stake to the Aditya Birla Group. Thus Vodafone will be left with a 45.1% stake in the merged entity.
  • In the post-issue capital, while Vodafone will hold 45.1%, the promoters of Idea Cellular will hold 26% in the merged entity. The balance shares will be held by the public. Both parties will have a 3 year lock-in with the Aditya Birla group having the right to buy another 9.5% stake in the company over the next 3 years at a price of Rs.130/share.
  • The merged entity will have a total of 39.5 million subscribers. This will be substantially larger than the 26.5 million subscribers for Bharti Airtel and the 10 million subscribers for Reliance Jio. Of course, Jio has completed just 6 months of operation and its subscribers are still growing rapidly on a daily basis. Hence the equations could substantially change in the future.
  • More importantly, the merged Idea/Vodafone entity will be the highest holder of spectrum among all the 3 telecom companies. While Bharti will hold 1403 MHz of spectrum, Jio will be holding 1107 MHz of spectrum. The merged Vodafone / Idea entity will lead the pack with a holding of a whopping 1850 MHz of spectrum. This will be the big advantage for Idea.
  • The big concern for the merged Vodafone / Idea entity will be the efficiency of revenue generation. For example the combined revenues of the merged entity will be Rs.81,592 crore compared to Rs.74,714 crore for Bharti Airtel. That means the merged Idea / Vodafone entity will generate 10% higher revenue with 50% more number of subscribers. That raises serious questions over ARPU and quality of customers.
  • Continuing on the subject of ARPUs, the current ARPU of the Idea / Vodafone combine will be lower than Rs.150, which is roughly half of Jio. That will be a big challenge and will mean that the customer accretion at the merged Vodafone/Idea combine will have to happen at a much faster pace to compensate for these lower ARPUs.
  • The deal is expected to reduce the price war in the industry. Over the last 6 months, Jio had triggered a virtual price war in the telecom space. With just 3 large players left in the fray, the shareholders will benefit in the sense that there will be fewer competitors fighting for the same market. A degree of cartelization is likely to creep into the telecom space. Hence customers need to get prepared for higher tariffs going ahead.
  • The merger is still pending minority shareholder approval. As we saw in the case of Cairn India’s proposed acquisition by Vedanta, minority shareholders like Cairn UK and LIC played hardball and squeezed better terms for the deal. That is something that the Idea management will have to be cautious about.
  • Apart from minority shareholder approval, the merger will also require the approval of the CCI in India and the EU anti-trust regulators. Since Vodafone is a European company, this merger will also be covered by EU anti-trust regulations. However, we do not expect these anti-trust issues to post any serious challenges for the Idea / Vodafone merger.
  • The merger may hit a regulatory hurdle because there is currently an open dispute of $2.5 billion against Vodafone pertaining to their previous deal with Essar Group in 2007. That is still under dispute and the regulators may insist on a resolution to the dispute before approving the merger. That will also be in the interest of Idea shareholders.
  • The Aditya Birla group will continue to exercise substantial control over the merged entity. While the CEO and the COO will be appointed on the recommendations of the Aditya Birla Group, the Vodafone Group will have the power to appoint the CFO of the merged entity. However, the big challenge for the merged Idea / Vodafone entity will be how they handle the cultural issues post the merger in terms of infrastructure and in terms of personnel.
  • The merger will be a financial boon for the Vodafone group. It will transfer debt to the tune of Rs.55,000 crore to the merged entity and in the process will reduce its annual expense outgo by nearly Rs.14,000 crore.

It may be interesting to note that the stock of Idea has fallen sharply after the merger announcement. There could be 3 reasons for the same. Firstly, the merger has valued Idea at around Rs.109 per share and that is where the stock was quoting at around the time of merger announcement. That limited the upsides. Secondly, the huge transfer of liability of Vodafone to the merged entity will be an overhang on the stock. Lastly, the sharp rally may have also caused a situation where in the smart traders may be selling out on the actual announcement.

However, it cannot be disputed that the merger will be positive for the pricing power of telecom players. To that extent, it should be positive for the telecom players overall.

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