Idea-Vodafone merger: A long-term connection

The speculation of merger between Idea Cellular and Vodafone India was put to rest when the boards announced the tie-up last week. The merger deal values Idea at ₹72,200 crore, slightly lower than what was pegged by the market.

While the implied swap ratio of 1:1, increased market share and spectrum capacity and cost synergies are positives, intensifying competitive scenario, possible regulatory hitches and a still large debt pile on the books of the combined entity limit the upside for Idea shareholders in the near term.

The deal essentially values Idea at ₹72.5 a share, based on the 30-day average closing price as on January 27. The rally over the past month ahead of the merger announcement, saw the stock giving up some of its gains last week, falling over 15 per cent.

According to the merger announcement, both Idea Cellular and Vodafone India will have equal rights in the combined entity. Vodafone will transfer 4.9 per cent stake in the combined company (around 35 crore shares) to Aditya Birla Group for ₹3,900 crore.

Following this, Vodafone will hold 45.1 per cent and Aditya Birla Group 26 per cent in the combined entity. The Birla group will have the option of buying 9.5 per cent stake from Vodafone at ₹130/share, to equalise the shareholding (35.5 per cent). If the shareholding is not equalised by the expiry of the fourth year, Vodafone will have to sell its stake to a third party.

The merged entity would be the largest telecom player in the market with 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.

Prior to the merger, Idea Cellular provided 4G services in 20 circles and 3G coverage in 15 circles, while Vodafone’s services for 3G and 4G are in 16 and 17 circles respectively.

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.

The merger is expected to bring in capex and opex synergies in the form of lower infrastructure costs, network consolidation and cost efficiencies in information technology. The initial years would entail integration costs, estimated by the management at ₹13,300 crore. Total cost synergies of ₹14,000 crore on annual basis, are expected to flow in only from the fourth year after the merger. Hence, cost savings/synergies, which hold the key to future earnings, are expected to come in only in later years.

The October 2016 spectrum auction has left the telecom players saddled with heavy debt. The intense price war after the entry of Reliance Jio, led to a drop in revenues in the last two quarters. Idea’s revenue declined by 3.8 per cent y-o-y in the December quarter while Vodafone’s revenue declined by 1.9 per cent.

The net debt of the combined entity is pegged at about ₹1.07 lakh crore.

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.