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Consolidation Canvas Proposed Vodafone-Idea merger to reshape the industry landscape

March 20, 2017
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By - Akanksha Mahajan Marwah

The ongoing consolidation saga in the Indian telecom sector took a very interesting turn recently, when Vodafone India confirmed that it is contemplating a potential merger with Idea Cellular. The country’s second and third largest telecom operators are planning to join hands in an all-share deal to create a telecom giant that will claim about a third of the total subscribers in the country and close to half of the industry’s total revenues.

The proposed deal, which would be the biggest ever in the industry, comes at a time when the competitive intensity has reached an alarming level following the entry of Reliance Jio Infocomm Limited (RJIL). RJIL’s disruptive pricing strategy, coupled with aggressive roll-outs, is driving down the profits and cash flows of the incumbents.

This was first reflected in the disappointing results posted by the incumbents for the quarter ended September 2016, when data realisations declined by 10-12 per cent for both Idea and Vodafone. The following quarter, October-December 2016, was possibly worse with operators’ profitability taking a major hit. As per a recent report by India Ratings and Research, the telecom industry lost about 20 per cent of its revenue due to the free voice and data services offered by RJIL. Further, the data and voice usage pattern for each operator is likely to remain inconsistent and unpredictable, and may result in a redistribution of market share. The incumbents would have to augment their capacity and coverage to retain their customer base; however, overstretched balance sheets are preventing them from undertaking massive capex. Idea Cellular’s precarious leverage is a key area of concern, while Vodafone too has not been able to raise fresh capital through an initial public offering (IPO) due to unfavourable conditions in the sector.

A merger of Vodafone and Idea would thus result in a stronger balance sheet, potentially higher profit margins, and more fire power to survive competition and achieve long-term growth. Further, a merger may arrest the expected decline in market shares forecast over the next few quarters for both operators due to RJIL’s presence. The combined spectrum holdings and 3G/4G capabilities of the merged entity can finally match up to those of Airtel and RJIL.

Besides, the deal is likely to have large-scale ramifications for the telecom industry and change the competitive landscape.

A look at the proposed merger between Vodafone and Idea, and what the deal holds for both the operators and various stakeholders…

Creation of a telecom behemoth

Together, Vodafone and Idea will create the country’s biggest telecom company, overtaking current numero uno Bharti Airtel and knocking off RJIL in the race to the top slot. According to a Motilal Oswal research report, the merged entity will be an industry leader, with subscriber and revenue market shares of 36 per cent and 42 per cent respectively. Meanwhile, according to Credit Suisse, the combined entity will command 26 per cent spectrum market share, as against current industry leader Airtel, which has 21 per cent share, followed by RJIL with 17 per cent. The merged entity would have 35 per cent network capacity share, displacing RJIL which has about 31 per cent. Further, the combined entity will have 130 carriers across 3G and 4G networks, much higher than the 109 carriers with Airtel and 110 with RJIL, as per analysts at IDFC Securities.

Big synergies, improved financials

The proposed merger promises revenues of around Rs 745 billion and an improvement in the earnings before interest, taxes, depreciation and amortisation (EBITDA) margin by 350-500 basis points owing to major savings on networks, and employee and marketing costs. According to analysts at HSBC, both operators have substantial overlapping coverage and consequently, they would look to shut down duplicate base transceiver stations (BTSs), saving on tower rental costs. They estimate the shutting down of at least 8 per cent of base stations contracted over a period of 18-24 months. Overall, the merger would create a synergy value potentially ranging from $5 billion to $9 billion, as per various estimates.

Improved competitive landscape

In a recent interview with tele.net, J.S. Deepak, secretary, Department of Telecommunications (DoT), stated that ideally the sector should have five operators to avoid spectrum fragmentation. With the Reliance Communications, MTS and Aircel merger already under way, the proposed Vodafone-Idea merger will consolidate the industry around four key private players, including Bharti Airtel and RJIL. This scenario would support industry ARPU accretion as well.

No respite from competitive pressures

The consolidation is unlikely to reduce competition in the sector in the near term. According to a research report by Edelweiss Securities, RJIL will continue to disrupt the market till it gains volume market share proportionate to its capacity market share. Similarly, IDFC Securities states that the pricing pressures would continue as companies with deep pockets fight for data market share.

Thus, a proposed merger between Vodafone and Idea will help them withstand high pricing pressure but will not ease competition in the sector at least in the next 12 months. In fact, analysts expect that it will take the next three to four quarters for the merger to be finalised, and this may provide Airtel and RJIL with an opportunity to strengthen their market standing as Vodafone and Idea become involved in the merger process.

Win-win for Idea-Vodafone

The merger promises to address key concerns regarding Idea’s earnings’ visibility. The company performance has been very disappointing in the past few quarters, with profits plunging owing to high competitive pressure. For the quarter ended December 31, 2016, Idea posted a loss of Rs 4.79 billion (the first ever quarterly loss reported by the company since its listing in 2007), against a profit of Rs 225 million reported during the corresponding quarter in 2015. EBITDA fell by a massive 24 per cent sequentially during the same period. Further, Idea lost 5.5 million data customers during the October-December 2016 period, despite its slashing voice and data tariffs substantially. The operator has undertaken massive capex investments, including the purchase of spectrum in the past two years, which has led to higher depreciation and amortisation charges. In fact, owing to the acquisition of additional spectrum recently, Idea’s interest and finance costs have jumped by 170.5 per cent between the quarters ended December 2015 and 2016.

The going will only get tougher in the future, as the industry migrates to an unlimited/limited free voice regime, and competitive pressures demand more network investments. Analysts believe that while the quarter ended December 2016 has been difficult for Idea, the quarter ended March 2017 will be much worse. The move to merge, thus, comes as a major breather for Idea and will help improve its stressed balance sheet and limited 4G reach. Meanwhile, for Vodafone, the merger will allow the group to deconsolidate its Indian assets, thereby refocusing attention on improving the European growth outlook. Besides, it will result in an improved cash flow profile and enable the operator to fulfil its local listing plan without taking the IPO route. The proposed structure for the deal would not require any more capital to be injected in the Indian operations.

Key hurdles

While the move looks like a positive one for the parties involved as well as for the industry as a whole, it faces several challenges.These include conforming to the sector’s merger and acquisition (M&A) rules, complying with anti-trust norms and dealing with Vodafone’s unresolved tax issues.

India’s telecom M&A rules announced in 2014 do not allow the revenue and subscriber market shares of a company to go above 50 per cent. The M&A rules also require that an entity should have less than 50 per cent of spectrum in each band individually, in addition to having less than 25 per cent of the spectrum allocated to all operators in all bands, in each circle.

Given the current spectrum holding of the two operators, the merger would lead to a breaching of the norms in quite a few circles in the 900 MHz and 2500 MHz bands, as per various industry estimates. The merged entity would have to either surrender the excess spectrum to the government or sell it off to other players in the market. The former option is not very viable as the government will not provide any refund or set-off of money for the excess spectrum. This leaves the entity with the option of force selling the excess spectrum to its competitors, thereby strengthening their portfolio. That said, Motilal Oswal’s report suggests that the new company could get as much as Rs 75 billion (based on the latest spectrum valuation, pro rata for the remaining licence term) from such a sale, which could be used to enhance its own operations.

Meanwhile, another bottleneck for the merged entity would be Vodafone’s unresolved taxation issues, which involve an amount of about $2.5 billion and has been in arbitration since 2012.

Potential deal structure

The structuring of the deal is complicated as Idea has demanded an end-state of equal rights between the Aditya Birla Group (Idea’s promoter) and Vodafone India in the business, even though Vodafone is a larger entity as compared to Idea. An equal rights arrangement would imply a capital infusion from the Aditya Birla Group in the combined entity. A Credit Suisse research report estimates that to bridge the valuation gap, the required equity infusion could be in the range of $2.39 billion to $3.72 billion.

As per an HSBC report, Vodafone and the Aditya Birla Group would most likely end up with 37.5 per cent each in the merged entity, with 25 per cent being held by existing Idea minority shareholders. Vodafone could take a higher stake, but the bank expects that management control would be equally split.

Vodafone India, in its press release, stated that any merger would be effected through the issue of new shares in Idea to Vodafone, and would result in the Vodafone Group deconsolidating its Indian assets. To this end, analysts at JP Morgan expect the operator’s management to alter the capital structure of its Indian operations prior to the merger, or place some of its equity in the market as part of the targeted merger, or sell some of its equity to the Aditya Birla Group. Meanwhile, Vodafone is likely to retain its 42 per cent stake in Indus, which can then potentially be sold off separately and may fetch the operator around $1 billion.


The merger would have to align with the telecom M&A rules, besides securing approval from several authorities including DoT and the Competition Commission of India. The overall process is expected to take about nine months to one year. During this time, it will be crucial for both the operators to sustain their respective market shares as the industry expects aggressive pricing from Airtel and RJIL in the near term. Currently, both Vodafone and Idea are much behind the curve in terms of investments and 4G reach as compared to the other two players.

The industry is yet to fully decode the impact of the proposed merger on the sector’s structure, profitability and competition in the long run. Over the next few months, it will be interesting to see how the equal-rights merger story of India’s two telecom heavyweights unfolds and how the industry landscape evolves in response to the consolidation.

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