In November, when British telecom major Vodafone Group slashed the value of its local business by five billion euros, for once it seemed that the India’s second largest telecom operator is hanging up its boots in the battle of the might, triggered by Mukesh Ambani led Reliance Jio.
Vodafone’s announcement to merge with Idea Cellular changed what the industry was thinking about the company. The merger will make the combined entity, the largest telecom company in the country.
This would leave three big telecom players – Airtel, Vodafone-Idea and Reliance Jio, apart from the state owned BSNL. The merged entity is estimated to hold a revenue market-share of 42%, overtaking Airtel, which has 31.4% currently in the telecom sector. Emerging talks between Vodafone India and Idea Cellular indicate that Aditya Birla Group chairman Kumar Mangalam Birla could become Chairman of the merged entity.
The merged entity is likely to have 12 directors on its board, three on each side and six independent ones.
Consolidation was inevitable, especially after 2008, when six new licences were given to new players. The number of telecom operators grew to 12.
Although, after the 2G scam surfaced a couple of years later, some of the small players pulled out of the telecom market, while others were reduced to marginal players, operating in a selected few cities. The entry of Reliance JIO sparked the inevitable. Had it not been for Reliance Jio’s entry, the merger would have been delayed. Analysts wrote that “Jio’s disruptive free distribution of SIM cards” served as a catalyst to the proposed merger.
Jio’s free service offerings have been extended to 31st March due to which many of the big players including Vodafone and Airtel have lost a vast market share. Even discounts offered by these giants are not adequate enough to stand tall against JIO. One can’t simply compete with free offerings.
Advantages of the merger
A potential merger of Vodafone India and Idea would make the entity the biggest spectrum holder in India and would knock off Reliance Jio from the top slot on the overall network capacity market share metric Credit Suisse believes.
The merger will complement the circle presence of both the companies – Vodafone India has strong presence in urban localities while Idea has it in rural areas. It will also improve the competitiveness of the resultant company compared to other telecom leaders in around 60 percent of circles.
Further, the spectrum of Vodafone India in seven circles and that of Idea in two, which are expiring in 2021, are not in common circles, resulting in potential spectrum Capex synergies.
“This could unlock $9 billion in potential synergies and offer an elegant route for Vodafone to deconsolidating India, thereby helping focus attention back onto a rebounding European equity story,” said New York-headquartered financial services firm JP Morgan.
The combined entities’ revenue will be around Rs. 77,500-80,000 crore and EBIDTA margins of around 28 per cent,” India Ratings said in a statement.
The merged entity, the brokerage said, would command a 26% spectrum market share and relegate Bharti Airtel to second place on this score. At present, Sunil Mittal-led Bharti Airtel leads the industry in terms of spectrum holding with a 21% market share, with Jio at second spot with 17%.
India Ratings estimated that the ROCE will also improve for the industry by around 300 basis points over 2016 to 2018 while the total capital deployed will increase 90 per cent by 2018 over 2015.
The key challenge will be operational and management control of the merged entity, along with the outstanding tax matter of Vodafone.
According to Indian regulations, a telecom carrier cannot have more than 50% revenue share in any circle.
According to Credit Suisse, the proposed merger has a 60 percent chance of going through because such disposals could make it more difficult for Idea and Vodafone to take advantage of their combined circle scale because India is divided into 22 geographic circles, meaning a telecom carrier needs critical mass in each to maximize pricing power within that circle. The two operators have airwaves in five such circles that exceed the regulatory limit of 50 percent per band and 25 percent across all bands.
Carriers need more spectrum to improve service quality and extend their coverage.
Prior to Jio’s entry, Bharti Airtel, Vodafone and Idea were able to increase revenue and profit, even as they were dependent on heavy borrowings to pay for spectrum and infrastructure. Jio, which stormed India’s crowded cellphone market with free voice calls for life, has now forced rivals to cut prices and expand their mobile broadband networks.
Credit Suisse said the Vodafone-Idea merger would be good for the industry and combining entities in the long term, but “coming years would remain challenging from the perspective of pricing and capital expenditure pressures“, especially as Jio is expected to slug it out for a 30-plus% market share to justify returns on its large investment.
The London-based Vodafone Group surprised all by confirming speculation on the merger, saying it is indeed in talks with the Aditya Birla Group entity for a merger, but added nothing has been finalised as yet. Media reports have said that the two parties, which are the second and the third biggest telecom companies at present, are looking at an equal ownership in the merged entity.
The proposed merger between Vodafone and Idea Cellular seems to be a positive move for the telecom sector and will push the combined entity’s margins up by around 3 percentage points on cost synergies.
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