Vodafone India and Idea have announced that they are exploring a merger through an issue of shares in Idea. The combined entity would become the #1 player in India by revenue. Synergies are evident from potential cost savings and lower capex, although there are revenue/subs/spectrum cap breaches in a few circles. Challenges would be Vodafone’s tax issues, Indus ownership, control of the merged entity and management bandwidth amidst competition from R Jio.
Vodafone India and Idea explore merger: Vodafone and Idea, in separate releases, announced exploring a merger by way of share issuance in Idea. The operational strengths of the two operators make them a good fit, with the combined entity having a 42% revenue market share vs Bharti at 33%. This would also be a way of backdoor listing for Vodafone India subsidiary. The combined entity would also have the largest 4G 1800MHz footprint and a pan India 3G spectrum. Vodafone’s 42% holding in Indus is not included in the merger plan.
Key synergies: (i) Complementary positioning with Idea a strong player in rural, while Vodafone is strong in urban circles; (ii) potential synergies on the profitability due to saving particularly on network operating costs (23% of revenue); (iii) lowering of annual capex; Idea +Vodafone FY17E capex is estimated at R185 bn vs Bharti at R160 bn; (iv) reduction in cost of active infrastructure due to overlapping sites; (v) one less competitor in the market.
Challenges: (i) Hitting revenue/ subscriber share and spectrum holding caps in few circles (ii) Vodafone India’s past tax issues unresolved; (iii) Idea + Vodafone’s ownership of Indus at 58% would be a majority stake in a JV structure; (iv) control of merged entity would be a moot point in merger discussion; (v) management bandwidth would be taken away and could prove costly in face of R Jio competition.
Impact on Idea, the maths given the 25% stock rise after announcement: The combined entity with 10% cost synergy would have an Ebitda of R220-250 bn. At 6.5x EV/Ebitda multiple this leads to a per share value of R62-82, largely captured in the share move after announcement. The merger might trigger a value unlocking from share sale in Indus tower; shareholding of Idea in Indus valued at R35/share. At the same time there could be regulatory costs associated with the merger not factored into the calculation. Competitive pressures from R Jio would continue to weigh on the profitability of the merged entity, even if the merger were to happen. We have an Underperform rating on Idea.
Impact on Bharti Airtel: One less player in the market would improve the industry structure and over the longer term help profitability. However, apart from the competition from R Jio, circle wise profitability would also be impacted for Bharti where the merged entity becomes more dominant. We have a Hold rating on Bharti Airtel, and in the current setting prefer it due to leadership in network rollout, spectrum holding and relatively robust balance sheet.
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Impact on Bharti Infratel: Consolidation of two large players will not only have long term impact due to capex related synergies but also immediate impact due to redundancies in case of overlapping cell sites, a significant negative for Bharti Infratel. We have a Hold on Bharti Infratel.