The Aditya Birla Group will hold the rights to acquire an additional 9.5% stake from Vodafone within 3 years post completion.
Vodafone India (not listed) and Idea announced details regarding a potential merger. Some of the key highlights are: (a) Valuations — implied enterprise valuation is R828 bn for Vodafone India and Rs 722 bn for Idea (excluding stake in Indus), valuing Vodafone India at 6.4x and Idea excluding Indus at 6.3x EV/Ebitda; (b) Synergies — estimated net present value (NPV) of synergies suggested at R670 bn post integration costs, with an estimated run rate of $2.1bn (R140 bn) on annual basis by the fourth year of full operation post completion. Moreover, 40% of this will be capex and 60% opex; (c) Shareholding—Vodafone will own 45.1% of the combined company after transferring 4.9% to the Aditya Birla Group, which will own 26%, and other Idea shareholders 29%. The Aditya Birla Group will hold the rights to acquire an additional 9.5% stake from Vodafone within 3 years post completion.
Synergies are more medium term: Merged entity expects to achieve synergies with an NPV of $10.5 bn and estimated $2.1 bn of savings in the fourth year of completion, which suggests limited upside in the near term. The consolidated entity plans to continue with a multi-brand strategy, removing an obvious area for savings around marketing costs. Similarly, savings in terms of employee costs are expected to be limited. Hence, opex synergies will need to come from network and IT only. At the same time there is an attempt to monetise Indus and, hence, network savings may need to come from other tower companies and this may imply gradual savings on network costs until Indus is monetised.
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Leverage and read across for the sector: Combined entity leverage of 4.4x net debt/Ebitda is a concern given pricing pressures on data tariffs and as none of the shareholders in the merged entity has any immediate plans to infuse cash and bring down debt. Moreover, even post the tower deal, leverage may come down marginally to c4x and to achieve 3x all synergies may need to accrue, which are more medium term in nature. Separately, challenge for Idea is more pre-merger as it is guiding for lower capex for FY18e despite its present 4G spectrum holdings being lower than Bharti and 4G entrants, and both telcos continuing to spend. We are of the view that Bharti and 4G entrants may look at gaining market share pre-merger and benefit from a lower capex intensity. In the medium term, leveraged balance sheet of the combined Vodafone and Idea may limit its ability to participate in data growth. We Maintain Reduce on Idea Cellular with a DCF-based target price of Rs 62.
Good strategy but possibly late: We believe the consolidation strategy being pursued by Vodafone and Idea is positive given the Indian wireless market is going through one of its most disruptive phases. However, there are two issues with the strategy: (i) how both Idea and Vodafone India will handle market disruption (by Jio and Bharti) over the next 12-18 months; and (ii) telecom JVs are always a challenge. While we view the merger as positive, we note benefits could have been far higher if initiated a couple of years earlier.
Spectrum consolidation gradual— From a big picture perspective, the number 2 and number 3 players are merging to achieve sizable spectrum holdings. Idea Cellular has suggested that broadband spectrum market share of the merged entity is likely to increase to 30%, higher than competition. Further, the merged entity will have 18% spectrum share in Sub 1 GHz band. We agree that in the medium term this will be one of the largest benefits for the merged entity in a data centric market. However, we see several constraints: (i) spectrum in the 2500MHz band has limited ecosystem at present and it may take
12-18 months before this could be put to meaningful use. (ii) The underlying assumption is that the merged entity will be able to deploy 900 spectrum for data and we highlight that it is more of a gradual process and not something that may be achievable over the next 12-18 months.