Vodafone, Idea Merger Talks - Full of Opportunities and Challenges

Ending months of speculation, Vodafone and Idea Cellular have acknowledged that they are in talks for a merger of operations in India. The Vodafone-Idea merger, if a deal indeed goes through, would be the biggest such consolidation in the sector, and create the largest telecom operator of India. Not only would the joint entity race past Airtel, it will also be at a safer distance from Reliance Jio, the new disruptor in the sector. However, before the deal is finalised, there is a long road ahead, full of challenges and opportunities.

Vodafone-Idea merger a 50-50 partnership

The Vodafone-Idea merger is still in preliminary discussions, as both companies need to agree upon certain conditions in order for the deal to go through. From what Vodafone has revealed so far, the merger proposes an all-stock deal that would give it shares in Idea Cellular; new shares will be issued by Idea for Vodafone, and the Vodafone India entity as it exists now will be deconsolidated. The deal is based on the premise that both companies would hold equal rights in the Vodafone-Idea merged entity, Idea has said.

Notably, the Vodafone-Idea merger would exclude the British telecom operator’s 42 percent stake in Indus Towers, a joint venture between Airtel, Vodafone, and Idea.

Vodafone-Idea merged entity will be India’s biggest telco

The merged Vodafone-Idea entity will become the biggest telecom operator in India, both by subscribers and revenue. At present, Airtel leads the market with 265.85 million mobile subscribers, as per COAI data, while Vodafone and Idea have 204.69 million and 190.52 million mobile users respectively. Reliance Jio, which has upended the market with its free services, trails all three with 72.4 million users, but its growth is rather notable considering it only started operations in September 2016. The merged Vodafone-Idea unit will have a combined user base of 395.21 million, putting it far ahead of Airtel.

In terms of market share, COAI says Airtel had a 32.82 percent pie of the segment in December, while Vodafone had a 25.27 percent share and Idea had a 23.52 percent share. This would mean the Vodafone-Idea merged entity would have share of nearly 49 percent. Mergers in telecom sector can go through if the new entity’s market share does not cross 50 percent. The joint entity would be able to make considerable savings via shedding of excess cell sites, and some of those can also be deployed again, which would result in profits. The two companies have a combined debt of Rs. 72,000 crores.

New problems may surface for Vodafone-Idea

The Vodafone-Idea merger would result in a strong balance sheet as well as spectrum holding for the joint entity. As per a BloombergQuint report, the merged unit will have 1,120Mhz spectrum across the five bands, making it the biggest holder of spectrum in India. But the consolidated entity cannot have more than 50 percent spectrum in any individual circle and more than 25 percent overall spectrum in order for the deal to go through, as per TRAI rules.

This poses a problem for the Vodafone-Idea merged entity as it will have more than 50 percent spectrum in five circles, namely Maharashtra, Gujarat, Kerala, Haryana, and Uttar Pradesh (West). Thus, the companies will have to sell either sell the excess spectrum to other operators or give it back to the government without any monetary compensation.

Similar is the case with revenue market share (RMS) and subscriber market share in some circles as well the rules cap the market share of the merged unit for both parameters at 50 percent. The merged entity will have over 50 percent subscriber market share in five circles - Maharashtra, Gujarat, Kerala, Haryana and Uttar Pradesh (West). Similarly, it will cross the 50 percent limit in RMS in seven circles - Mumbai, Maharashtra, Gujarat, Kerala, Haryana, Uttar Pradesh (West).

"In some circles the RMS cap of 50 percent will be breached during this M&A," said Shobhit Srivastava, Research Analyst, Counterpoint Research. "But the RMS shares will get readjusted for the operators once Reliance Jio starts to charge for its services. Hence, we will have to wait to get a clear picture till then."

Vodafone-Idea merger may face regulatory hurdles

The above mentioned problems may turn the deal sour if the regulatory authorities step in. Then there is the issue of Vodafone India's ongoing $2 billion (roughly Rs. 13,000 crores) tax case, which may factor into play. Also, the deal would make Airtel a minority player in Indus Towers (in which Airtel, Vodafone, and Idea have 42 percent, 42 percent, and 16 percent stakes, respectively); however, it must be noted that Vodafone India’s Indus Towers stake will be transferred to its global parent company, not the Vodafone-Idea merged entity. TRAI would have to step in to ensure that none of the practices of the Vodafone-Idea joint entity are anti-competitive, considering the large market share.

Impact of Vodafone-Idea merger on Airtel, Reliance Jio

Bharti Airtel chairman Sunil Bharti Mittal had said at the 47th World Economic Forum at Davos that the Vodafone-Idea merger was a perfect match. He had said that the strengths and weaknesses of the two companies match very well (especially the rural-urban structured portfolio).

Airtel CEO Gopal Vittal said about the Vodafone-Idea merger that it is good for the industry. He added, "However, it is important to ensure that such consolidations are not an outcome of a forced situation created by offering an 'unfair playing field' to any particular company while completely destroying the viability of the others." Reliance Jio executives have not said anything publicly about the merger so far.

The impact of Vodafone-Idea merger on Airtel and Reliance Jio is unlikely to be very significant in the short term. The scale, size, and synergies, if integrated appropriately, will show results soon for the merged entity, and may even result in another price war.

"Even if VoDea [Vodafone-Idea] becomes the number one in terms of subscriber base, it still would need to fight Reliance Jio and Airtel in getting 4G subscribers as it lacks in content ecosystem space," Srivastava added.

Share market has greeted the news of the merger talks with rising stock price for not just Vodafone and Idea, but also for Airtel, Reliance Communications, and Tata Teleservices.