Aurum Deal of the Month – April 2017

Idea Cellular announced a merger with Vodafone India and its wholly owned subsidiary Vodafone India Mobile Services, to create the country’s largest telecom operator with over 400 million subscribers and nearly 41% revenue market share. The implied valuations of Vodafone is INR 828 billion and Idea is INR 722 billion (6.4x and 6.3x EV/EBITDA respectively).

The Transaction

The transaction does not include Vodafone’s 42% stake In Indus Towers. Idea and Vodafone will each hold equal stakes in the merged entity. The shareholding structure will be achieved in the following manner :

  • Vodafone will sell 4.9% at a price of INR 110 per share to Idea’s promoter – the Aditya Birla Group (ABG) – to reach 45.1% stake while enabling ABG to reach the critical 26% stake threshold. The other 28.9% shareholding will be held by non-promoter shareholders of Idea.
  • ABG, will have the option to purchase a 9.5% stake from Vodafone over the next four years at a consideration of INR 130 per share to bring the final shareholding of ABG and Vodafone to 35.5% each
  • Vodafone India and Idea Cellular will sell their respective standalone towers along with Idea’s 11.2% stake in Indus Towers in order to reduce leverage in the combined entity. Vodafone India and Idea have 10,500 and 8,800 towers respectively.
  • The board of the combined entity will comprise of 12 directors, with three (including KM Birla role as chairman) appointed by Idea and three appointed by Vodafone India. The balance (50% of total directors) will be independent.
  • Vodafone and Idea expect the deal to complete in CY18 and a breakup fee of INR 33 billion becomes payable under certain circumstances.

Regulatory Scenario

The transaction is subject to approvals from the relevant regulatory authorities and other customary closing conditions. The proposed merger requires approvals from the stock exchanges, Securities and Exchange Board of India, National Company Law Tribunal and the Competition Commission of India, besides the court and the Department of Telecommunications (GoI). The three key areas of scrutiny would be revenue market share, subscriber market share and spectrum holdings.
Merger Rules – Limits in India

Type Limit
Subscriber market share 50%
Revenue market share 50%
% Spectrum held out of total spectrum assigned in the circle for access services 25%
% Spectrum held in a given band 50%

A hindrance to the deal could arrive from the regulatory conditions regarding the combined Revenue Market Share (RMS). As per the Circle-by-circle analysis, the proposed combined entity would be over the 50% threshold in six circles.

RMS across circles (Sep 16, TRAI)

Circle Idea Vodafone Total
Andhra Pradesh 24% 11% 35%
Gujarat 21% 37% 58%
Kamataka 11% 15% 26%
Maharashta 33% 25% 58%
Tamil Nadu 7% 24% 31%
Haryana 27% 28% 56%
Kerala 42% 23% 65%
Madhya Pradesh 42% 10% 52%
Punjab 25% 17% 42%
Rajasthan 13% 22% 35%
U.P.(East) 14% 28% 42%
U.P.(West) 31% 22% 53%
West Bengal 9% 37% 46%
Assam 5% 23% 28%
Bihar 13% 14% 27%
Himachal Pradesh 13% 10% 23%
J&K 7% 10% 17%
Northeast 4% 18% 22%
Orissa 6% 16% 21%
Delhi 13% 29% 41%
Kolkata 7% 34% 42%
Mumbai 10% 37% 47%
Total 19% 23% 42%

Post-Merger Prospects

The combined entity will have over 400 million subscribers and nearly 41% revenue market share

Market

Source: Company Reports, MOSL

Idea and Vodafone combined currently have 273,000 GSM and 189,000 mobile broadband sites. The combination intends to rationalise the total number of sites to ~225,000 and eliminate 30-40% redundancy in mobile broadband sites, which can be redeployed to enhance network capacity and coverage.
Management indicated cost and capex synergies of USD 10.5 billion at net present value, post adjusting for integration costs and spectrum liberalisation payments. Annual savings are estimated at USD 2.1 billion by the 4th year post completion. Also, Vodafone is strong in urban markets, Idea in rural markets.

Key Areas of Synergy (Source: Company, Edelweiss)

  SNetwork
  • Rationalisation of co-located sites following network consolidation
  • Energy savings & operational efficiencies with elimination of older GSM sites
  • Savings related to small cells, IBS and connectivity cost
Opex Customer Acquisition
  • Service centres, back office and distribution efficiencies
  IT
  • Lower costs due to infrastructure sharing
  Brand & Advertising
  • Combined advertising & business promotion
  • Leverage strong affinity of two powerful decade old brands
  Others
  • Reduction in General & Other administrative expenses
Capex Network
  • Higher spectrum availability & high capacity SRAN deployment resulting in lower capex
  • Re-deployment of overlapping broadband equipment & avoidance of duplicate 4G network expansion and upgrades
  • Lower fibre and electronic rollout needed for building large broadband capacity
  IT
  • Large scale to drive cost efficiencies for IT platforms
  • Common IT systems for the combined entity

Conclusion

The Indian telecom sector is going through turbulent times, with most operators reporting losses and struggling with high debt. Industry revenue is under pressure, with the new operator offering free services. Even larger operators are facing the pressure from the increased competition. The competitive intensity driven by Jio’ aggressive push to acquire customers has seen prices and realizations take a nosedive in the last 6 months. Reliance Jio is now reporting 100 million customers after only 6 months of business.

Indian mobile service revenue growth (Source: Company Data, HSBC)


Bharti Infratel is likely to be the biggest loser in case of reduction in the total number of sites as the combined entity will look at doing away with duplicate sites resulting in lower number of tenancies for Bharti Infratel. However, the Vodafone-Idea merger is likely to improve overall industry structure. It would move the industry to three large players and might result in relatively better pricing medium term. Such a merger might put a check on the disruption caused Jio and could cause a shift in pricing strategy from disruptive to just competitive.