High debt to weigh on Vodafone-Idea

Net debt of two firms was ~1.2 trn at end-Sept, against Airtel’s ~953 bn and Jio’s ~395 bn

With a debt of ~1,200 billion, Vodafone and Idea will have to work harder together to turn profitable as the consolidating mobile telephony market in the country changes rapidly.

When the merger is completed, Vodafone-Idea would have the largest subscriber base, about 400 million. But it will also be the most indebted telecom company. Its consolidated debt will be 30 per cent higher than Bharti Airtel’s ~953 billion and nearly three times that of Reliance Jio’s ~395 billion, as of end September last year.

This might even hit the merged entity’s growth plans, though it will be the market leader in revenue share.

The merged entity would lead the market with a revenue market share of about 37 per cent against Airtel’s 31.2 per cent and Jio’s 14.5 per cent.

“Despite being a market leader, we see significant challenges for Idea (after its merger with Vodafone). We expect it to lose revenue market share as lack of related businesses and balance sheet constraints limit competitive capabilities,” wrote Jefferies’ Piyush Nahar and Somshankar Sinha in their latest report on the sector.

They expect Idea and Vodafone combined to report decline in their operating margin because of downward pressure on their average revenue per user (ARPU).

In its result for the December 2017 quarter, Idea Cellular said the combined entity would be the market leader in 10 circles of the country. These markets account for around 48.7 per cent of the industry’s combined revenues.

A typical subscriber of the firm, however, will yield lower ARPU per month than that of an Airtel or Jio customer. This translates into lower profitability for the operator given the industry’s high fixed costs.

For example, Vodafone-Idea’s ARPU is likely to decline to ~103.7 per month in 2018-19, against Airtel’s ~112 and Jio’s ~125, according to estimates by brokerage firm Jefferies India. Vodafone and Idea are likely to end 2017-18 with ARPU of ~121.1 against Bharti Airtel’s ~134.1.

This translates into a significantly lower operating margin and internal cash flow generation for Vodafone and Idea, compared to their peers.

Vodafone-Idea reported a combined operating profit of ~70.4 billion during the first half of 2017-18, against Airtel’s ~162.1 billion. The gap is largely due to Airtel’s higher revenues. Airtel reported revenues of ~445 billion, against Vodafone-Idea’s combined revenues of ~346 billion.

Vodafone and Idea are also constrained by a lack of non-mobile revenues to cushion the blow from price war in mobile services. Mobile services in India accounted for only 51.4 per cent of Airtel’s revenues during the first nine months of 2017-18. This ratio is 94 per cent for Idea Cellular.

Jio is even better placed, as it accounted for 4.1 per cent of Reliance Industries’ consolidated revenues in the same period.

Vodafone-Idea reported an operating profit margin of 20.9 per cent (on a combined basis) in the first half of 2017-18, against Airtel’s 36.4 per cent and Jio 23 per cent.

The implication is clear: Idea will either have to induce its customers to spend more or its will have to bring down its operating cost to match the lower level of revenue per user.

This, experts say, would make it tough for the merged entity to retain a competitive edge.

“Vodafone-Idea will have to do what T-Mobile did in the US. Despite being a third operator, T-Mobile grew fast by chipping away subscribers and revenue market share from their two big rivals. It will require a further investment in improving network quality, which is still lacking in the country,” says Jayanth Kola, founder partner, Convergence Catalyst.

To work around the financial constraints, Kola suggested, the merged entity could either restructure its balance sheet to reduce debt load or adopt a low-cost growth strategy that did not depend on a pan-Indian presence.

“Rather than becoming another mobile operator, Vodafone-Idea should focus on geographies, consumer segments, or products where competitors are weak and they can build dominance,” says Jayanth.

This will reduce the incremental capex for the company, besides avoiding a head- on competition with two cash-rich rivals. The numbers suggest this could already be happening.

“The capex outlay by Vodafone-Idea has been below the levels of Airtel and Jio. This is despite the combined entity’s subscriber numbers being higher. Even the data carried by the group is ahead of Bharti,” say Jefferies Piyush Nahar and Somshankar Sinha.