WHY VODAFONE-IDEA DIALLED M FOR MERGER
The bigger, leaner entity will still have a tough time defending its turf
Can the combined entity of Idea-Vodafone continue to hold the number one slot in terms of revenues, despite the bruising challenge from Reliance Jio as well as Bharti Airtel? And will the merged entity be able to fight the battle more effectively than going it alone?
Naturally, the two partners — Vodafone and the Aditya Birla group — think it will. That is why just last week they jointly took one more big step towards the merger, which is expected to be completed by June, when they announced the new top leadership team. Balesh Sharma, Vodafone’s current chief operating officer, was appointed CEO of the merged entity with Kumar Mangalam Birla as non-executive chairman.
But the Jio 4G onslaught and the disruptive pricing that it has unleashed have raised the stakes. Jio’s entry has already taken its toll on the combine since it announced the merger in March last year. At that time their combined gross revenue market share was 42.5 per cent; by the quarter ended December, it was down to 37.5 per cent. And this will be under pressure; because the merged entity exceeds a 50 per cent revenue share in three circles of Maharashtra, Gujarat and Kerala, it will have to reduce its customer base in these key circles to comply with competition laws.
That apart, many of their key circles have seen a decline in revenue share. Idea, for instance, has lost around 10 percentage points of adjusted gross revenue share in four out of its eight leadership circles (MP, UP west, Haryana and Punjab) from the time the merger was announced till the quarter ended September 2017. Vodafone took a hammering in Delhi with its share down over 10 per cent between the merger and the quarter ended December.
Jio plans to grab more than half the market in revenue terms. This may be ambitious but analysts reckon it will hit close to 20 per cent by Marchend 2018. And with Jio unleashing a price war in January, just when everyone thought the worst was over, telcos expect the bloodbath to continue for at least 24 months till it gets closer to its target.
Meanwhile, Bharti is now in a sweet spot after buying out Tata Teleservices and Telenor. Its revenue market share is expected to be close if not ahead of its main rivals byMarch this year, depending on how many Tata Tele and Telenor subscribers switch. If it gets them all then its revenue market share will be about 37 per cent, marginally lower than that of Vodafone-Idea combine.
Clearly, most telecom experts believe that the pecking order will change after the mergers are completed. CLSA predicts that the revenue market shares by the end of calendar year 2020 would see Jio and the Vodafone-Idea combine locking horns at 32 per cent each with Bharti close behind with 30 per cent. Both Vodafone and Idea refused to comment on the merger.
In many ways, however, the combined entity would be much better placed to fight the battle . Individually they are far behind in 3G/4G and LTE (Long Term Evolution technology, a high-speed wireless communication standard) compared with Jio and even Airtel. Together they have over 88 million 3G/4G customers, against Airtel’s 62 million, though only half of that of Jio.
Still, the synergies from the merger will help save the merged entity over ~140 billion a year after two-three years. Most of this will accrue from lower operating expenses due to the reduction in the number of overlapping towers by at least 70,000, which would cut rentals and energy costs.
There are, however, some serious network challenges to contend with. The two have competing vendors who have supplied them equipment to run their respective networks in several key circles. Integrating them would be a complicated process, since it would entail moving equipment across or within the circle, which could disrupt customer service.
The combined entity will also face the challenge of streamlining its manpower — it has over 21,000 employee currently. Pink slips have been the norm in most other telcos and Vodafone-Idea is unlikely to be different. A source involved in the merger process says the attrition rate jumped 15 per cent after the merger was announced, and those posts have not been filled.
To catch up with its competitors, the combine will require to quickly roll out 4G LTE and VOLTE (Voice Over LTE) services across the country. Jio has a substantial edge as it has begun operations with a pan-India 4G LTE network with VOLTE services. Airtel has set a deadline to have VOLTE across the country by the end of this year, and has completed its 4G LTE roll-out. In contrast, Idea just announced in March the launch of VOLTE services for its employees, with plans to offer it to customers across 20 circles by April next year, while Vodafone launched it in January.
The combined entity has a tough task of shifting its over 300 million 2G customers to 4G. Apart from improving spectrum usage, which can be deployed for taking care of the huge increase in data, this shift will lower operation costs per tower.
All this means that the two have to make large investments — not only to pay for spectrum but also to invest in a massive network upgrade and expansion and absorb the cost of a price war. Analysts say it will have to invest around ~160 billion per year at least for the next two years, in line with what competitors are forking out. But the combined net debt to EBITDA has been climbing sharply and is projected to peak to a staggering 17.5 in 3Q of FY 2019, according to IIFL estimates. This is far higher than the debt to EBIDTA ratio of Bharti Airtel, which is at just above 3.
The good news is that the combine has enough assets to monetise and both players are also looking at raising equity. Idea has raised equity of ~67.5 billion, which Vodafone will match after the merger. The two also have a 53 per cent stake in Indus Towers, which can fetch them over $5.3 billion. They have already sold their captive towers to ATC to raise $1.2 billion. Analysts say if the monetisation goes as schedule (excluding Vodafone selling its stake in Indus) the debt to equity ratio would be a manageable 6 by 4Q of FY 2020.
But the future financials would also crucially depend on one factor over which they have no control — how long Jio continues to play the pricing game.