Telecom Battle

It took exactly 49 days for Idea and Vodafone to stitch together a merger deal after it was officially announced by Vittorio Colao, ceo, Vodafone group, on 30 January 2017 in London. The basic precondition spelt out then by Idea was that the merger would happen only if “the rights are split equally” between the two promoters – the Aditya Birla group and Vodafone. When the deal was announced on 20 March 2017, the point stressed strongly was that at the end of four years, both Vodafone and Idea would have an equal stake in the merged entity. Vodafone even went out of the way to assure the Birlas that any excess stake held by Vodafone at that point would be sold within five years from the expiry of that four-year period. During the first leg of the deal, Vodafone will have a 45.1 per cent stake in the entity, while the Aditya Birla group will hold 26 per cent. The latter reserved the right to buy a 9.5 per cent stake from Vodafone within the next four years, at a fixed price of R130 per share increasing its stake to 35.5 per cent, while simultaneously bringing down Vodafone’s stake to 35.6 per cent, thereby creating an equated holding 

structure in Idea.

There is little clarity at the moment on issues like ‘what the new name of Idea Cellular would be’ and ‘the names of the CEO and COO of the combined entity’. What has been agreed upon, is that the chairman of the company would be Kumarmangalam Birla, while the CFO would be appointed by Vodafone. The press release, as well as the analysts’ presentations, by Vodafone and Idea stated that the CEO and COO would be the “best persons for the job”, without elaborating what roles Sunil Sood, current CEO, Vodafone India, and Himanshu Kapania, CEO, Idea, would hold.

The deal is expected to be operational in the next 24 months. It is estimated that the merged entity would have received all the statutory approvals by CY18. With this merger, Vodafone/Idea will emerge as India’s largest telecom player, with 400 million subscribers, a 35 per cent customer market share and 41 per cent of the market by revenue. But the numbers may not portray a correct picture as Reliance Jio has not yet started billing. Once Jio starts billing, the market share by revenue of the combined entity could come down. Data presented by Vodafone plc to analysts reveal that it would be number one in terms of revenue in all the three metros; number one in two out of the five ‘A’ circles and number one in seven out of the eight ‘B’ circles (see table: Circle-wise revenue).

In the interim, both entities will continue to operate separately till all legal formalities are over. During this period operational synergies would be closely watched by the industry. What strategy Jio would now adopt will be crucial, as Reliance Industries has never settled for being number three in any industry it operates. Current leader Bharti Airtel would become number two after this merger, with a revenue market share of 32 per cent. “For Idea shareholders and lenders who have supported us this far, this transaction has been highly accretive, and Idea and Vodafone together expect to create a valuable company, given our complementary strengths,” writes Kumarmangalam Birla in a company release. “We look forward to working with the Aditya Birla group to create value for all stakeholders,” responds Colao, in the same press statement.

The industry, which was once the darling of investors, particularly foreign telecom players and funds, has been finding it challenging to keep them engaged. Several listed companies in this space have seen great erosion in their market cap, as competition as well as costs are on the rise, pushing margins down. Idea, which till last year was a profitable company, is all set to report losses for FY17. For the first nine months of the current financial year, it has reported losses of R72 crore, as against a profit of R2,276 crore during the corresponding period last year. Meanwhile, Bharti Airtel’s profits too have collapsed during the first nine months of the current year from R4,757 crore to R3,426 crore. Vodafone India’s operations have also faced the heat of competition in the last six months. In all probability, for all the three players, the numbers for the quarter ended March would be depressed.

To a great extent, this is due to the grand entry of Reliance Jio. Its ‘out-of-the-box’ pricing policy has changed the way the telecom business is being run in the country. Voice revenue, which formed 70 per cent of the industry’s intake, is all set to become close to zero, as Jio has promised a lifetime of free calls (incoming and outgoing). The data business, which once looked promising enough to lift the average revenue per unit (arpu) for the industry, has come crashing down, after the Jio free offer. From here on telecom players are focussing on getting more customers on board for data and that they use more data to lift the arpu numbers.

The stock market did not give a thumbs-up to the announced merger. Idea’s share price tanked by 10 per cent that day, and fell another 5 per cent the next day. Vodafone’s parent company, which is listed on the London Stock Exchange, did not see any gain either; it closed marginally below the previous day’s closing price. Kumarmangalam Birla had, at a media interaction, suggested that the market would take time to understand a complex deal like this. He sees the fall in Idea’s share price only as a “knee-jerk” reaction. To be sure Idea’s share price did jump after the preliminary discussion announcement in January with Vodafone from about R70 to R110. The market seems to be following the old adage of ‘buy on rumour and sell on news’.

There are concerns, experts feel, which would be closely watched by the industry. To begin with, this may not be an easy merger. On the one hand, you have a traditional, family-controlled business house while, on the other, is a company oriented in the MNC tradition. The fusion of these two cultures could be a big challenge for any new CEO. At the board level, Birla and Vodafone will have to align with each other which, though not impossible, is not easy either. Many a merger in the world has failed to reach true potential due to cultural differences among partners. There are no previous instances either, to draw a parallel from, as Birla has not yet jointly managed a listed company with a foreign listed partner. The group does have joint ownership with AMCs and insurance majors, but they are all closely held companies. Also, G.D. Birla, the great-grandfather of Kumarmangalam Birla, had run companies like Hindalco jointly with foreign partners like Kaiser Aluminium. The shareholder agreement allows Birla as well as Vodafone to have three seats each in the 

board, which will also have six independent directors.

The combined entity will have a debt of Rs1.08 lakh crore as on December 2016, which means that it would have debts that may not be easy to serve, when the pressure of competition is high. Deven Choksey believes that Idea may sell a part of its stake to someone like Softbank in the next few years, to reduce the company’s debt. To some extent, the debt burden should reduce for the company, as Idea, which has stand-alone towers as well as an 11 per cent stake in Indus Tower, could sell these. The tower business is also going through a consolidation phase and there is a possibility that an investor like Blackstone may show interest in these assets as they offer steady returns.

If for any reason Idea sells shares to someone like Softbank then what happens to the shareholders agreement is not clear. Any dilution in the equity capital means there would not be an “equal” stake – even at a later stage. The shareholder agreement suggests that the moment the stake goes below 26 per cent (till March 2020), the right to nominate shareholders will be nullified. Birla, with a 26 per cent stake, has a higher probability of breaching the threshold if Idea opts to dilute.

One telecom expert, who chose not to disclose his identity, says that the way the board has been structured, one cannot get a clear idea as to whose baby Idea is now. What commitment will Vodafone have in India’s telecom markets, from here on, he wonders. Vodafone’s India operations have not lived up to expectations. The parent company had to write off €6.6 billion in the name of its Indian subsidiary. In fact, the present stake sale is actually a desperate attempt to reduce the burden on the parent company, as it did not want to pump more money to take on the Jio competition. One option for Vodafone was to take the company public; but the competition from Jio did not allow that.

With Vodafone’s stake in the merged entity below 50 per cent, there is a high probability that once the lock-in period to sell the stake is over (which, in this case, is three years), Vodafone may initiate a process to exit the Indian market, though Colao denies this possibility, in media interactions.

The success of Vodafone in the Asian market has not been that great. It had quit Japan in 2006, selling its stake to Softbank. It does not have any presence in the other two large Asian economies – China and South Korea. The company has a few minority owned operations in Asian markets like Malaysia, Singapore, Taiwan, Sri Lanka, etc. In the Asia-Pacific region, there were only three countries in which Vodafone had 100 per cent owned mobile service companies – India, Australia and New Zealand. Vodafone exited the US market too. It had tied up with AT&T for a mobile business called Verizon, where it controlled a 45 per cent stake. In 2013 Vodafone sold its stake for $130 billion to invest more in emerging markets. Though, not so long ago, the company had described India and Turkey as its key markets for growth – Jio’s entry has disturbed all its calculations. And, to be fair to Vodafone, in the last one decade or so none of the other foreign players could ride the Indian telecom wave successfully – be it Telenor, Docomo, Sistema or AT&T. Hutchison made good money before moving out of India after selling its controlling stake to Vodafone. Singtel too made money by investing in the Holco of Bharti Airtel. Both these investments were made more than a decade ago.

One is not sure how close the telecom business is to Kumarmangalam Birla’s heart. The group has done well in the commodity business but, in new businesses like IT and telecom, its success has been limited. When Jio emerged, research analysts had a field day knocking Idea as a weak player. And, Idea’s market cap, which was once in excess of Rs 70,000 crore, fell to Rs 26,000 crore in 15 months as concerns on the competitiveness of Idea’s mobile service business came under a shadow. This is one of the reasons Idea chose to partner with Vodafone before continuing the battle.

Currently, the Birla group is in restructuring mode, with the upcoming merger of Grasim and Aditya Birla Nuvo. And it may be reluctant to invest more in telecom. Hence, it has opted for a four-year window to acquire 9.5 per cent stake from Vodafone at a price of R130 per share. Whether Birla will increase its stake at the end of the four years – it’s too early to say. The industry calls for capex at regular intervals and Birla’s willingness to keep on drawing money from other businesses to invest in telecom would be studied keenly. Any merger is a long-drawn out process and so is this one. Birla considers it complex too. So, it’s too early to cheer either for the telecom industry or for Idea. Jio may continue to disrupt the industry, till it reaches its desirable scale. Battle is on.

(This is excerpt from Story Published in Business India)