MUMBAI -- In a consolidation of two telecom giants, Vodafone India and Idea Cellular have decided to merge their operations in India to take on increasingly tough competition as well as sustain the pricing pressure on margins in the near term.
Together, Vodafone and Idea Cellular will become the largest telecom company in India, with a subscriber base of nearly 400 million, customer market share of 35% and a 41% revenue share, a joint statement from the two companies said on Monday. Current market leader Bharti Airtel has a 33% market share and recent market upstart Reliance Jio Infocomm, part of Reliance Industries, has quickly seized 13%.
Anglo-Dutch Vodafone Group will hold a 45.1% stake in the merged entity after transferring a share of 4.9% to Aditya Birla Group, one of India's largest conglomerates and Idea's parent, for around 39 billion rupees ($579 million) in cash. Through the deal, Vodafone will be able to lower its net debt which stood at 552 billion rupees as of the end of December 2016.
Aditya Birla Group will hold 26% of the new entity but will have the right to acquire more shares from Vodafone with "a view to equalizing the shareholdings over time."
"From the beginning of the fifth year after completion, if Vodafone and the Aditya Birla Group's shareholdings in Idea are not yet equal, Vodafone will sell down shares in the combined company to equalize its shareholding to that of the Aditya Birla Group over the following five-year period, " Vodafone and Aditya Birla said in a joint statement.
Through the combination, "Idea and Vodafone will establish a company with the scale and efficiency required to offer innovative and attractively priced mobile services, enhancing consumer choice in a highly competitive market with at least five major telecoms providers", the companies said.
The companies hope to gain run-rate cost and capex synergies worth 140 billion rupees annually by the fourth full year after the merger is completed in 2018. The synergies are expected to come in from areas such as rationalizing network infrastructure, generating operational efficiencies, lower maintenance expenses and savings in energy costs; also from higher spectrum availability and streamlining regional and nationwide information technology systems.
"This is equivalent to a net present value of approximately 700 billion rupees, after integration costs," the statement said. "Operating cost savings represent 60% of the expected run-rate savings".
The merged entity will be chaired by Aditya Birla Group chairman Kumar Mangalam Birla, while the chief financial officer will come from Vodafone. Both Vodafone and the Aditya Birla Group will jointly agree on the appointment of the chief executive and chief operating officer.
Shares of Idea Cellular fell a steep 14.73% a few minutes after the announcement on heavy profit taking, after the stock had soared 14.68% in early trade. It ended the day's trading down 10.08% at 97.20 rupees on the Bombay Stock Exchange. Meanwhile, shares in Bharti Airtel closed at 349.45 rupees, up 0.76% from the previous close, while Reliance Communications ended 0.26% lower at 38.15 rupees.
"It is a step in the right direction for the industry that is consolidating," said Nitin Soni, director of Asian corporates at Fitch Ratings Singapore. "We believe the combined entity could be able to improve its EBIDTA margin by 250-350 basis points mainly driven by the cost savings and marketing expenses".
Analysts at India Ratings beleive the two companies can complement each other -- Idea has a strong presence in rural areas and Vodafone India in urban areas -- and will be more competitive together.
Consolidation in the sector was much anticipated after Reliance Industries launched Reliance Jio into the market in September with aggressive pricing packages.
Reliance Jio is luring customers with free voice calls and ultra-low data rates -- which rivals have been quick to imitate. In December, the company extended the free calls offer until March, and is rumored to be extending it again. Reliance Jio will start charging for data usage from April 1.
According to Mayuresh Joshi, fund manager at local brokerage Angel Broking, the effect of the aggressive stance adopted by the telecom operators has pulled down the average revenue per user on both data and voice, and the average revenue per minute and data realizations per megabyte have also come down drastically for most telecom companies, m
aking market consolidation inevitable.Heavyweight Bharti announced in February a plan to buy the Indian operations of Norway's Telenor.
In December, Reliance Communications sought to pare back its debt by selling a stake in its telecom tower business to Canada's Brookfield Infrastructure for $1.6 billion. The Canadian company is also said to be in talks with Bharti Infratel for a majority stake worth $5 billion, according to CNBC's local affiliate.
Fitch's Soni, however, is still negative on the telecom sector, at least in the short-term. He said the competition represented by Reliance Jio will put pressure on telecom companies in 2017.
"But in the medium-to-long term it will be positive because now three telecom companies will emerge after the consolidation. There is a possibility that in the medium-term pricing power will come into the market. While Reliance Jio right now is very competitive and trying to gain market share purely based on price, in the medium term they are looking to increase revenue per user level."
The result of the consolidation could be that in the next two years, telecom tariffs may rise to a level where telecom companies rake in profits, thus ending the current ultra-low prices.