Voda-Idea merger won't give pricing power to new telecom giant

The merger of UK-based Vodafone Plc's Indian telecom operation and Aditya Birla group's Idea Cellular will make the combined entity the largest telecom operator in terms of market, spectrum and revenue shares but this pole position will not afford it pricing power or the ability to dictate the average revenue per user (Arpu), say analysts.

Telecom experts believe benefits would accrue to the Vodafone-Idea combine mostly on the cost side, on the revenues front the merged telecom behemoth would still struggle in a stiffly competitive market.

"Benefits (of the merger) will purely be on the cost side. Revenue and Arpu will continue to be under pressure. The belief that they will be able to dictate Arpu will not be true. The demand of being in the sector is very big today and this combination allows them to compete better than they did individually. Individually, they were simply unviable because they were under a lot of stress. Now, they will be in less stress (as merged entity) than they are currently in but will still not have pricing power," said a telecom analyst with a leading management consultancy firm who did not want to be named.

He said in terms of market and spectrum share, they will have to give up their positions in many circles.

Harsh Jagnani, VP - sector head, Icra Ltd, said once the two telecom companies joined forced they will market leaders in 12 of the 22 circles and would be the second largest player in nine circles.

According to him, operational synergies derived from the merger would make them more profitable. "The merged telco (telecom companies) should also benefit from operational synergies which will allow it to curtail some expenses such as co-location rentals and energy costs, customer acquisitions and support teams and reduced expense on branding and advertising. This should translate into profitability uplift to the merged entity, although the same will take some time to materialise".

With four major blocks of private players – Vodafone-India, Airtel-Telenor, Aircel-RCom-Sistema and Reliance Jio – and one block of state-owned telco – BSNL and MTNL – emerging, analysts feel Tata Telecom would have to decide soon as to which coalition it would like to align with.

The speed of consolidation in the telecom sector has be accelerated after Mukesh Ambani's Rel Jio launching its fourth generation (4G) long term evolution (LTE) data and voice services late last year by offering them for free. This intensified the rivalry among telecom service providers for the data market, where the tariff has dropped by more than one fourth over the last one year.

Icra's Jagnani does not see the tariff war among the telcos abating any time soon.

"While there are many regulatory hurdles for the merger (Voda-Idea), it would nevertheless create a strong player in the industry. We do not expect any reduction in the competition in the industry in the medium term as the large telcos would continue to keep the intensity high. However, in the long term this consolidation is expected to be positive for the industry, as it would restore some pricing power and give better bargaining terms with vendors/suppliers," he said.

Jagnani, who expected the deal to be completed in a year, sees the merger deal facing many hurdles as it is likely to "breach spectrum holding cap in five circles in 900 megahertz (MHz) band and in two circles in the 2500 MHz band; and likely to breach the revenue market share cap of 50% in six circles".

"These would have to be resolved in a fixed time frame. Further, the debt levels of the merged telco would be high at around Rs 108,000 crore, which translates into a debt/Ebitda of approximately 4.4x. Both the entities would have to inorganically deleverage to rein in the debt," he said.

Gautam Duggad, head-research, Motilal Oswal Securities Ltd, said if the combined entity did not move fast on getting the deal through then there was a major "risk" of losing market share to rivals like Reliance Jio and others, who are extremely aggressive in the current market.

"Since the telecom market is highly competitive given RJio capacity game, there is a major market share dilution risk if the deal take prolonged period to fructify. Our channel checks with regulatory and telecom M&A verticals indicate that the spectrum and revenue caps may not be a major obstacle. We think there is a likelihood of this deal getting sooner than expected," he said.

Duggad further added; "Over FY16-21E, we are currently building about 250-300bp (basis points) market share dilution for Idea and Vodafone each vs Bharti's 50bp market share loss. If the deal goes through given the merged company's superior spectrum/network position, higher revenue market share and about 20%-25% lower capex requirements, the high FCF could reach about Rs 80-10,000 crore, which could be used to strengthen the market position".