Vodafone-Idea Merger: Cost Synergies At Play

Idea shareholders expecting a valuation bonanza from its merger with Vodafone have their hopes dashed. The merger is much more of a cost-synergy benefit that will play out over the next three-four years than an immediate valuation gain that would benefit Idea shareholders.

Both the entities have an equal stake in the new joint venture that pegs the joint venture’s (i.e Idea-Vodafone) valuation at current market prices (Idea stock at Rs 97.60) at Rs 70,340 crore. The combined debt of the new entity will be Rs 107900 crore pegging the enterprise value at about Rs 1.78 lakh crore.

The Idea stock saw an increase in volatility once the finer nuances of the deal came through which showed that both the companies have equal stake in the merged entity. The Idea stock crashed from Rs 110 to Rs 97.6 levels in the market. The deal has been done at a price of Rs 72.5, which was the 30-day average trading price.

Analysts point out that the Vodafone-Idea merger is all about consolidation and cost savings depending on how quickly the combined entity is able to merge its operations. The merged entity is expected to save substantially on operations costs of approximately Rs 6,700 crore in present value after integration and spectrum liberalisation payments.

From the fourth year onwards, the combined entity is estimated to have cost synergies of approximately Rs 1400 crore in the combined operations. The new merged entity is also better placed on the spectrum front with huge spectrum capacity of 34 3G and 129 4G network carriers, which will enable the company to compete with other players in the market.

However, the market is highly competitive given the entry of RJio and thereby putting pressure on the market shares of the combined entity, thus there is a likelihood of some market share losses for the enterprises.

Says Gautam Duggad, head-research, Motilal Oswal Securities: “Over FY16-21E, we are currently building about 250-300bp 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 per cent lower capex requirements, the high free cash flow could reach about Rs 8000-10000 crore, which could be used to strengthen the market position.”

In a note, concurs Naval Seth of Emkay Global: “In our view, the upside is restricted first due to hyper competitive scenario with Jio expected to remain aggressive in race to gain revenue market share, second, long dated cost synergies and third, lack of debt reduction in medium term. Progress on regulatory approvals would also be closely watched as both the entities have number of pending litigations.”