Shares of Reliance Communications Ltd (R-Com) rose by over 12% based on a news report that Emirates Telecommunications Corp., known as Etisalat, is in talks to buy a 25% stake in the firm.
The Times of India reported that the deal size will be Rs18,000 crore. Assuming that this includes the mandatory open offer for an additional 20% stake, the per share valuation works out to Rs174. Assuming the deal size mentioned in the report is only for the 25% stake, the per share valuation works out to Rs349, a huge premium over the market price of Rs155.
Also Read | Dismal performance drags down Punj Lloyd
R-Com is in dire need of cash with a net debt of close to Rs30,000 crore and a net debt to Ebitda ratio of close to four times. Etisalat, on the other hand, is cash-rich. It had cash worth Rs14,500 crore as on 31 December and generates free cash flow—after capital expenditure—worth Rs6,000 crore every year. The deal seems like a good fit.
But based on current regulations for acquisitions in the telecom sector, Eitisalat can’t just acquire a 25% in R-Com. It already owns 45% in Swan Telecom Ltd and can, hence, acquire only a 10% stake in R-Com, unless it dilutes its stake in Swan.
Graphic: Yogesh Kumar/Mint
But then Etisalat has invested about a $1billion (Rs4,720 crore) in Swan and it doesn’t make sense to exit the company in a hurry. The two companies could consider a merger, but again, current regulations are prohibitive in terms of spectrum usage of the merged entity.
According to a HSBC Research report, “A merger would be a more effective solution should the new rules come into effect. Prevailing merger and acquisition norms do not allow the merged entity to assume the spectrum advantage. As per the new proposed rules, the merged entity can hold up to 14.4MHz of spectrum.”
It may be a while before the new norms are effective. And in the case of a merger, the deal would be a little more complex compared with the structure mentioned above.
Another possibility for R-Com is to reconsider a merger with MTN Group. But according to an analyst with a domestic brokerage, such a deal may work against the promoters’ interests.
When the firm was in talks with MTN, R-Com shares were trading at much higher levels and after the merger, the promoter group would have had a stake of around 32%, making it the largest shareholder in the merged entity. But R-Com shares have fallen considerably since and the promoters may end up a stake of only 15-16% based on current prices, says this analyst.
There’s little doubt, however, that R-Com must raise equity funds to bring down its debt. For this reason, an equity dilution deal in some from or the other may well materialize.
We welcome your comments at email@example.com