Rarely does a merger agreement suit the majority of the shareholders on both sides of the deal. Normally, one side tends to overpay or dilute its equity by too much, hurting its shareholders’ interest.
Idea Cellular Ltd’s plan to merge with Spice Communications Ltd, in that sense, is unique, because both companies seem to have gained.
For the purposes of the deal, Spice has been valued at Rs77.3 per share, a 40% premium to its prevailing market price, and Idea has been valued at Rs156.96, a 58% premium to its market price prior to the deal. Much of this extra tab will be picked up by Telekom Malaysia International (TM), which is estimated to bring in about Rs7,828 crore to pick up a stake of about 19.3% in the combined entity. This is based on the assumption that TM and Idea will contribute equally to the open offer to buy out minority shareholders of Spice Communications.
The companies have said they’ll make a joint open offer for 20% of Spice’s capital, but haven’t disclosed how much each side will pick up in the offer.
Based on the prevailing market price of Idea and Spice, a 19.3% stake in the combined entity would have cost less than Rs5,800 crore, so TM is bringing in a substantially higher amount. Spice shareholders can make a fast buck by tendering shares in the open offer (which will have 100% acceptance because the minority stake is 20%).
Idea shareholders, on the other hand, will reap long-term benefits of adding two lucrative circles to its portfolio, which takes it much closer to becoming a pan-India player. Besides, it will be left with cash worth Rs4,000 crore after the entire deal is done, which will help it become nearly debt-free.
Of course, there’ll be substantial equity dilution of about 24%, but note that most of these shares have been issued at a substantial premium to TM. The state the markets are in currently, with initial public offerings and private placements practically drying up, etting such a large premium is a luxury.
The fact that TM is willing to pay such a large premium indicates that it’s extremely bullish on the Indian telecom sector. The markets seem to have taken this cue, going by the 7% rise in the shares of Reliance Communications Ltd and the 4% rise in those of Bharti Airtel Ltd after the deal was announced.
Some lessons from the mid-1990s
The last time Indian interest rates were hiked dramatically was in the mid-1990s, when the yield on the 91-day T-bill went up from around 8% in August 1994 to a high of around 13% in November 1995 and remained high before starting to fall off in the middle of 1996. The result was that after GDP growth rates of 7.3% and 8% in 1995-96 and 1996-97, respectively, growth plummeted to 4.3% in 1997-98.
The behaviour of the stock market was much more complicated. The Sensex peaked at 4,643 in September 1994 and it wasn’t till August 1997 that it was able to briefly touch the 4,600 level again, before falling to as low as 2,741 in November 1998. The 1994 high was breached only in July 1999.
The experience of the mid-1990s tells us two things. One, there’s a long lag between higher interest rates and a slowdown in growth, which explains the upbeat remarks of firms and bankers about the current pace of economic growth. In other words, the effect of the Reserve Bank of India’s current bout of tightening will be felt at least a year later.
The second lesson seems to be that higher interest rates lead to a sell-off in the stock market, which continues to be in the doldrums long after interest rates come off their highs.
But markets are affected by many other factors, besides interest rates and the inflow of foreign funds has been an extremely important factor. The period was marked by local scams as well as a falling off of inflows into Asia. The MSCI Emerging Markets Asia index reached a peak on 31 December 1993 from which it slid down until the Asian crisis struck, after which it fell off a cliff.
At present, while everybody says the economy is far more resilient than it was in the mid-1990s, we have a global event to cope with, exactly as we did then. And perhaps most importantly, the rate hikes of the 1990s were made at a time when commodity prices were low. This time, inflation is an altogether different beast.
Another point that comes across is the behaviour of the consumer goods and capital goods sectors during the mid-nineties. At the time, while the consumer durables index fell sharply as soon as interest rates started going up, they also revived more rapidly when the cycle turned.
In contrast, capital goods demand was affected only with a lag and it took longer to recover. But observers say that this time there hasn’t really been a capex binge as had occurred in the mid-nineties, so perhaps it won’t take quite so long for the sector to recover. Nevertheless, the point about consumer durables recovering more rapidly when the cycle turns, holds true.
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