Mumbai: In a setback to the Reliance Communications Ltd (RCom) plan to reduce its debt burden, the Anil Ambani-controlled firm and GTL Infrastructure Ltd have called off talks for a deal that would have created India’s second largest operator of cellphone towers.

The non-binding term sheet signed by the two companies to form an independent transmission network with around 80,000 towers and valued at Rs50,000 crore expired on 31 August.

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“... Despite efforts, both parties have neither extended the term sheet nor entered into any definitive transaction agreements as envisaged therein," GTL Infra said in a stock market filing on Monday. “Consequently, the process of merger as originally contemplated would not take place."

Neither RCom, nor GTL Infra explained why the deal had fallen through, though until recently both indicated that the merger was on track.

“Owing to the provisions of mutual confidentiality agreements, RCom cannot provide any comment on the reasons for the inability to conclude a transaction with GTL Infrastructure Ltd," RCom said in a statement. RCom has begun discussions with other potential investors and is also considering an initial public offering of shares in the tower unit, called Reliance Infratel Ltd?(R-Infratel),?it said, without specifying names.

On 27 June, the two companies had announced that their telecom tower assets would be merged and R-Infratel would transfer around 54,000 towers to GTL Infra. The combined entity would have been behind only Indus Towers Ltd—jointly owned by Bharti Airtel Ltd, Vodafone Essar Ltd and Idea Cellular Ltd—that has more than 100,000 towers.

The sale was to help RCom reduce the Rs33,000 crore debt on its books by at least half. The company’s debt exceeded cash and equivalents by Rs28,400 crore as of end-June, according to the phone operator.

“RCom’s balance sheet is very stretched at the moment and it is surprising that the deal was called off. Without any equity infusion, it will be difficult for them to raise debt to fund their expansion plans," a senior executive with a public sector bank said on condition of anonymity.

Foreign exchange fluctuations and higher interest costs on account of debt secured to pay third-generation (3G) spectrum fees saw RCom’s net profit in the first quarter plummet to Rs251 crore, a quarter-on-quarter slump of 80% and a decline of 84.66% from the year-ago period.

RCom recently paid Rs8,585 crore to the government to secure 3G spectrum in 13 telecom circles.

For its part, GTL Infra had taken on debt of around Rs5,000 crore for completing a Rs8,400 crore deal to buy Aircel Ltd’s 17,500 towers, announced earlier this year.

“GTL had already leveraged its books for completing the Aircel transaction and going through with the Reliance Infratel deal would have significantly added to the debt on books," said Mritunjay Kapur, managing director at multinational advisory Protiviti Consulting Pvt. Ltd.

“Several factors, including increasing number of players in the passive infrastructure space, higher competition and lower cost of setting up telecom towers have led to lower valuations overall," he added.

RCom’s announcement of the proposed deal with GTL Infra implied a valuation of around Rs59 lakh per tower, which was much higher than GTL’s previous deal with Aircel, where the average valuation was about Rs48 lakh per tower.

Some experts said the market had already factored in a situation in which the deal might not be consummated. That may explain the subdued stock market reaction in Monday’s trading.

While GTL Infra shares gained a marginal 0.88% on the Bombay Stock Exchange (BSE) to close at Rs45.60 apiece, RCom’s shares lost 0.31% to end at Rs162.90. BSE’s benchmark index, the Sensex, rose 1.86% to 18,560.05 points.

Shares of the two companies have been underperforming the Sensex, with GTL Infra gaining a marginal 0.55% and RCom losing 15.38% of its market capitalization since the announcement of the deal.

Some analysts said the deal might have fallen through due to lack of agreement on the valuation of RCom’s tower assets and GTL Infra’s inability to raise debt to fund the cash component of the deal.

Analyst and rating agencies are reviewing their call on RCom primarily due to the heavy debt on its books.

Archit Singhal, research analyst at Mumbai-based Jaypee Capital Services Ltd, said the development was a “clear negative" for RCom’s stock.

“With the deal being announced, the market was expecting significant debt reduction to the tune of at least 15,000 crore. So the debt burden will continue, now that the deal is called off," he said.

Jaypee has a hold rating on the RCom stock with a price target of Rs182, but is coming out with a revision after the latest development.

Rating agency Icra Ltd, which had put RCom on ratings watch at the time of the GTL Infra deal announcement, said it was reviewing RCom’s rating in view of the transaction being called of.

“We will be talking to the company and taking their views into consideration," Icra analyst Vikas Aggarwal said.

RCom said following the expiry of the term sheet, it was “engaged in discussions with certain other strategic and financial investors, to pursue a similar transaction aimed at a significant reduction in the company’s debt", adding that another announcement would be made in due course.

A person familiar with RCom’s plans said the expiry of the term sheet did not mean that it could not hold talks with GTL Infra any more although it had the option of seeking other investors. He did not want to be identified.

“Since the company is not exclusively in discussion with GTL Infra any more, it would have the option of exploring a better valuation and a greater cash component with other interested partners," he said.

The consideration that RCom was to receive for its towers would have been a combination of cash and stock in the merged entity.

“The merger looked like a long shot right from the start," said an investment banker with a foreign bank who advises telecom companies on mergers and acquisitions. “GTL Infra is a relatively small company and the combined entity would have come with a high leverage uncomfortable to lenders."

Bloomberg also contributed to this story.