Vodafone’s partial exit from India, lower synergy should worry investors

The merger agreement between Idea Cellular Ltd and Vodafone India Ltd includes a partial exit by the latter’s parent firm, Vodafone Group Plc. The UK-based telecom company will gradually bring down its stake in the merged entity from 50% to start with, to possibly as low as 26%.

From having invested billions of dollars into the Indian market, Vodafone now suddenly looks far less ambitious about its India plans. Besides, without its deep pockets, it’ll be interesting to see how the merged company fights Bharti Airtel Ltd and Reliance Jio Infocomm Ltd, who are deploying huge resources in building their networks.

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Vodafone’s investors have been recommending an exit from India, where its operations don’t throw up cash even after years of operations. Although the company appears to have chosen the middle path—by retaining a stake (of between 26% and 35.6%) and raising cash by selling its remaining exposure—investors in the merged company should view this shrinking ownership as a sign of lower confidence in the Indian market’s prospects.

Idea Cellular’s shares fell by over 10% on Monday to Rs97.20 after the deal structure was announced. An analyst at a multinational brokerage firm says the big idea behind the merger was the prospect of huge synergy benefits by combining operations, and some of that is now being questioned. With the two firms deciding to operate as separate brands post-merger, there are now question marks on whether synergy benefits will be as large as expected.

Vodafone and Idea have estimated operating cost savings of around $1.3 billion in the fourth year since the completion of the merger. This amounts to as much as 11% of the combined entity’s current pro forma revenues. It has estimated savings of another $800 million or so from capex (capital expenditure) savings annually. Merging firms are typically sanguine about synergy benefits, and these estimates may well be ambitious, given the decision to operate as separate brands.

Vodafone’s Indian escape act is heavy on the contortions

As part of the deal, Vodafone will sell a 4.9% stake in the merged entity to the Aditya Birla Group at around Rs109 per share, for a total consideration of Rs3,874 crore. This transaction will bring its stake down to 45.1% and take the Aditya Birla Group’s stake in the merged entity to 26%.

The Aditya Birla Group has also retained a right to buy another 9.5% stake at Rs130 per share. If it goes ahead with the purchase, Vodafone will end up getting a 70% premium for the cumulative 14.4% stake, against Idea’s valuation before the two firms announced they were in merger talks.

If the Birlas don’t exercise this right within four years of the completion of the deal, then Vodafone has to sell its shares to outside shareholders and bring its stake down to 26%. For this, it has a five-year time frame after the Birlas’ right to buy its shares elapses. In this scenario, Vodafone will be effectively cutting its interest in the Indian market by more than half.

The deal excludes its 42% stake in Indus Towers Ltd, and the company’s press release suggests that a partial or a full disposal of this stake is also on the cards.

All the same, the Aditya Birla Group appears to be a firm believer in the prospects of the merged entity. An increase in its stake to 35.6% by buying additional shares from Vodafone will provide investors some assurance that at least one of the partners in the merger is increasing its bet on the Indian market substantially.

It’s worthwhile noting here that in the restructuring of Aditya Birla Group firms last year, the promoter group effectively cut its stake in the telecom business from about 23.6% to around 20%. It remains to be seen to what extent it actually invests and increases its exposure to Indian telecom.