Financial markets are often adept at sending critical messages to company managements and boards. Idea Cellular Ltd’s shares have one, too. They have fallen 21% from the time the company announced details of its merger with Vodafone India Ltd. They now trade at Rs85 per share, far lower than the Rs110 per share valuation at which the Birla group has agreed to buy shares worth Rs3,874 crore from Vodafone Group Plc.
The key message from Idea’s languishing shares is this: the company should get the merger done quickly.
There is hardly any value left in stand-alone operations, and the key is to get the deal done quickly and work on extracting synergy benefits.
Analysts at Credit Suisse Securities (India) Pvt. Ltd said in a 20 April note to clients, “Our base value for (Idea’s) stand-alone business is almost negligible—Rs9 per share, implying 7.5x FY19E EV/Ebitda multiple on mobile and 9.5x on the Indus stake."
The brokerage estimates Idea’s earnings before interest, taxes, depreciation and amortization (Ebitda) to fall by 45% between FY16 and FY19.
The majority of Credit Suisse’s valuation of Idea’s shares comes from estimated synergy benefits from the merger.
Put simply, the merger needs to happen sooner, rather than later.
In fact, the longer Idea stays as a stand-alone entity, the harder it will fall. It is highly leveraged, which limits its ability to invest in its network, taking it further behind competitors Bharti Airtel Ltd and Reliance Jio Infocomm Ltd in terms of network coverage. Worse, both of these firms, led by Jio, are aggressively cutting tariffs to gain market share.
While Idea is trying to match tariffs, there is no way it can match the 4G network coverage of its competitors. As such, it is expected to lose customers ahead of the merger, and face the double-whammy of a lower customer base as well as lower tariffs.
Post-merger, leverage is expected to fall gradually, while the quality of spectrum assets will rise. Even after they surrender excess spectrum, they will hold more spectrum than both Airtel and Jio. There are a host of other synergy benefits, and it turns out that a large proportion of shareholder value hinges on extracting these benefits.
Analysts at JM Financial Institutional Securities Ltd said in an 18 April note to clients, “On a pro-forma basis in CY16, the merged company had 40% more revenues than Bharti’s India mobile business but only 3% more Ebitda, which underscores the synergy potential."
The two companies expect the net present value of synergy benefits at roughly $10 billion, which works out to Rs93 per share. Idea shares now trade at only Rs85 per share. If, as Credit Suisse’s analysts assume, there is a 70% probability that synergy benefits will come through as estimated by the companies, then the stand-alone business is being valued at merely Rs20 per share by investors.
Any delay in the completion of the merger will result in a drop in the estimate of synergy benefits as well. A large part of the synergy benefit is dependent on having a large customer and revenue base. There is near-consensus that as stand-alone entities, both companies will lose market share, especially with both Airtel and Jio snapping at their heels.
Analysts at JM Financial said in their note, “We assume the merged company would begin operations in FY19. For FY18, we forecast pro-forma revenue/Ebitda to decline 8%/28% on a y-o-y basis. High leverage constrains capex ability, and should there be delays in deal completion, both telcos could see revenue decline in FY19 as well." When the two firms announced the merger timeline last month, it was longer than what analysts and investors had anticipated. Since a number of investors have voted with their feet since, the message is loud and clear: get this done quickly.