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The government will become the largest shareholder in Vodafone Idea Ltd after the struggling telco opted to convert its dues of about 16,000 crore to stock, sending its shares crashing on Tuesday.

After the interest conversion on deferment of adjusted gross revenue (AGR) and spectrum dues, the government will own 35.8% of India’s third-largest service provider. The shares were priced at 10 apiece. The conversion will also lead to dilution of promoters’ stake in Vodafone Idea, with parent Vodafone Group Plc and Aditya Birla Group expected to own around 28.5% and 17.8%, respectively. The conversion is subject to government approval.

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Shares of Vodafone Idea plunged 20.54% to close at 11.80 on BSE.

Vodafone Idea exercised the option provided by the government in September as part of a rescue package, which offered telcos a moratorium on the deferred spectrum and AGR payments for four years and allowed them to convert dues arising from interest payments during the moratorium period into equity.

Rival Tata Teleservices also opted to convert the interest from AGR dues amounting to 850 crore to equity, leading to the government holding 9.5% in the company. The deadline for opting for equity conversion on interest is 12 January. Tata Teleservices said the conversion would be subject to a mutual agreement on the terms and conditions, including the governance of the company after conversion.

Sector experts and brokerages said Vodafone Idea’s move would lead to equity dilution for shareholders but should be seen as an overall positive development as it would open up more opportunities to raise funds.

“I would see it as an overall positive. By opting for equity conversion, Vodafone Idea has improved its ability to service the debt liability, and with better financials, it will be in a better position to raise funds required for capex plans," said Sanjiv Bhasin, director at IIFL Securities, adding that the stock price should stabilize in a few days.

“Their ability to raise funds from other sources would anyway have been impacted by such a liability standing in their books," said Ajay Rotti, partner at Dhruva Advisors, who added that the liability has moved from debt to equity with the conversion, hence improving their chances for raising funds.

In a note to clients on Tuesday, analysts at Credit Suisse said, “some investors believe that the government stake may ease regulatory policy regime for Vodafone Idea as it becomes one of the key stakeholders in the company and can aid in further price increases in the sector, improving sentiments for the fundraise."

“This step will align the interest of the financial stakeholders; that is the government being the largest creditor, as well as the shareholders of the company," said analysts at Edelweiss in a note, adding that the government’s role on the company’s board will be keenly watched. As the owner of a large portion of the industry, the government will be getting more feedback on the economic impact of its policies and will probably be more sensitive to policy impact on operators, said analysts at Deutsche Bank Research in a note to clients on Tuesday.

“We are surprised it (net present value of debt saved) is not more, as, by our estimates, the annual interest cost on these two items (AGR & spectrum) is above 10,000 crore, but even should we assume 40,000 crore in dues fades away, that is just one-sixth of debt, so it is more a good start than an endpoint," the firm said, highlighting the upside.

The four-year moratorium on the spectrum and AGR will produce cash flow savings of about $11 billion from FY22 till FY25 for Vodafone Idea, analysts at CLSA said. However, they noted that the company’s spectrum burden was the highest at 1.09 trillion or $14.7 billion, compared to Reliance Jio’s 65,600 crore and Bharti Airtel’s 62,700 crore. Also, Vodafone Idea’s AGR liability stands at a massive 63,400 crore.

While the telecom package has provided temporary relief to the company, the average revenue per user (Arpu) growth remains the most critical factor for the company’s long-term viability, analysts noted, adding that Arpu needs to more than double from present levels of 109. “Arpu needs to increase to 250, from its current 109, over the next 3-4 years for it to sustain the leverage," analysts at Edelweiss said.

Vodafone Idea will likely struggle to fund annual spectrum payments beyond the additional four-year moratorium unless Arpu reaches 250-300, analysts at CLSA said.

Some also flagged the company’s cash flow situation would remain challenging despite the conversion of dues into equity since it does not significantly reduce its liabilities post the four-year moratorium, and the company will need frequent equity injections in the absence of sustained operational improvement. “Our back-of-the-envelope calculations suggest Vodafone Idea would need an Arpu of ~ 280 to achieve cash flow breakeven after the end of the moratorium," said analysts at Credit Suisse. They added that the company would face a cash flow shortfall of 25,000 crore on an annual basis even after accounting for an Arpu of 189 on the back of further tariff hikes and an increase in the subscriber base to 274 million.

“The onus is on the company to successfully complete its capital raise, accelerate network investments, and stem subscriber losses, which come with their fair share of challenges. There is also still considerable uncertainty on the ability of the company to meet its enhanced payments to the government after the moratorium period ends," flagged analysts at Citi Research.

Yet another concern is that large government ownership may dissuade potential investors, considering possible government intervention, even as it may increase the likelihood of long-term survival for the company.

“There are concerns on the possibility of increasing subscriber churn with more government control and an eventual merger with BSNL," said analysts at Credit Suisse.

But Rotti of Dhruva Advisors said, “The government may hold the shares through Statutory undertaking of Unit Trust of India (SUUTI), which is different from Vodafone Idea becoming government ownership like in PSUs. SUUTI, for instance, holds 8% of ITC," indicating that the government may not actively intervene in the day-to-day operational management of the company

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