Telecom battlefield and the Idea -Vodafone merger: The fineprint decoded
Idea Cellular slumped another five per cent on Tuesday to Rs 93 on the National Stock Exchange (NSE), a day after it lost 10 per cent following a union announcement with Vodafone’s India business, to create the country’s largest telecom company. By comparison, NSE's Nifty50 index ended flat at 9,121. A compilation of how brokerages and research houses read the deal’s fine print.
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The synergies from the union are adequately priced into the stock price, but the risks are not. The scale of the transaction and the time required during and after the union for operations to stabilise make these risks significant and understated at the current price. We tweak our sum-of-the-parts-based stock target price to now include the captive tower business into the core business, in line with the structure of the union announced and value the 11.15 per cent stake that Idea holds in Indus Towers separately. Our price target is reduced to Rs 85 (Rs 90 previously); we maintain 'underperform' rating.
Idea expects synergies worth $10 billion in net present value with annual operating-expenditure synergies of $1.3 billion from the fourth year of completion. We believe the market will be anchored to these targets and benchmark it on a regular basis. Overall, given the longish timelines for deal conclusion (18 months), even longer timelines on synergies, retention of competitive positioning, and the extent of synergies projected — the phase of seeking positives of union from the Idea stock will now be replaced with studying the assumptions and exploring the downside risks. We stay cautious on Idea.
While outlining aggressive cost synergies from the union, both Idea and Vodafone continued to paint a gloomy picture of the sector's revenue growth in FY18. The same remains challenging owing to newcomer Reliance Jio's gargantuan revenue market share aspirations, which continue to hurt telcos and pressure sector revenue. We remain sellers on Idea, given its history of over-optimism on synergy benefits.
MOTILAL OSWAL RESEARCH
The telecom battleground is all set to intensify, with Idea and Vodafone announcing to join up their businesses in a deal that will create a telecom giant. The current sub-30 per cent operating profit margin could scale up to 36-39 per cent over four-five years, led by synergies and scale benefits. Furthermore, reducing capital-expenditure requirement and tower sale could lower leverage to around 4x by FY19. We upgrade Idea to 'buy' with a target price of Rs 120, implying a 9x enterprise value (EV)/operating profit on FY19 estimates for the combined entity. In our view, the rich valuation is justified, as the expected recovery from FY19 could drive operating profit compound annual growth of 18 per cent over FY18-22.
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RELIGARE INSTITUTIONAL RESEARCH
The market is more than factoring in the upsides from Idea’s tower sale and synergy benefits for the entity. Though we model for a better operating profit margin and synergy accrual in our combined profit and loss for FY19, the risk-reward remains unfavourable. The transaction will take nearly two years to complete and the annual $2-billion synergy will be achieved only at the end of the fourth year. We adjust our standalone estimates for Idea to factor in lower margins, but value it on a post-union basis to arrive at our March 2018 target price of Rs 90 (September 2017 Rs 80), based on 6.4x FY19 estimated EV/operating profit. We maintain ‘hold’.
The transaction faces many challenges and would take almost a year to conclude. The joined-up telco would breach the spectrum holding cap in five circles in 900-megahertz (MHz) band and in two circles in the 2,500-MHz band; and likely to breach the revenue market share cap of 50 per cent in six circles. These would have to be resolved in a fixed time frame. Further, the debt levels of the joined-up telco would be high at Rs 1,08,000 crore, which translates into a debt/operating profit of 4.4. Both entities would have to inorganically deleverage to rein in the debt.
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Upside for Idea is restricted by (1) a hyper-competitive scenario, with Reliance Jio expected to remain aggressive in race to gain revenue market share; (2) long dated cost synergies; and (3) lack of debt reduction in medium term. Progress on regulatory approvals would also be closely watched as both entities have a number of pending litigation cases.
Also Read: Stay cautious on Idea, advise analysts