Idea Vodafone merger may not happen

If market rumors are believed, this is a wonderful proposal in the otherwise boring telecom space:

1. Synergy through consolidation of marketing cost, operations & office space.
2. Unlocking value through sale of excess of excess spectrum. Giving the new company cash to fight Jio aggressive promotions
3. Idea is the 3^rd largest player and might soon turn 4^th before fading away as irrelevant. This deal will give the promoters a chance to exchange their equity for a stake in the largest telecom player.
4. Reverse listing for Vodafone is attractive. It allows them to unlock the value through listing and share the losses with Indian shareholders till the market is back into viability.

Being contrarian by nature, here is why I think it might not happen:

1. The deal requires either Birla’s to cut their existing holding 42% of Idea to less than 20% of the new company or infuse cash or exit completely.
   • Option A is risky, thanks to Indian promoters love of micro management. If Infosys, & Tata board squabble throws any light Birla’s might not be OK with back-seat.
   • Option B: requires purchase of additional equity in cash to gain back equal voting rights in the board. This is also unlikely as stock price is almost 70-80% higher than what it was before the news making it more pricey for Birla for additional stake. Secondly as a 3^rd If the deal was happening, then they would not have allowed Vodafone to spoil the party.
   • If Vodafone had any interest in buying out Birla, then they would have not shared their intentions and allowed the stock price to zoom up.
2. Jio could offer 90-180 days of free data because it had zero subscribers to begin with. Also they really limited the number of new connections & portability request last year to limit the cash burn rate. The New entity will have a whopping 40%+ market share with wafer thin margins. So no price reduction that they do will be economically viable & Jio can always match is as their subscriber base is still small (so limited cash impact from the scheme)
3. By same logic, the war-chest from Birla’s cash infusion & spectrum sale to counter Jio’s promotion may not be useful. Idea could gain more new connections at lesser cost as the 3^rd largest player rather than the largest player. Therefore, if Birla’s had to infuse cash, they would have purchased additional equity through rights at pre-news levels and not at present levels.
4. Unlocking value through sale of excess spectrum is also doubtful. The sale will happen at below market price & will only strengthen the spectrum availability for the competition. No businessman likes to idea of selling precious & limited asset at loss to its competition.
5. Vodafone’s history with Indian government’s regulatory approval cannot be ignored. They badmouth Indian Income tax department on its tinkering with the fine print to bring the Essar-Vodafone transaction into tax ambit. Now this has two repercussions, firstly Vodafone will be once bitten twice shy and extremely cautious of going back to seek approval for deals. Secondly some babu in Indian government might be holding a grudge and really make them hoops. In any case, the deal will add one more layer of bureaucracy from SEBI which unlisted company like Vodafone India is free from adhering to.
6. Not only Vodafone is bigger entity but it also in the core business of telecom. So effectively, Birla’s would always fear the risk of relinquishing the mgmt. control to Vodafone even after cash infusion to get equal stakes. Remember a listed company means that either player can make an open market purchase and gain the control.

However, one should not ignore that Idea is a sinking ship. As long as Jio is not able to capture enough market share, they will ensure that the tariffs are subdued and the established players bleed. In addition, Idea risks being the fourth player, a position from which it could never recover. Therefore, it is likely that the mgmt. will trade its current equity position to a minority stake in the larger combined entity.
Disclosure: I have a shorted the Idea shares in the F&O market.