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Is Idea Cellular's sharp price rise justified?

The run-up in share price of Idea Cellular seems to be a knee-jerk reaction given the fact that the merger, as per Vodafone, will be effected through issue of new shares in Idea to Vodafone. While details of the number of new shares are not available, it would in any case result in swelling Idea Cellular‘s equity base.

January 31, 2017 / 04:55 PM IST
 
 
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Shishir AsthanaMoneycontrol ResearchIdea Cellular zoomed 25.90 percent to Rs 97.95 on Monday following news of Vodafone confirming that it was in talks for a merger. The merged entity is expected to have a 43 percent market share of the Indian mobile market. The merger has been defined as synergistic as Vodafone has a stronger base in metros while Idea has a greater presence in the rural market.But is the sharp rise in Idea Cellular justified given the fact that the details of the deal are still sketchy and it could face regulatory hurdles going forward. A Moneycontrol article lists three hurdles that the deal may face. The merger will need to be cleared by the Competition Commission of India (CCI), especially since the combined entity would have the lion’s share of 43 percent.However, the merged entity will have to make some sacrifices. M&A norms in the telecom spectrum require that revenue market share of the merged entity not exceed 50 percent. While this may not be a hurdle to the merger going ahead, there are two more rules which mandate that spectrum holding shouldn’t exceed 25 percent across all bands and 50 percent in each band individually.This would mean that the new entity will have to relinquish spectrum in circles where there is a breach of these ceilings. The Moneycontrol article says that a few circles like Gujarat, Maharashtra, Haryana, Kerala and UP West will have to be given up. Additionally, the joint entity will have to liberalise its historical spectrum (those allocated without auction) amounting to around Rs 2,000-3,000 crore which will need to be paid in case of a merger. This amount is big given the current market cap of Idea is at Rs 32,278.55 cr as on January 30, 2017. However, analysts feel that this amount can be raised by selling its excess spectrum. But it can be argued that the company will face issues in finding a buyer for its excess spectrum.The run-up in the share price of Idea Cellular seems to be a knee-jerk reaction given the fact that the merger, as per Vodafone, will be effected through issue of new shares in Idea to Vodafone. While details of the number of new shares are not available, it would in any case result in swelling Idea Cellular’s equity base.Though latest profit details of Vodafone are not available, its management has been quoted as saying that its Indian business has not delivered returns equivalent to the cost of capital.Both Vodafone and Idea are not in the best of financial health, especially after launch of Reliance Jio. Operating parameters are under pressure and both the companies are sitting on a pile of debt. Vodafone’s parent company had recorded a non-cash impairment charge of 5.0 billion euros for the six-month ended period September 30, 2016, highlighting the pressure in its Indian operations.Depressed market conditions and Reliance Jio’s launch also resulted in Vodafone India delaying its IPO plans.Idea Cellular, on the other hand, has been adding on its debt base. Analysts expect that Idea Cellular will have a net debt close to Rs 55,000 crore (from over Rs 41,000 crore in FY16), nearly 1.5 times its annual revenue.Both the companies will have to add on more debt to purchase spectrum in the auction planned in FY18. Pre-Budget expectations are that government will earmark Rs 90,000 crore from spectrum sale in FY18. As things stand neither company is individually in a position to take on additional debt to purchase spectrums. However, the load on a merged entity would be lower, but still would be significant.Raising equity in the current market scenario is not a very good option given the falling profitability of all telecom players. The merged entity would thus have to resort to adding debt to fund its spectrum purchase.For Idea Cellular there is an additional cost if the Birlas want to continue to control the joint entity in which case they will have to pay a premium to the British entity.Apart from the high cost of operations a merged entity would result in more aggression in the market as players fight for market share. Finally, Idea Cellular is yet to declare its December quarter numbers. Analysts expect the company to post a loss during the quarter.Given such a scenario where there is uncertainty on all fronts on the merger, the spike in share price seems to be an over-reaction.(Disclosure: RIL, which owns Reliance Jio, also owns Network18 and moneycontrol.com).

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