Investors had high hopes from the merger between Idea Cellular Ltd and Vodafone India Ltd. The former’s shares raced from an average of around Rs72.5 per share just before the two companies announced they were in merger talks, to as high as Rs120 within a month.

Now they are having second thoughts. Idea’s shares have fallen 14% since the two companies announced details about the deal, and now trade at Rs93 per share. Incidentally, the net present value of the estimated synergy benefits announced by the two companies itself amounts to Rs92.3 per share.

If the price ahead of the announcement of merger talks is assumed as the fair pre-merger price, the current price suggests investors are factoring in a mere fifth of the estimated gains from synergies.

In the process, they are also brushing aside the vote of confidence from the Birla group, which will buy shares worth Rs3,874 crore at a price of Rs110 when the merger closes, besides retaining the right to buy shares worth another Rs9,000 crore at a price of Rs130 within three years after the merger closure.

Perhaps, the concurrent selling by the Vodafone group is causing concern. Read more

In addition, investors are concerned about the longer-than-expected time (around 18 months) for the completion of the merger, and the two companies’ estimate that synergy benefits will fully accrue only in the fourth year since the closure of the merger. Analysts at JM Financial Institutional Securities Ltd wrote in a note to clients that their near-term outlook is dampened by longer M&A approval/completion cycle and a rather extended time-frame for full synergy extraction, among other things. They had anticipated synergy benefits to accrue in FY20, within two years of the completion of the merger.

For some other analysts the synergy estimates themselves are ambitious. Analysts at Bernstein Research said in a note to clients, “We remain skeptical on the (companies’ estimates on) synergies, particularly in light of the poor showing Vodafone and Idea had in our latest survey of Indian smartphone users. We expect the next four quarters to be challenging, and expect the combined entity will lose market share during the integration period."

By the time of the closure of the deal, things would have changed dramatically. JM’s analysts, for instance, expect operating profit of the two companies to erode by around 25% in about a year, thanks to the erosion in tariffs.

And since synergy benefits are some time away, this would mean that leverage in the medium-term could rise to an unwieldy 5.5 times, even after accounting for proceeds from tower sales. This is expected to inhibit the two companies’ ability to invest adequately in their businesses. Analysts at HSBC Research said in a note to clients, “The challenge for Idea is more pre-merger, as it is guiding for lower capex for FY18 despite lower 4G spectrum holdings than Bharti and 4G entrants (Jio). We are of the view that Bharti and 4G entrants may look at gaining market share pre-merger and benefit from the lower capex intensity. In the medium term, the leveraged balance sheet of the combined Vodafone and Idea may limit its ability to participate in data growth."

It’s anybody’s guess where the market share of these companies will settle, as Reliance Jio Infocomm Ltd pushes for its target of a 50% share of India’s telecom market within the next four years.

In fact, this is far from an ideal time to get a merger done, given the rapid transition the industry is going through. The need of the hour is a management that is on its toes; although getting the merger done may take away some of its time. Of course, the two companies hardly have any other alternative. On their own, their spectrum footprint is far inferior compared to both Bharti Airtel Ltd and Jio, and the danger of losing share was much higher with data usage increasing.

In short, there is a lot of ifs and buts when it comes to synergy benefit calculations. Besides, mergers typically carry risks such as a clash of cultures, disruptions such as employee churn, and these can’t be completely ignored.

But more than anything, it is the state of flux in the industry that should cause investors the biggest concern. If they are unwilling to factor in the majority of savings expected from synergies, they seem to be doing so for good reason.

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