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Fitch Ratings says the announced merger between Vodafone India and Idea Cellular has strong business logic and strategic sense - both in terms of the scale of the enlarged group as well as how it may affect the overall market structure. On a reported basis the transaction will have a positive effect on net debt/EBITDA leverage once India is deconsolidated at the group level. However, Fitch estimates a mildly negative effect on funds from operations (FFO) lease adjusted net leverage given that Fitch does not currently include the Indian spectrum in its leverage calculation. Roughly 80% of the combined entity's pro-forma debt represents spectrum commitments. The effect is estimated at around 0.2x negative turns of leverage and is not considered material in the context of Vodafone's 'BBB+/Stable' rating and the wider positive implications of the deal.
With FFO net leverage of 3.3x as at September 2016, the group has limited headroom versus a rating sensitivity of 3.5x. An ownership equalisation put option granted to Vodafone by joint venture partner, Aditya Birla Group, following a three-year lock-up period, would realise cash proceeds at the Vodafone Group level of USD1.3bn. This could provide leverage relief if at the time it was needed. The transaction is expected to immediately be accretive to Vodafone's cash flow. The limited impact on leverage and timing of the transaction, which is not expected to close until sometime in 2018, reduce any potential leverage risks.
Fitch considers the strategic rationale for the merger is strong. It brings together India's number two market player (Vodafone India) with the market number three (Idea). Importantly the enlarged group will have the market number one or two position, in 21 of the 22 circles (regions) in which they operate, with Vodafone strong in markets where Idea is weaker and vice versa, making a strong complimentary fit.
The combined business is targeting run-rate annual synergies of USD2.1bn to be achieved over the four years from closing. Of these, opex savings are expected in the region of 60% and the business estimated to deliver an EBITDA margin of around 40% subject to the market becoming more rationale once new entrant, Reliance Jio, starts to charge its subscribers (expected from April 2017). The latter entered the market a little over a year ago and has quickly built a customer base of 72 million and 6% share of the market on the back of free "trial" subscriptions. Given the costs of developing a greenfield-mobile business, a free subscription model is not sustainable indefinitely.
Elsewhere in the market, Telenor is selling its Indian operations to current market leader, Airtel. Fitch regards both transactions as positive signs of the consolidation the market has been waiting for.
Fitch does not believe the Indian transaction reveals a new economic model at the Vodafone group level, given that it represents a second transaction where it has been prepared to address a structural market weakness through a joint venture; the other recent example being the VodafoneZiggo JV with Liberty Global in the Netherlands. Moreover, Fitch sees both transactions as pragmatic and strategic approaches to markets where a partnership makes a strong economic proposition. In both examples the combinations will provide what Fitch regards as structural solutions to markets where competition has proven intense.
In the Netherlands the combination was about securing a strong convergent position relative to a strengthened incumbent. In the latest transaction Vodafone is seeking a solution to a market which has long needed consolidation and where competition has been intensified by the entrance of an aggressive new entrant. Fitch regards both as providing sound strategic logic, ultimately seeking ways of de-risking the overall group perimeter.
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