Idea Cellular (19.8% owned by Axiata) has agreed to merge their Indian operations with Vodafone India to create the country’s biggest telecom player to compete in a fierce price war sparked by new rival Reliance. Although no decision has been made by Axiata for now, we do not rule the possibility of an exit plan in view of the massive ownership dilution post-merger. All in, we are keeping our Axiata’s FY17E/FY18E earnings forecasts unchanged for now. We reiterate our UNDERPERFORM call on Axiata with an unchanged SoP-driven target price at RM4.64. India’s largest telco in the making. India’s Idea Cellular and Vodafone India Ltd agreed to merge their India operations (excluding Vodafone’s 42% stake in Indus Towers Ltd) to create the largest telecom company in the nation with a total revenue of Rs80k crore (c.USD12.0b or 41% revenue market share) and almost 400m customers or 35% customer market share. The merger, however, will be subjected to necessary approvals (i.e. from shareholders, stock exchanges, authorities, the Reserve Bank of India and etc.) and targeted to be completed during CY18.

Merger synergies are expected to come from: (i) operating cost and capex saving of INR700b (or c.USD10b) in net present value after integration costs and spectrum payments (where operating cost savings represent 60% of the expected savings), and (ii) spectrum liberalisation costs that are expected to have a net present value impact of approximately INR30b (or c.USD0.5b). Total integration costs and capex, meanwhile, is expected to be c.INR133b (or USD2b) from completion until the end of the fourth full-year.

Highly competitive telecom landscape. The merger comes after India’s mobile industry was thrown into turmoil with the launch last year of Reliance Jio Infocomm, which offers free voice calls and cut- price data services, forcing the big three – Bharti Airtel, Vodafone and Idea – to slash prices and accept lower profits.

Shareholder structure. Vodafone will own 45.1% of the merged entity, after it transfers 4.9% to the Aditya Birla Group for c.INR39b (c.USD579m) in cash concurrent with completion of the merger. The Aditya Birla Group will then own 26.0% and has the right to acquire up to 9.5% additional shares from Vodafone under an agreed mechanism with a view to equalising the shareholdings over time.

The merger ratio implied enterprise value of INR828b (c.USD12.4b or 6.4x EV/LTM EBITDA) for Vodafone India and INR722b (USD10.8b or 6.3x EV/LTM EBITDA) for Idea excluding its stake in Indus towers. The ratio, however, is below than the 10.4x median target companies’ EBITDA multiplies of cellular companies in the Asia Pacific Emerging market over the past five-year, according to the data compiled by Bloomberg.

Evaluate from all angles. No decision was made for now as Axiata is currently engaged in analysing all potential impact on the group arising from the proposed merger. Having said that, should Axiata decide to go with the merger exercise, its equity stake is expected to be diluted to c.10% under the enlarged entity. In view of the insignificant ownership, we do not discount that Axiata may consider disposing the stakes and shifting focus to its core businesses.

Earnings estimate remains unchanged, pending management’s decision. We reiterate our UNDERPERFORM call on Axiata as we believe the group may face another tough year ahead as a result of heightened completion, tax and regulatory uncertainties in its key OpCos. Our SoP-driven target price stays at RM4.64.

Source: Kenanga Research - 21 Mar 2017