The long-awaited merger announcement from Reliance Communications Ltd (RCom) and Aircel Ltd is so sketchy on details, it almost gives the impression the two companies have decided to make things up as they go along. The all-important detail of how much equity the two companies plan to bring in to the merged entity has been left unanswered.
“On consummation of the merger, RCom and Maxis Communications are committed to additional equity infusion into the merged company to further strengthen the balance sheet, fund future growth plans, and enhance financial flexibility. Both parties are already in talks with leading international investors in this regard,” RCom said in a statement. Maxis Communications Bhd owns Aircel. A moot question here would be: What if the talks with investors amount to nothing?
Unless the merged entity is well capitalized, its future is bleak. As the chart alongside shows, both RCom and Aircel were at the bottom of the pack in the previous auction in March 2015. Loaded with debt, RCom did not bid for renewal spectrum in five circles. It attempted to migrate its 2G customers to its 3G network, but was hardly successful. And as a result, its revenues in these circles have fallen sharply. In the past year, RCom’s revenue market share has fallen significantly.
So, while the combined entity boasts the second largest spectrum portfolio among all operators in India, it’s far more important to have the financial capacity to invest in improving the network and user experience. Of course, another possibility is that thanks to RCom’s various arrangements with Reliance Jio Infocomm Ltd to use its 4G-LTE network, the merged entity may be able to do without substantial investments. The release does mention that the combined entity’s subscribers will have access to Reliance Jio’s 4G network, thanks to spectrum sharing and ICR (intra-circle roaming) arrangements. But the terms of these arrangements are not known, and it isn’t clear how profitable operations will be under them.
The release is also not clear about how much debt will be transferred to the new entity. It seems safe to assume that bringing two debt-laden companies will result in a larger debt-laden company.
The RCom-Aircel merger announcement also comes close on the heels of the Reliance Jio launch. Jio’s low tariffs, especially for voice customers, will drive down realizations for all telcos in the country. But the worst hit will be companies with lower economies of scale. The large incumbents would have to settle for lower returns on invested capital, but they will still make money thanks to their economies of scale. But smaller companies are expected to struggle to stay afloat, after accounting for lower tariffs and high debt servicing costs.
One detail RCom has been quite precise about is expected gains from cost synergies. “The combined entity will enjoy substantial benefits of scale driving significant revenue growth, and capex and opex synergies with an NPV (net present value) of around Rs20,000 crore ($3 billion),” the release said. But studies show that companies are overly sanguine about cost synergies during mergers. Investors will do well to ignore these estimates.