Vodafone Group Plc doesn’t have much of a choice but to accelerate consolidation moves in India — likely with Idea Cellular with whom it is in talks — as the UK telecom major tries to counter Reliance Jio Infocomm in a key market where it has been struggling to ward off value erosion, add customers and grow revenue market share (RMS).

Vodafone India, the No. 2 telco, and third ranked Idea are reckoned to be in merger talks, people aware of the matter told ET, with latest discussions locked over who will have operational control of the merged entity. If the two decide to merge, the new entity will be the largest telco in India by revenue and subscribers, replacing Bharti Airtel.

Recent reports suggested Vodafone could also be open to a consolidation with Jio, but the latter has denied it, saying it is focusing on organic growth.

Industry insiders expect a Vodafone and Idea consolidation to be the more likely option. Any such move though will face regulatory hurdles associated with spectrum caps and significant market power in terms of combined customer base and RMS, but these, they say, can be dealt with as the companies will have a year to do so.

INDUS TOWERS STAKE

Ex-Bharti Airtel CEO Sanjay Kapoor said the big challenge for Vodafone and Idea would be “how they take a call with Bharti Airtel on the future control of Indus Towers”, especially since the combined entity would become the majority 58% shareholder of India’s biggest tower company, reducing Bharti to a minority shareholder.

Bharti and Vodafone are equal stakeholders in Indus with 42% holdings each, while Idea owns the remaining 16%. Bharti’s Indus stake is routed through tower arm Bharti Infratel. Airtel is also looking to pare stake in Infratel, which only complicates the matter.

Idea’s stake in Indus is routed through subsidiary, Aditya Birla Telecom (ABTL). Since US private equity firm Providence Equity Partners reportedly has stakes in both Idea and ABTL, it effectively owns 5% of Indus, with Idea’s real ownership at 11%. Accordingly, the net Idea-Vodafone combined holding in Indus is 53%.

Another senior executive agreed “control of Indus” would be critical for Vodafone and influence the pace of the merger with Idea, since a substantial part of the value of the British carrier’s India operation is reckoned to stem from its Indus stake.

BLEEDING FROM JIO’S ENTRY

Vodafone India’s financial woes have lately been exacerbated by the bruising impact of Jio’s free voice and data services launched last September that will continue till end of March.

The mix of its recent £4.4 billion write-down, its till now modest on ground 4G spectrum footprint reflected in slower customer adds, and continuing price cuts in response to Jio’s free services have further hit revenues and profits, which have all contributed to the consolidation overtures.

The impact of Jio’s free services has already dealt a body blow to Bharti Airtel, which reported a 55% fall in its third quarter net profit to Rs 504 crore, its worst in four years, amid a first ever on-year revenue drop too. But Vodafone India and Idea are expected to perform a lot worse, with some analysts estimating Idea to report its first ever net loss.

Vodafone though said it is fast expanding its 4G footprint and is well placed to take on the new player.

Consolidation talks have pushed Idea’s stock price higher in recent times with returns on its scrip at 9.3% over the past month, ahead of Airtel’s 8.7%.

At press time, neither Vodafone nor Idea confirmed their merger talks. However, in response to ET’s detailed queries, a Vodafone India spokesman said the company remained “committed to investing and continuing to grow its businesses in India” and that it had “successfully launched 4G services across all 17 circles planned and is on course to make it available across 2,400 towns by March 2017”.

CONSOLIDATION ONLY OPTION?

An analyst at IIFL said M&A appears to be the only option left for Vodafone, which has been struggling with RMS relatively flat at 23% for the last 14-15 quarters, a view seconded by Jaideep Ghosh, partner & COO (management consulting) at KPMG India, who noted that Vodafone is “a late entrant” in 4G.

Kapoor feels blending Vodafone and Idea’s distinct corporate ecosystems to derive the targeted synergies towards a healthier bottomline would be the other key challenge for both companies.

Another top industry executive said Vodafone and Idea may not find it too tough to rejig customer numbers to within requisite post-merger limits by weeding out dormant subscribers by reclassifying active users.

He said any potential RMS breaches (beyond 50%) will also get rebalanced in a year, post merger, once Jio starts generating RMS, which would reduce the RMS of Vodafone and Idea.

India’s telecom merger and acquisition rules require a merged entity to hold up to 25% of total assigned spectrum and up to 50% in a specific band. This apart, the rules entail a merged entity’s combined customer market share and RMS does not exceed 50%.

Brokerage CLSA said a potential Vodafone-Idea combine would breach requisite spectrum caps in five circles but industry veteran and ex-VSNL chairman, BK Syngal said this can easily be overcome if Vodafone and Idea surrender excess spectrum to the government.