Over the last few days, expectation on the street are high concerning the merger between Reliance Communications (RCom) and the Indian operations of Sistema, a Russian telecom company.
In our view, the underlying reasons for the merger are mutual needs for market share gains. Both companies have synergies in the form of 800 MHz spectrum, which is ideal for expansion into 3G and 4G data services.
Sistema has a lot of unused spectrum owning to its low subscriber base. On the other hand, acquiring spectrum through a merger is much more economical for RCom as against a spectrum auction, where it was unable to hold on to its all spectrum holdings.
Over the last few years, the telecom industry has witnessed a consolidation with the four top players leading, both in terms of revenue and subscriber market share. The remaining 9-10 players are left with low market shares which is insufficient to earn positive returns on invested capital. This is also critical when we take into account the fact that the industry fiber capacity utilization is around 60%, clearly reflecting that smaller players are unable to use their spectrum and infrastructure.
What makes it all the more aggravating is that the entire telecom industry will need to invest significantly over the next five years to upgrade their infrastructure including optical fibers and base stations to move towards the next generation technology services.
Since, with single digit market share, standalone telecom companies would not be able to make these investments, we expect to witness multiple mergers and acquisitions in the telecom sector over the next 12-18 months.
In the RCom-Sistema scenario, we believe just spectrum synergy would imply a virtual exit of Sistema from the Indian market as they would have a single digit stake in the combined entity. Since, they are interested in the Indian market, we believe fund infusion would be the obvious next step and that would be something RCom would be interested in to reduce the pile of large debt on its books. RCom is constrained by its overleveraged balance sheet and any fund infusion would be a welcome step for its shareholders. The company has expressed its desire to lower its debt to Rs 200 billion from Rs 350 billion. Naturally, any merger attempt would more likely than not include fund infusion into the business.
For now, until there is clarity on the quantum of funds for RCom shareholders, the stock is unlikely to see any major value creation as spectrum alone cannot guarantee market share gains.
