On April 25, 2018, Bharti Infratel and Indus Towers announced that the two companies would merge to create a telecom infrastructure giant. The combined entity will have a portfolio of 163,000 towers spread across all 22 telecom circles. Indus Towers currently owns 123,073 towers, while Bharti Infratel owns 39,264 towers. The merged $14.6 billion entity will be the second largest tower company in the world. It will handle the current businesses of Bharti Infratel and Indus Towers and will be listed on the stock exchange under the name of Indus Towers Limited.

There are multiple regulatory hurdles for the merger. Although the Delhi High Court has given its clearance, the deal must pass muster with the Competition Com­mis­­sion of India, the Securities and Exch­an­­­­­ge Board of India (SEBI), the National Company Law Tribunal and the Depart­ment of Telecommunications. The aim is to complete the merger by the end of 2018-19.

Bharti Infratel is a listed entity. The promoter, the Bharti Group, holds 53.5 per cent stake in it. Indus Towers is an un­listed entity. Three major telecom operators, Bharti, Vodafone India and Idea Ce­ll­u­lar (along with a subsidiary), hold 42 per cent, 42 per cent and 11.15 per cent stake respectively. The remaining 4.85 per cent is held by Providence, a private equity investor. The two companies earned over Rs 253 billion ($3.8 billion) in combined revenues for 2017-18.

The proposed deal involves a share swap wherein 1,565 shares of Bharti Infra­tel will be exchanged for one share of Indus Towers. On April 23, 2018, Bharti Infratel traded at Rs 363 per share with a total market capitalisation of Rs 602 billion. Based on SEBI’s pricing guidelines, the merger ratio implies an enterprise va­lue of Rs 715 billion ($10.8 billion) for Indus Towers. This is equivalent to valuing Indus Towers at 9.3 times the ratio of the enterprise value divided by the operating profit (earnings before interest, taxes, depreciation and amortisation) for the past 12 months, according to a statement by the companies.

The merger conditions are complex and final shareholdings in the merged entity could vary, depending on sell or ho­ld decisions by Idea and Providence. How­ever, irrespective of the final ratios of shareholdings, Vodafone and Bharti will control the combined entity with Bharti holding the largest stake.

Vodafone will be issued 783.1 million new shares in the combined company, in exchange for its 42 per cent shareholding in Indus Towers. Idea could also opt to re­ceive new shares in the combined entity, based on the merger ratio.

However, Idea also has the option to sell its 11.15 per cent shareholding in In­dus Towers for Rs 65 billion cash. This is based on a valuation linked to the volume weighted average price for Bharti Infratel’s shares during the 60 trading days prior to the completion of the merger. Providence also has the option to sell up to a maximum of 3.35 per cent of its holding for cash, while it must exchange 1.5 per cent of the shareholding for shares in the merged entity.

The merged $14.6 billion entity will be the second largest tower company in the world. It will have a portfolio of 163,000 towers spread across all 22 telecom circles and will handle the current businesses of Bharti Infratel and Indus Towers. The entity will be listed on the stock exchange as Indus Towers Limited.

If Idea decides to sell out, and Provi­dence also decides to part-sell, then Bharti would have a 37.2 per cent stake in the new entity, Vodafone 29.4 per cent, Pro­vidence 1.1 per cent, and the public shareholding would be 32.3 per cent. If Idea and Providence decide not to sell, they will own 7.1 per cent and 3.1 per cent stake res­pectively. In that case, Bharti will hold 33.8 per cent, Vodafone 26.7 per cent and the public 29.3 per cent.

The combined company will continue to offer passive infrastructure services to all telecom operators on a non-discriminatory basis. This is interesting since telecom op­erator Reliance Jio Infocomm Limited (RJIL) is a major client of both Infratel and Indus Towers, while being a business rival of Vodafone, Airtel and Idea. Both Infratel and Indus will continue to operate normally until the merger is complete. Hence, the­re would be continuing capex for the two entities during this fiscal year.

Quite apart from sheer scale, the merger should create significant savings in terms of eliminating duplication and creating synergies in the coordinated management of operations. There will be significant savings in terms of dividend distribution tax (DDT).

Indus Towers pays a little over Rs 5 billion annually as DDT and the merger will obviate the need to pay DDT for dividends to Bharti Infratel. Analysts are estimating that over Rs 5.5 billion of savings can be accrued owing to lower DDT and savings created by better efficiencies. The merged entity will be well placed to dominate the passive infrastructure space to support the roll-out of new technologies.

There has already been a trend of major consolidation in the tower business. There are approximately 400,000 towers in India and the number is growing at 2.5-3 per cent per annum. An estimated Rs 2.5 trillion has been invested in creating this infrastructure. There are pure-play telecom infrastructure companies such as Bharti Infratel, In­dus Towers, ATC India, GTL and TowerVision. Private telecom operators also own towers directly and government-owned Bharat Sanchar Nigam Limited (BSNL) owns 66,000 towers.

Given the intense competition in the telecom service segment, many operators are looking to fund more investments in their core business. Spin-offs and divestments of infrastructure assets have occurr­ed as a result. Bharti Airtel has sold 18.5 per cent stake in Bharti Infratel in several tranches for a total consideration of about Rs 120 billion. Vodafone India and Idea Cellular have also sold tower assets to ATC India for Rs 78.5 billion.

The second largest pure-play telecom tower company, ATC India is a subsidiary of the US-based MNC. ATC has grown inorganically through acquisitions, apart from building its own tower portfolio. The company acquired 51 per cent stake in Viom Networks for Rs 76.35 billion in 2015-16. That gave it control of Viom’s hol­d­ing of 42,000 towers. It is in talks with Tata Teleservices Limited (TTSL) to buy out TTSL’s remaining 26 per cent in Viom as well. Given the 10,200 towers ATC bou­ght from Vodafone and the 9,800 towers it bought from Idea, it will control ne­arly 80,000 towers by the end of 2018-19.

Reliance Infratel, a subsidiary of the Anil Ambani-controlled Reliance Commu­nica­­tions (RCOM), is another player that is on the block. The debt-laden RCOM has been attempting to sell Reliance Infratel’s assets, which include 43,000 towers, as a part of a debt resolution exercise. How­ever, the proposed sale of assets to RJIL has been stayed after a lawsuit was filed by Reliance Infratel’s minority shareholders, including overseas investor HSBC Daisy In­vestments (Mauritius). Given that RCOM has a huge debt of over Rs 450 billion on its balance sheet, it may safely be assumed that, sooner or later, the assets will be sold, if not to RJIL, then to some other player or players.

Tower sharing has been the preferred model of infrastructure operations ever since it was allowed. On an average, the te­nan­cy rate per tower is around 1.77. Ren­tals are generally charged on a long-term basis, with built-in escalation clauses and penalties for premature exits.

Bharti Infratel, for example, has an average tenancy of 5.4 and its master service agreements include a 2.5 per cent per annum escalation clause. The merged en­tity will have a significantly higher-than-average tenancy of about 2.3 per tower with over 380,000 tenancies across its 163,000 towers.

There has been a slowdown in de­ma­nd as telecom operators have been forced to consolidate. Another 25,000 tenancy reductions are expected in the wake of the Vodafone-Idea merger. How­ever, initiatives such as Digital India and the Smart Cities Mission should provide future growth opportunities. In addition, the rapid growth in data usage has created more demand for towers. Concepts such as radio access network sharing, and more efficient energy solutions have helped to cut costs.

The consolidation in the tower business reflects the consolidation in the overall telecom market. Until two years ago, there were up to a dozen operators in eve­ry circle. However, the launch of RJIL’s services in September 2016 triggered a price war, which led to a sharp consolidation. After the merger of Idea and Voda­fone, the three major players – Bharti Airtel, RJIL and Idea-Vodafone – will hold around 88 per cent revenue market share (RMS), with PSUs Mahanagar Telephone Nigam Limited and BSNL holding around 5.3 per cent RMS.

Data usage per capita has shot up. In the second quarter of 2016-17 (July-Sep­tember 2016), just before RJIL was laun­ched, data usage was around 789 MB per month. By December 2017, this had risen to 5,046 MB, an increase of 540 per cent in just 15 months. The contribution of data and other non-voice services to revenue had increased to around 28 per cent by 2016-17 and this segment will continue to grow.

Given that smartphone penetration is low, at 33 per cent of subscribers (June 2017), and broadband usage is even lower, at around 25 per cent, there is plenty of scope for growth. The Ericsson Mobility Report (June 2017) assumes that smartphone penetration could increase to around 60 per cent by 2022 and mobile broadband subscriptions could increase to 85 per cent of mobile subscribers.

The smart city concept involves the setting up of telecom infrastructure, which includes towers, micro sites and fiberised backhaul to ensure 100 per cent mobile ph­o­ne coverage. Infratel and Indus won smart city bids for Vadodara, Bhopal and the New Delhi Municipal Council.

Bharti Infratel has reasonable financials. Its 2017-18 revenues reached Rs 144.9 billion, up 8 per cent over the 2016-17 revenues of Rs 134.2 billion. Net profit after tax reached Rs 24.9 billion, down 9 per cent compared to a profit after tax of Rs 27.4 billion in 2016-17. Its capex am­­ou­nted to Rs 21.8 billion in 2017-18, which was roughly the same as in the previous two financial years. Bharti Infratel has 7 per cent exposure to smaller telecom companies, which are going out of business. About 10-12 per cent of tenancies could be at risk due to the Vodafone-Idea merger.

The consolidation in the telecom industry has been driven largely by financial stress. Even the biggest operators are under pressure. Bharti Airtel had net profits of Rs 830 million in the fourth quarter (January-March 2018), a steep fall from the Rs 3.7 billion of net profit posted a year ago. This was its worst quarter in 15 years. Airtel saw a steep fall in revenues, both in India and overseas. Consolidated revenues fell by 10.5 per cent, while mobile revenues for Indian operations dropped by 20 per cent year on year. Excluding exceptional items, the stand-alone India business lost Rs 9.4 billion. The ARPU dipped to Rs 116 from Rs 158 a year ago.

Idea Cellular’s consolidated losses rose to Rs 9.6 billion from Rs 3.3 billion a year ago. Revenues fell 22 per cent year on year and its ARPU fell to Rs 105 from Rs 114. Vodafone India is also expected to witness losses. Meanwhile, RJIL posted a net profit of Rs 5.1 billion, which was marginally higher than its third quarter profits of Rs 5.04 billion. The ARPU dropped to Rs 137 from Rs 154 in the third-quarter as RJIL continued to fight a price war. The company will continue to outspend and undercut its rivals. It already holds a dominant market share in mobile broadband data. The average RJIL user consumed 9.7 GB of data per month. Airtel, on the other hand, saw a data usage of 6.6 GB.

RJIL’s reported capex was Rs 140 billion in the fourth quarter, double its  third quarter capex of Rs 70 billion. The company has spent Rs 280 billion in the last three quarters. Reportedly, it will spend at least another Rs 600 billion in capex. As a wholly owned subsidiary of energy giant Reliance Industries Limited (RIL), RJIL has RIL’s balance sheet to back it.

Bharti Airtel and the combined Idea-Vodafone entity must seek investments that allow them to continue competing with RJIL. This has played a large role in driving the merger of Bharti Infratel and Indus Towers.

Devangshu Datta