Why RCom And Jio Have Settled For A ‘Virtual Merger’ And Not The Real Thing

Anil Ambani, younger brother of Reliance Industries Chairman Mukesh Ambani, surprised the markets yesterday (27 September) by telling his shareholders at the Reliance Communications (RCom) annual general meeting that his company has “virtually merged” with his brother’s telecom venture, Reliance Jio.

He is quoted by The Economic Times as saying: “As far as our 100 million customers are concerned, as far as our one million retailers are concerned, as far as our employees are concerned, and as far as our vendors and partners are concerned, there has already been a virtual merger of the two organisations (RCom and Jio).” For good measure, he added: “Our spectrum is shared, our network is shared, our fibre is shared, our towers are shared, our voice is shared…”.

This raises the question: when a virtual merger has happened, can be physical merger be far behind? One can surmise that the answer must be yes and no. Yes, because it would make commercial sense to merge two entities that already work like one to generate true economies of scale. But it’s also a ‘no’, because RCom is in the process of merging Sistema and Aircel with itself, which will make it the fourth largest player with nearly 188 million customers. According to Trai data, as at the end of June, RCom had 99 million wireless customers, and Aircel 89 million. Merging with Jio would not make sense till this merger process is completed.

Even from angle of Reliance Jio, which is currently a wholly-owned subsidiary of Reliance Industries, immediate merger does not make sense, since its valuations will not reflect its potential future size. Without independent scale and revenues established before a merger, it will not be valued very highly. Assuming that Mukesh Ambani would want full control over the merged entity, it makes sense to think of a merger later rather than earlier. Hence a virtual merger is best for now.

Both the brothers will thus be working towards a higher valuation, assuming a future merger is on the cards. Anil would want a higher exit price for his part of the enterprise, and Mukesh a higher valuation to keep that price as low as possible, so that he retains much more than 51 percent in the merged company. He will need more than 51 percent if he wants to raise more capital from an IPO at a later stage. Right now, Jio is bankrolled by the parent Reliance Industries, but a listed Jio will need to raise its own money for future growth.

Anil Ambani is keeping his tower and global assets (Flag Telecom) out of the cashless merger with Aircel, with Sistema already merged. This means only the customers, the retail operations, network and spectrum will remain with the merged entity, for which a new special purpose vehicle is being created.

Anil Ambani’s problem is debt; at last count, the group he headed had over Rs 1,20,000 crore of debt, on which the annual interest costs were Rs 8,300 crore against pre-tax earnings of Rs 9,850 crore. His cash flows are clearly squeezed. Mukesh Ambani’s challenge is to scale up quickly to a size where he can reap economies of scale and generate positive returns on his Rs 1,50,000 crore investment. A merger is logical from both angles, since the younger brother needs cash and the older one scale and returns.

A merger is logical at some point. But not right now. A virtual merger with RCom is vital for now, for it allows Mukesh to take on the Big Three of telecoms, Bharti, Vodafone and Idea, with over 630 million customers between them, who are ganging up to deny Jio and easy entry. The fight over alleged denial of enough interconnect points between Jio and the Big Three, which has resulted in an abnormal number of call failures for Jio customers, means that RCom is the only network on which Jio calls can terminate with reasonable assurance.

The brothers need each other more than ever in the short-term.