RCom-Aircel Merger: The Real Story Is Promoter Fatigue & Pathway To Exit

The big headline in business papers today – that Reliance Communications (RCom) and Aircel will merge to create a 50:50 joint venture between Anil Ambani and Maxis Communications of Malaysia – is not the real one. The real headline should read: “RCom-Aircel merger prepares ground for one partner to exit at the appropriate time.” It could, of course, be both partners exiting in favour of a more moneyed giant. It is a case of promoter fatigue.

But first, a few details about how this merger of equals is going to be done. RCom will unload its customer-facing wireless business into a new special purpose vehicle (SPV), leaving the tower and global (Flag Telecom) units out of it. This SPV will then merge with Aircel, where both partners will have equal directors on the board, but both Anil Ambani and Maxis owner T Ananda Krishnan may stay out, leaving the company in professional hands. After this merger, both will dilute 12.5 percent each, and invite a third partner in an unstable menage a trois, leaving no dominant partner in the venture. Sistema, which got merged to RCom and retains a 10 percent stake in the company, is being asked to put in money. (Read the details here).

The merger is thus about getting somebody else to bring in extra money with a combined 25 percent stake dilution in his favour (possibly for around Rs 6,000 crore), with minimal additional cash commitments from the two main partners themselves. It is also significant that Ambani is keeping the tower business out, which means he will get cash for that sale, when it happens.

A cashless merger is like a loveless marriage of convenience. It is meant for a limited purpose and not for consummation.

The precipitating factor in this loveless marriage may have been the arrival with a bang of brother Mukesh Ambani’s Reliance Jio, which is speeding up the pace of consolidation in the industry. But the problem with mergers is that the logic of two plus two equals five usually fails to deliver in the end.

The two plus two equal five logic in the RCom-Aircel case runs thus: the combined entity will have nearly 180 million users, with an 11-12 percent revenue market share. It will become the fourth largest telecom company in India after Bharti Airtel, Vodafone and Idea. Plus, there is talk of synergies worth Rs 20,000 crore in operations and capex, and a large spectrum holding of nearly 450 Mhz across the country in 2G, 3G and 4G.

But the underlying logic of the merger, which will take at least six months to clear the regulatory and legal hurdles, is exit of one or both partners. It is not meant to be a marriage that lasts. Here’s why:

First, no joint venture with equal ownership has ever lasted in India. And once the stakes are diluted to 37.5 percent each for RCom and Maxis after inducting a third partner, neither will have anything more than an investor’s interest in the company. A promoter-less company offers the ideal opportunity for one or both partners to exit when the time is ripe. It makes no sense to keep idle investments only for dividends, and especially in an industry that is going to need more capital in future for spectrum and investment in tower networks.

Second, the merged entity will face a tough first two years, as the focus will have to be internal, not the customers, as networks, people, systems, and customer profiles are merged. The partners will also have to strengthen their spectrum holdings to retain customers when the profitable parts of demand shift from voice to data. The forthcoming spectrum auctions in October may need both Aircel and RCom to bid for some circles – raising the debt for both companies. This is probably why they want a third partner – to foot this bill. At the time of the merger, the debt profiles of both may be higher than now (Rs 14,000 crore each, adding to Rs 28,000 crore in the merged entity).

Third, both partners are underinvesting in customers and growth. In May, RCom lost over a million customers. And Aircel sold Rs 3,500 crore worth of 2,300 Mhz spectrum to Bharti Airtel in eight circles. This is hardly indicative of a promoter’s willingness to stay in for the long haul. Cost savings are driving this merger.

Fourth, it is not clear how the rump listed entity – the one left with the tower and Flag Telecom business – will fare once the wireless part is carved out into an SPV. The SPV automatically provides a limited exit for RCom from telecom services, minus the hardware part (towers, Flag, etc).

So, make no mistake. This merger is about future exit by promoters, not anything else. It is defensive in nature in the short-term, to prevent a rapid erosion in enterprise value when the competition is hotting up.