India’s mobile telecom market is undergoing a radical change. Last month, U.K. telecom giant Vodafone announced that it was merging its Indian subsidiary with local competitor Idea Cellular in a $23 billion deal to form the largest wireless telecom carrier in India — the world’s second-largest telecom market after China.

By Kj1595 (Own work) [CC BY-SA 4.0 or Public domain], via Wikimedia Commons

The new company will serve nearly 400 million customers and capture a 35% customer market share and 41% revenue market share. It also unseats leader Bharti Airtel, which had been busy with its own deals. Earlier this year, Bharti announced the acquisition of the Telenor’s India business. Telenor, a largely Norwegian government-owned entity, has been in India since 2009 but had made limited headway in the fiercely competitive market. It also paid $244 million for Tikona Networks, which has 20 MHz of 4G spectrum in five cellular mobile service areas.

“What is happening in the Indian telecom market is what you should expect given the cost and revenue structure of the industry: very high upfront fixed costs combined with very low marginal cost of voice and data transmission and a market that is very price sensitive,” says Ravi Aron, a professor at Johns Hopkins University’s Carey Business School. “We should expect to see rapid consolidation in such a market leaving only a few viable operators.”

Manoj T. Thomas, professor of strategic management at Indian business school XLRI, agrees. “This will lead to consolidation within the industry and enable merging firms to improve competitiveness,” he says. “Since inception, players in this industry have been trying to gain market share and also improve their margins by reducing costs and providing value-added services. Becoming a bigger player may help on both these dimensions.”

Triggering the spate of consolidation was the entry of a new mobile carrier, Reliance Jio Infocomm, which offered free services for months and sparked a brutal price war, according to Reuters. By merging, telecom companies can scale their services faster and combine staff and operations to reduce costs, giving them the wherewithal to offer lower prices on its services.

“Indian telcos have been engaged in a price war for quite some time to gain market share among India’s one billion mobile phone users,” says Soumya Sen, professor of information and decision sciences at the Carlson School of Management of the University of Minnesota in Minneapolis. “Such competition usually benefits consumers by keeping prices low, but such mergers between competitors are also expected until equilibrium is reached.”

“What is happening in the Indian telecom market is what you should expect given the cost and revenue structure of the industry.” –Ravi Aron

The markets had a mixed reaction to the transaction. Shares of Idea Cellular fell from $1.50 on March 20 when the deal was announced to $1.31 on April 3 — a drop of 13%. Typically, the target company being acquired sees an increase in the share price. (Vodafone India is not public.) Idea Cellular hit a 52-week high of $1.95 in April 2016 and shares have largely been falling.

Details of the Deal

Vodafone and Aditya Birla (A.B.) Group, Idea Cellular’s parent governed by a shareholders’ agreement, will jointly control the new company. The U.K. telecom company will own 45.1% of the new company after transferring a stake of 4.9% to the A.B. Group for INR 39 billion ($579 billion) in cash upon the merger’s completion. Aditya Birla will then own 26% of the new company, with the right to acquire more shares and work towards equalizing their stakes over time, the companies said.

If Vodafone and the A.B. Group’s shareholdings in the new company are not equal after four years, Vodafone will sell shares to equalize its shareholding to that of the A.B. Group over the following five-year period. “The agreement starts with 45% and 26% and meets somewhere in between over a period of time,” says Vodafone CEO Vittorio Colao.

Vodafone India has an implied enterprise value of INR 828 billion ($12.4 billion) and INR 722 billion ($10.8 billion) for Idea, excluding its stake in Indus Towers, which Vodafone will retain. The valuation comes to 6.4x enterprise value/EBITDA for the last 12 months for Vodafone India and 6.3x for Idea. The newly combined company expects to save $10 billion after integration costs and spectrum liberalization payments and reduce costs by $2.1 billion annually four years after the merger closes, which is expected in 2018, pending regulatory and other approvals.

Chairman of the A.B. Group, Kumar Mangalam Birla, will be chairman of the new entity. The CEO and the COO will be appointed jointly, but Vodafone will have the sole right to appoint the chief financial officer. In 2016, Vodafone India had revenues of $6.7 billion against $5.5 billion for Idea. Vodafone India serves around 205 million subscribers and Idea more than 190 million, according to December 2016 Telecom Regulatory Authority of India (TRAI) figures. In contrast, Bharti serves about 265 million.

“Idea and Vodafone will together create a very valuable company given our complementary strengths,” explains A.B.’s Birla. Adds Vodafone’s Colao: “Vodafone is more typically a leader in the major metros and the urban market, whereas Idea has led the way in the rural and semi-urban areas.” He sees five carriers staying in the market over the long term, with the spectrum and capacity to be major players.

Telecom secretary J.S. Deepak told the Press Trust of India that the wireless telecom industry consolidation “is going to be very good for India.” The market will likely end up with four private and one government carrier … which is ideal.” A parliamentary committee has proposed a merger between two state-owned operators — Bharat Sanchar Nigam Ltd. (BSNL) and Mahanagar Telephone Nigam Ltd. (MTNL) – according to The Economic Times.

A Five-player Scenario

The other telecom player doing deals is Reliance Communications (RCom), owned by Indian business magnate Anil Ambani, says Gagandeep Kaur, consulting editor at Telecom Talk, a New Delhi-based trade journal. In 2016, it announced the acquisition of Sistema Shyam Teleservices Ltd. (SSLT) in an all-stock deal. SSLT, operating under the MTS brand, adds nearly 6 million subscribers to RCom, which has more than 86 million customers. RCom is merging with Aircel Ltd., which has 81 million customers. Meanwhile, the Tata Group has approached the RCom league to join forces, reports The Economic Times.

Can the Indian market support five big telecom carriers? For one, the state-owned operators will start out with a competitive disadvantage since they are hampered by higher labor costs. “The employee costs of both MTNL and BSNL are 10 times higher than their private counterparts,” Sen says.

“Since inception, players in this industry have been trying to gain market share and also improve their margins by reducing costs and providing value-added services.” –Manoj T. Thomas

However, it’s not so easy for the others to cut costs as well, despite the talk of merger savings. “The companies offer the usual rationale — efficiencies and synergies,” Aron says. “Let us examine this claim. In mergers between competitors that are in similar lines of business — think of airlines, banks, retailers, hotels — the efficiencies arise from productivity gains and attendant layoffs. In India, the

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