RCom-Sistema M&A is easier said than done; and ultimately one has to exit

The talks between Anil Ambani's Reliance Communications (RCom) and Russia's Sistema Shyam Teleservices on a possible merger are being touted as a win-win move (assuming valuations are agreed) for both parties. While the merger is supposed to give Sistema, which lost all but one of its licences in the 2G scam, a wider footprint in India, RCom’s access to the latter's CDMA spectrum will help it launch 4G LTE services.

 RCom-Sistema M&A is easier said than done; and ultimately one has to exit

A Reliance Communications logo. Reuters

However, the deal will be tough to pull off for a variety of reasons. And even if it is signed, sealed and delivered six months down the line, there is no guarantee it will work. Here’s why.

First, and most obvious, is the reality that the government's rules for pan-India mergers, spectrum transfers and sharing are still a work-in-progress. The department of telecom (DoT) and the Telecom Regulatory Authority of India must move their butts on these issues quickly to enable faster consolidation. Till then, we can’t be sure any merger will be viable. What if unfair conditions are imposed on spectrum transfers to the merged entity?

Second, two plus two seldom equals four in a merger. Both RCom and Sistema are overloaded with debt. While the all-share merger is supposed to be a takeover of Sistema’s assets rather than its liabilities, that will still leave the combined entity with over Rs 36,725.7 crore of RCom debt (as at the end of March 2015). As against this, RCom’s market valuation was less than Rs 14,800 crore at Tuesday’s market prices. The point is this: if Sistema is going to be acquired (or merged) with only its assets, RCom will have to pay a higher price for it. High debt was what forced RCom to cede three circles where it had the prized 900 Mhz spectrum in the auctions earlier this year. Valuations will thus be a major sticking point if the Russians, who own nearly 74 percent of Sistema, are expected to take a huge loss on their investments for mere access 10 percent of RCom paper, which additionally carries a high debt overload.

Third, RCom has 110 million subscribers and Sistema, which runs largely data services under the MTS brand, around 10 million. Clearly, the swap ratios will be decided by their relative customer bases, the unexpired spectrum of the two companies, and the levels of debt on RCom’s books. MTS has eight CDMA circles whose licences expire only in 2033; many of RCom’s spectrum licences expire in 2021 – just six years away. As things stand, there is talk that RCom will offer just 10 percent to Sistema, enabling the Anil Ambani Group to retain a near majority stake (its current stake is around 60 percent, of which over 13 percent in pledged to banks). If Sistema seeks a higher stake for the merger, Ambani will have to cede some degree of control to the Russians. RCom also runs two types of mobile services: CDMA and GSM. It is GSM that is growing. Sistema runs only CDMA services. Merging this complex web of two technologies and two businesses is not going to be easy.

Fourth, RCom has been consistently unsuccessful in unloading its assets – especially its tower business – for years now. Reliance Infratel had 45,443 wireless telecom towers at last count, making it the third largest tower operator after Indus Tower and Bharti Airtel, says a report in The Hindu. It has not been able to sell a stake even though it has been talking about this for more than five years now.

Fifth, the real sticking point will be ultimate ownership: the world over, minority partners tend to divest their stakes if they have no management control. A report in The Economic Times, quoting unnamed sources, says that once the merger goes through, Sistema may offer more funds to the merged entity and even raise its stake to nearly 50 percent.

Well, it is unlikely that both the Anil Ambani group and Sistema can become equal partners, and the world is full of failed joint ventures where two partners have equal weight and different ideas about running the business. Moreover, partners will low equity stakes tend to exit at a convenient time. And let’s not forget, Sistema has an Indian partner with 24 percent and RCom over 40 percent minority shareholders. None of them will be easy to please on the merger details.

The real question about the Sistema-RCom merger, if it is finally consummated, is this: Who will finally exit the party? Anil Ambani or Sistema?

It’s a difficult question to answer, for neither party can just afford to throw endless amounts of money to take on the entrenched players in India (Airtel, Vodafone, Idea Cellular, and Reliance Jio, when it makes a big-bang entry later this year). Anil Ambani is strapped for cash, and so is the Russian government, which is being sanctioned by the west over its efforts to carve out portions of Ukraine.

Sistema-RCom is a merger mandated by the weaknesses of both parties - Sistema due to the loss of licences and sub-optimal operations, and RCom due to excessive debt.. It will be tough to make it work even if one party buys out the other; it could be even tougher if the company has two promoters.

(Disclosure: Firstpost is published by Network18, which is owned by Reliance Group, which plans to launch telecom services later this year).

Updated Date: Jun 16, 2015 12:50:15 IST