As we had mentioned in our update on Vodafone Idea FPO in bl.portfolio last week, a successful conclusion of the ₹18,000-crore FPO that opened on April 18, and closes on April 22, will ensure it survives comfortably for the next two years at least. The next two years will be a phase when it will survive to fight (later). However, when will it be in a position to fight to win? Read on to find out.

The FPO funds raise is part of a total fund-raising plan of around ₹45,000 crore, with balance ₹27,000 crore expected to be funded via debt. Statements from the Central government post the FPO announcement clearly indicate its intentions to ensure a viable pan-India third private player in the Indian telecom market. Given that out of total debt of ₹2.30 lakh crore (including optionally convertible debentures), 90 per cent is owed to the Centre, its statement of support means it will not rock the business for the sake of encashing its dues. Hence the FPO needs to be viewed from two different angles – what it means for the business and what it means for the shareholders.

For the business

From over 400 million wireless subscribers and market share of around 35 per cent at the time of merger of Vodafone India and Idea Cellular, in 2018, Vodafone Idea’s subscriber count has declined to 215 million now, with market share at 19.3 per cent. This decline was a consequence of company’s debt and funding issues constraining its ability to invest in essential infrastructure and marketing that was required to grow its 4G business.

This problem will get addressed with the FPO fund raise. Out of ₹18,000 crore,  ₹12,750 crore will be invested for setting up and expansion of 4g/5g sites, ₹2,175 crore to settle certain deferred payments dues to the DoT, and the rest for general corporate purposes. The company management is confident that the total fund raise will be sufficient to compete and grow its business over the next two years.  Further, its current spectrum holdings are adequate to grow its 4G business and sufficient to support migration of 4G subscribers to 5G over the next few years..

Hence, operationally, the performance of Vodafone Idea can improve, going forward. Management is also betting on improving ARPU driven by two factors — increase in data subscribers as well as tariff increases. With 4G customers at 58 per cent of total wireless subscribers — it is at 70 per cent for Airtel’s India business and 100 per cent for Reliance Jio — this provides scope for increase in ARPU even without tariff increases, given the company’s new investments are geared to enhancing its 4G customer base.

At present, ARPU for Vodafone Idea, at ₹145, is well below that of peers’ (Airtel’s at ₹208 and Reliance Jio at ₹182). The company has also highlighted an interesting data point in its presentation — in the seven-year period from September 2016 to September 2023, while average wireless data consumed/subscriber/month increased by more than  8,000 per cent, voice minute usage/subscriber/month increased by 160 per cent, blended mobile ARPUs in India have increased only by 24 per cent. ARPUs in India are amongst the lowest in the world. Management believes, given the value proposition offered by telcos, there is a strong case for tariffs to increase from here.

While management has a point here, it needs to be noted that how much the tariffs can increase will depend on competitors’ willingness to raise prices as well as other pressures that may surface. For example, when there was a mobile tariff increase in 2019, the RBI had noted that it will add to inflation. Globally and in India, inflation issues have not abated. Hence, with the government being a significant shareholder in Vodafone Idea (33 per cent, pre-FPO) and largest creditor, it may want to influence and ensure a balancing act between the need for tariff increases and controlling inflation.

The company also plans to grow its b2b business offerings. However, the revenue contribution from this segment does not appear to be significant at present.

For the shareholders

In the bl.portfolio edition dated September 10, 2023, we had recommended that investors sell the stock of Vodafone Idea given our view that there was not much fundamental upside in the stock when it was trading at ₹10.50 then. The mid-point of the FPO price band of ₹10-11 is exactly 10.50. While operationally things will improve, we are not convinced that FPO price offers value for shareholders for the following reasons:

At the FPO price, Vodafone Idea will have a trailing  EV/EBITDA of 16.5 times, ranking it as the most expensive large mobile telecom player globally. Even assuming a very optimistic 20 per cent CAGR in EBITDA over the next two years, it trades at 11.3 times CY25 EBITDA.

Bharti Airtel, with a solid balance sheet and well-diversified business, trades at 12 times CY23 EBITDA and at 9.5 times CY25 EBITDA. Hence, even under optimistic assumptions, the Vodafone Idea shares at ₹10-11 do not appear attractive. Further, investors need to consider a few other overhangs that may loom.

With trailing net debt/EBITDA at 14 times, with government support, debt repayment is not a problem, but only for a while. Current deferred spectrum payment obligations (DPO) liability stands at ₹1.3 lakh crore while AGR liability is at ₹65,000 crore, accounting for bulk of the company’s debt. A heavy repayment schedule will start towards the end of FY26. The FPO filing states that around ₹29,073 will be payable in FY26 and ₹43,018/ year payable for each FY from 2027 to 2031, towards DPO and AGR liability. To understand the significance of this, compare this with consensus estimates of FY25 revenue for Vodafone Idea at ₹47,000 crore.

It is clear the company cannot generate funds from operations or any asset sale to repay government dues. In all probabilities the government will have to support the company again by deferring DPO and AGR payment liabilities from FY26 onwards or convert most of this debt into equity or optionally convertible debt.

If this debt is converted into equity at the FPO price of ₹10, government will end up owning around 80 per cent of the company. If this is converted into equity at, let’s say, a price of ₹15/share, it will still end up with a high share of around 75 per cent. With complete uncertainty on how the debt overhang will be addressed, if converted into equity – at what price, implications if government ends up owning a huge stake etc — valuing the shares of Vodafone Idea is a big exercise in speculation.

Given these, we recommend that investors give the FPO a pass and wait and watch for now. Borrowing a quote from Warren Buffett, we applaud the endeavour (turning around the company), but prefer to skip the ride (for now). Fighting to win appears few years away.