Vodafone Idea: “What if?”

While Vodafone Idea created history by becoming the first Indian company to complete a rights issue of INR 250 billion (~USD 3.65 billion) successfully, I was intrigued by the huge interest which it generated. The promoter shareholders, Vodafone Group and Aditya Birla Group chipped in INR 110 billion (~USD 1.61 billion) and INR 72.5 billion (~USD 1.06 billion) respectively, i.e. cumulatively invested INR 182.50 billion (~USD 2.66 billion), or 73% of the issue, while the remaining 17% contribution for the issue was made by investors, including some marquee funds. (Hope they conducted their What if ?)

By definition, a rights issue is an invitation to the existing shareholders of the company to buy additional shares at a discounted price in proportion to their holdings of old shares. The shareholders get the right but are not obligated to buy the new shares at a discount to the current market price.

While looking at the Rights Issue’s Letter of Offer dated March 22, 2019, I had couple of “What if” questions?

What if some covenants under the company’s financial agreements get breached? Well, it’s happened in the past, when the company was able to obtain waivers.

What if the company is not able to obtain waivers on a go-forward basis?

One of the key objectives of raising such money was repayment: 75% of the INR 250 billion (~USD 3.65 billion), i.e. INR 187.5 billion (~USD 2.73 billion) would go towards repayment of deferred liabilities to the Department of Telecom and repayment of certain borrowings, including interest. With that, Vodafone Idea’s (‘company’) debt would decrease from INR 1,236.64 billion (~USD 18.05 billion) as on December 31, 2018 to INR 1,049.14 billion (~USD 15.31 billion).

Even if one were to consider the entire debt to be dollar denominated (unlikely) at a rate of 1.00% + 10-year LIBOR at 2.40%, interest expense @ 3.40% p.a. would translate to INR 35.67 billion (~USD 520 million) per year. (Govt. of India’s 10-year yield stands at 7.40% p.a.). Also, if the total debt of INR 1,049.14 billion (~USD 15.31 billion) were to be repaid in 10 years, it would translate to total repayment of interest and principal of INR 125.35 billion (~USD 1.83 billion) every year. What if the interest rates were just 1% higher from the assumed 3.4% p.a.? It would result in outgo of INR 132.21 billion (~USD 1.93 billion) per year, at least INR 6.86 billion (~USD 100 million) per year higher.

The company has been incurring losses over the last 2 years, loss for the 9-month ended December 31, 2018 was INR 97.22 billion (~USD 1.42 billion). What if the losses were to continue for a little longer, may be 2 to 3 years more? Since, the company clearly acknowledges the following:

Competition in the telecommunications industry is intense. It faces severe competition from companies, like Reliance Jio Infocomm, Bharti Airtel and internet- based services like WhatsApp and Skype. Competition may affect their ability to bid competitively for spectrum that the Government intends to auction, may result in decline in our subscriber base, cause a decrease in realisation rates and Average Revenue Per User (‘ARPU’), an increase in subscriber churn and an increase in selling and promotional expenses, all of which could have an adverse effect on their business and results of operations. The company has witnessed intense competition in the industry as certain competitors have historically provided aggressive pricing in the market including large scale free services.

Telecommunication licenses and spectrum allocations are subject to the terms and conditions contained in the licenses, ongoing review and other approvals by the relevant authorities. Some of the company’s licenses are coming up for renewal in 2021, 2024, 2026 and 2027. The company may be required to acquire the spectrum through auction, which could be at substantially high price. Inability to acquire the spectrum at reasonable prices would impact its business adversely.

Currently, the price of the bid in relation to auction of spectrum is typically the most important selection criteria. Increased competition may drive bidding prices for spectrum higher and the company may not be able to acquire additional spectrum or may be required to pay a higher amount for acquiring additional spectrum.

Outstanding litigation as on December 31, 2018, including regulatory or statutory action, disputes around direct and indirect tax, against the company and its promoters stand at INR 1,124 billion (~USD 16.42 billion)!!  Yes, that’s the amount. What if only 5% of the outstanding litigation were to materialize every year? This would result in an outflow of INR 56.23 billion (~USD 821 million) per year.

The huge on-going capex faced by the company and the industry has resulted in the company having negative cash flows over the last couple of years. The company had cumulative negative Free cash flow to firm of INR 71,151 million (~USD 1.03 billion) for the 9-month period ended Dec 2018 and Dec 2017. Negative free cash flows combined with debt of INR 1,049.14 billion (~USD 15.31 billion) would not leave any cash for the equity shareholders, leave alone dividends!!!

What if the company were to incur additional capex? Well, it’s a given!!

The combined entity, Vodafone Idea has provided an estimated synergy cost savings of INR 30,000 million (~USD 438 million) per year. What if the synergies don’t come through?

Well, by thinking about some of the What if questions enabled me to get answers to some of my questions, after all, as Warren Buffett has said so succinctly “I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.”

Disclaimer: Please note that these are my personal views. While, I am NOT a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014, all investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action.