The narrow-moat company plans to merge its Indian operation with Idea Cellular.
On March 20, Vodafone
VOD announced a formal agreement to merge its Indian operation with Idea Cellular. We still believe this is a good deal, but we don't expect it to change our fair value estimate and narrow moat rating. However, we still view shares as slightly undervalued. The deal accomplishes several things. First, it provides significant scale. The combined company will be the largest wireless operator in India, with almost 400 million customers. As an in-country merger, it should provide lots of opportunities to reduce costs. However, savings will likely be even more significant than in a typical European-country merger given the nature of India, where operations are split into 22 circles. While Vodafone competes in most circles, it is profitable in only 12. Second, the businesses are complementary. Vodafone has been particularly strong in the large metro areas, but Idea has been strong in rural and semirural areas. The combined firm should be profitable in almost all circles. Third, the combined company will be able to better compete with Reliance Jio, which has hurt pricing with its free offers. RJio will begin to charge for data services in April, which should help to stabilize the market. Fourth, it provides a listing in India. For years, Vodafone has been looking at a listing, which would provide flexibility to reduce its ownership or offer a currency for acquisitions. With Idea's stock being listed, Vodafone achieves this objective.
Allan Nichols, CFA, is a senior equity analyst for Morningstar.
Without RJio's entrance, we would likely increase our fair value estimate for Vodafone based on expectations of enhanced profitability. However, because of RJio,
we still expect a difficult market that will likely negate much of these gains. While International Financial Reporting Standards require immediate deconsolidation of large entities that are likely to be sold, we will not deconsolidate India for Vodafone's almost completed fiscal year that ends March 31. However, we will then model it as an equity investment.
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