India’s second and third largest telecommunications operators will merge to create the largest telecom company in India but the regulatory hurdles the deal will have to clear will be tough.

The deal

If the merger of Vodafone and Idea Cellular goes through, the new company will be the biggest telecoms company in India, ahead of Bharti Airtel, and the second biggest in the world behind China Mobile. Vodafone will own 45.1% of the combined entity after transferring a stake of 4.9% its shares to Aditya Birla Group (ABG) for Rs38.7 billion ($591 million) in cash. ABG, the owners of Idea, will hold 26% of Idea and the rest will be held by the public. Aditya Birla Group has the option to buy another 9.5% from Vodafone in three years at Rs130 a share. During this time, both companies cannot buy or sell shares to third parties. In the fourth year, there is the option for ABG to reach 35.5% by buying shares at market price. If Vodafone and ABG’s shareholding is not equal after four years, Vodafone will sell shares over the next five years to bring down its stake. Kumar Birla, ABG’s chairman, will chair the merged group. The proposed merger is aimed to be completed within 24 months from March 2017.

“The proposed merger will need regulatory approvals from the Indian government, including the Department of Telecommunications, the Competition Commission of India and the National Company Law Tribunal,” says Rajat Sethi, partner at S&R Associates.

Alka Bharucha

Stiff competition

India’s telecoms industry is facing increasing competition, forcing companies to consolidate to better compete with the strongest players, especially with the emergence of Reliance Jio , which has been using a free pricing strategy, in the market. “There will be intense competition amongst large players, exit of smaller players and possibly a change to the existing regulations to foster the growth and development of the sector and protect the huge investments made by the players,” says Alka Bharucha at Bharucha & Partners.

“There is a trend towards consolidation, both in India and around the world,” says Sethi.

“The Department of Telecommunication’s M&A guidelines which do not allow a player to hold more than 50% market share, 25% of the total spectrum or 50% in a single band of spectrum in any service area will be a significant challenge,” says Bharucha. “It is expected, or in any event hoped, that the Department of Telecommunications will take a fresh look at these guidelines to facilitate consolidation which seems to be essential for the telecoms sector.”

Idea Cellular provides 4G services in 20 circles (service areas for telephone licensing in India’s telecom industry) and 3G coverage in 15 circles. Vodafone’s 3G services covers 16 circles while its 4G services are in 17 circles. The merged entity may need to sell excess spectrum holdings depending on the decision of the Department of Telecommunications but will still be able to provide services across India’s 22 circles.

The Competition Commission of India’s approval will also be needed as the thresholds under the Competition Act will be triggered, with the merged company being the largest telecoms company in India and revenue market share is more than 50% in some circles. The National Company Law Tribunal will be the body deciding on whether the green light is given on the final scheme of arrangement.

Law firms involved

Vaish Associates (transactional aspects), AZB & Partners (competition aspects) and Bharucha & Partners (due diligence aspects) advised Idea Cellular. S&R Associates (due diligence and transactional aspects), Shardul Amarchand Mangaldas (competition aspects) and Slaughter and May (lead counsel) advised Vodafone.

“The single most innovative aspect is working out modalities for equalisation of rights given the differing sizes of merging companies, while keeping in mind the interests of public shareholders,” says Bharucha.

Rajat Sethi

“This is a remarkable transaction and there is an added complexity with telecommunications being a highly regulated sector in India,” says Sethi.

Challenging aspects

A number of issues, including unresolved disputes and competition law, are complicating the transaction. “The most challenging aspect of the deal was completing, within a very short time frame, a detailed diligence of two large companies and identifying contingent liabilities, especially given the number of regulatory and tax litigations involved,” says Bharucha. “Further, since this is a merger of competitors, both parties had to set up clean teams for sharing commercially sensitive information to ensure that there was no violation of competition law.”

Vodafone has been involved with a decade-long $2.1 billion tax dispute with the Indian government that has now gone to arbitration. A one-time excess spectrum charge of Rs50 billion is also under litigation.

Bharucha told Asialaw his firm worked with Idea’s in-house team in preparing the necessary documentation for seeking corporate approvals, issuing disclosure letters and also provided general advice on the proposed transaction, including negotiating representations, warranties and contingent liabilities.

A number of regulatory approvals are still needed, so details of the merger will need to be confirmed in the coming months. Both companies may feel that the commercial imperatives make a merger unavoidable. However it is far from clear that the Indian authorities will view the deal in the same light and wave it through unconditionally.