On 30 January Vodafone Group PLC (LON:VOD) confirmed it was in discussions with the Aditya Birla Group about merging Vodafone India with Idea Cellular.
Any merger would create India’s largest telecommunications firm, and JP Morgan Cazenove thinks that not only is a deal imminent, but the attractions of the amalgamation are being heavily under-estimated.
Cazenove had published various reports over the last year arguing in favour of a merger, so it is little surprise that it gives the idea the thumbs-up.
It reckons that any merger would see Vodafone India deconsolidated from Vodafone’s accounts, reducing leverage by some €10bn (25%) and would refocus attention on to a rebounding European equity story.
In terms of free cash flow, it thinks hiving off Vodafone India would have no effect in the first year and would be positive thereafter as associate company dividends pour in.
“This also significantly de-risks Vodafone’s returns profile by removing future Indian funding needs,” Cazenove argues.
The merger would also offer US$9bn of synergies “as well as market repair”.
By Caz’s calculations, Vodafone India’s enterprise value (EV) – the cost of acquiring the company adjusted for debt and cash – is 5.5 times annual underlying earnings (EBITDA); ratcheting this up to Idea’s multiple of 8.7 would imply €5bn of equity upside, which is equivalent to 8% of Vodafone’s market capitalisation.
If the merger does not happen, Caz expects management will recapitalise India, “removing the weight of costly local debt”, pushing up the broker’s earnings per share estimates by 5-10% a year.
Caz believes investors should be overweight Vodafone shares in their portfolio. Its sum of the parts-derived price target is 280p; Vodafone shares currently trade at around two quid.
Perversely, Jefferies has a less optimistic price target for Vodafone of 220p, but a more bullish ‘buy’ recommendation.
The broker has just trimmed its European Union revenue forecasts for the mobile phone networks operator, but sees an improving situation with regard to free cash flow (FCF).
“We model Headline FCF +€0.7bn y/y [year-on-year] in spite of -€0.5bn drag from India/Egypt,” Jefferies said.
Its view is that the shares are good value, despite its cautious view on India.
“On our (below consensus) forecasts, VOD trades on normalised Equity FCF yields of 8.4%/9.0% in Mar18/19, whilst offering a 6.3% divi yield that looks sustainable,” it said.