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The three-way merger between Reliance Communications (RCom), Aircel and MTS (brand of Sistema Shyam) is on course to create a formidable company, with best-in-class spectrum and reasonably strong financials.

Both RCom and Aircel are working on lowering their debt, which they have agreed to cap in the new entity at Rs.20,000 crore. Sistema Shyam has agreed to settle its liabilities ahead of the merger with RCom.

After the sale of its tower and fibre assets, RCom's debt is expected to come down to ~Rs.10,000 crore, which will be transferred to the merged entity. Aircel, too, is planning to bring down its debt to Rs.10,000 crore from the present Rs.26,000 crore. Sistema Shyam is also expected to pay off its Rs.4,153 crore debt ahead of the merger. 

Moreover, Investment Bankers said at Rs.20,000 crore, the debt to EBIDTA (earnings before interest, taxes, depreciation and amortisation) ratio of the new company would be 2.5 because the operating income of the new entity could be Rs.7,800 crore. RCom's current EBIDTA is Rs.7,000 crore, which includes income from tower assets and the wireless business. The wireless EBIDTA is Rs.4,000 crore, which will come to the new entity along with that of MTS.

If the new entity generates the Ebidta it estimates, then its net debt/Ebidta ratio will be better than the incumbents.

Currently, Bharti's debt/EBIDTA ratio stands at 2.8, while that of Idea is 3. RCom's debt to EBIDTA ratio is 5.3.

This three-way merger is expected to be a win-win for all players as it will provide the new entity a pan-India footprint, say analysts. The new entity will have 19.3% of the industry's spectrum holdings and will be the second largest player in terms of subscribers (200 million).

According to Navin Kulkarni of PhillipCapital, "The deal is a win-win for all players and will create a strong telecom player. However, with a revenue market share of 15%, the new company will still be behind Idea, which has a revenue market share of 19%".

According to experts, this merger will enable RCom to prevent loss of GSM subscribers in markets where it could not renew its 900 MHz licence (Assam, Bihar, Northeast and West Bengal). In markets like Himachal Pradesh and Odisha, RCom will be able to use its newly acquired 5 MHz spectrum in the 1800 MHz and 900 MHz bands for 3G/4G by moving its GSM subscribers into Aircel's 1800 MHz spectrum. 

The merged entity will be able to have 10 MHz of continous spectrum in four markets for improved 3G download speeds (Bihar, Jammu and Kashmir, Kolkata and Odisha). The merged entity will also have a pan-India 3G footprint in the 2100 MHz band except four markets (Gujarat, Haryana, Maharashtra, Uttar Pradesh West) and 4G footprint in 10 of the 22 markets.

The merger will also derisk RCom from imminent licence expiry. Most of RCom's 800/1800 MHz licences are expiring in the next five years, and Aircel's licences have another 9-10 years, except Tamil Nadu which is expiring in three years.

The Moody's Investor Service said April, 2016: 

"Growth in data revenues, particularly 4G services, will drive much of the improvement in RCom's operating metrics. But RCom has to wait until RJio commercially launches its 4G services before RCom can start to offer its own 4G services to new customers on the network and spectrum that it shares with RJio". 

Now, in all probably Reliance Jio is expected to launch their services from 15th August, 2016. Hence, we can expect a spike in the share price of Reliance Communications Ltd (Rs.50.15) from the end of this month.

RCom has been making attempts to sell its various assets, including DTH, submarine cables and the mobile tower business, but has not able to finalise any of the deal.

The company in December said it has been able to sell 150 residential flats in Navi Mumbai for Rs 330 crore. The rating firm believes that RCom is currently not pursuing the sale of GCX (Global Cloud Xchange) and DTH businesses as its deleveraging strategy now hinges on tower disposal and the merger of the wireless businesses.

The company signed an exclusive agreement with Tillman and TPG for the sale of its tower assets.

However, there is a negative news: The Department of Telecommunications (DoT) is considering barring all trading and sharing of airwaves and of mergers and acquisitions (M&A) in the telecom sector till the auctions end so that spectrum caps can clearly be defined while setting out the rules for the sale. The Aircel-Reliance Communications merger deal or any M&A by Telenor, which is in talks with Vodafone, might not get requisite clearances till the spectrum auctions are over. 

Meanwhile, there were media reports that Axis Capital maintains "BUY" on Reliance Communications Ltd with revised SOTP-based TP of Rs.90 (earlier Rs.97), based on ~5x FY18E EV/E, regulatory payouts (include deferred payments and one-time outgo). Their target price implies more than 70% upside from CMP of Rs.50.15..

Therefore, a strong BUY is recommended in the share of Reliance Communications Ltd at the CMP of Rs,.50.15, for a short term target of Rs72.

Courtesy: With inputs from the Business Standard, NDTV Profit and other publications.