Why Vodafone Idea's decision to convert debt into equity is a positive sign

The new shareholding structure at Vodafone Idea, with the government set to hold around a 35.8 per cent stake, could turn out to be a significant breakthrough for the financially-stretched mobile operator. It leaves Vodafone with a 28.5 per cent holding, while the Aditya Birla Group's stake will be at 17.8 per cent. This comes after the company's board gave the go-ahead for conversion of the full amount of interest related to spectrum auction instalments and adjusted gross revenue (AGR) dues into equity.

A statement put out by the company said, "The Net Present Value (NPV) of this interest is expected to be about Rs 16,000 crore as per the company's best estimates, subject to confirmation by the DoT. Since the average price of the company's shares at the relevant date of 14.08.2021 was below par value, the equity shares will be issued to the government at par value of Rs. 10/- per share. The conversion will, therefore, result in dilution to all the existing shareholders of the company, including the promoters."

The current shareholding has Vodafone with a 53.57 per cent stake and the Aditya Birla Group's holding at 18.48 per cent.

According to Deven Choksey, MD, KR Choksey Securities, the development augurs well since the burden of debt reduces in one stroke. "There is a good chance of bringing in a potential investor since that entity will be comfortable only with the prospect of acquiring equity," he says. Besides, a lower interest cost is a good thing since it leaves more room in the company's P&L. "Overall, it is a sensible and smart decision keeping in mind the interest of its stakeholders," adds Choksey.

The incumbent cellular operators were hit by the aggressive entry of Mukesh Ambani's Reliance Jio in September 2016. Tariffs dropped substantially on both the voice and data fronts seeing a huge surge in Jio's subscriber numbers. The existing players saw a sharp drop in their Average Revenue Per User (ARPU), a key metric to measure an operator's profitability. They had little option but to rework their tariffs but that severely affected their financials.

In March 2017, the Aditya Birla-owned Idea Cellular and Vodafone India decided to merge their operations to create Vodafone Idea.

On Tuesday, the company issued a stock exchange statement at around 8am, and the immediate impact was that the stock opened nearly 10 per cent lower at Rs 13.40. It fell further during the afternoon session to touch its lower circuit of Rs 11.90 -- a 20 per cent lower than Monday's closing price of Rs14.85. It did recover a bit and was trading at Rs 12.15 at 2:15pm.

Jayesh Bhanushali, AVP (Research), IIFL Securities is of the view that while the stock may take a hit in the near term due to the equity dilution being at a very low price, the company may benefit in the long term as the government becomes the largest shareholder.

"In the short term, Vodafone Idea's price will react negatively due to equity dilution at such a low price, but eventually as the ARPU rises, as has been the trend since the last few quarters, we expect the company to perform better in the long term," says Bhanushali, while adding that the latest move by the government is an initiative to save the telecom industry from a duopoly.

"We look at the ARPU increase required to bring down the company's net debt to EBITDA to 10x by the end of FY24. Based on some assumptions, ARPU has to nearly double to Rs 207 by the last quarter of that fiscal from Rs 109 from the second quarter of FY22."

Meanwhile, Choksey thinks that "from a strategic point of view, the government having a strong play in telecommunications is a positive since it may lead to price stability in the business."