Dues to equity conversion near-term positive for VIL, even Indus, but challenges remain

The government clearing conversion of Vodafone Idea's interest dues into equity is a near-term positive for the telecom company, as it would help it free up some cash flows, analysts said on Monday sounding out an increased possibility of tariff hikes up ahead. Market watchers, however, felt that the fundamental issues remain on Vodafone Idea, which is "significantly under invested in fiber, 5G and core telcos infra" and where investments to the tune of USD 6-8 billion will be needed to narrow the gap.

The analysts' views assume significance as Vodafone Idea got a lifeline on Friday, with the Centre clearing conversion of the troubled telco's accumulated interest dues worth over Rs 16,000 crore, into equity. Post-equity conversion, the government will hold about a 33 per cent stake in the company, sans management control. The latest move also allays immediate concerns about the telecom sector tipping into a duopoly as it mitigates the risks of VIL going into NCLT, experts felt. The interest dues-into-equity-conversion along with potential capital injection by promoters should help Vodafone Idea (VIL) clear pending dues of tower companies, and vendors and invest in 5G, BofA Securities penned in a note.

"We also consider this to be positive for Indus as its receivables will come down and improve the visibility of its cash flows. At a margin, we consider this negative for Bharti and Jio. This is because the pace of incremental subs gain from VIL would likely reduce," it said. Despite dilution (of promoter equity), BofA Securities said the government debt conversion will be near-term positive for VIL. It would free some cash flows. "While the current govt move drastically reduces any risks of VIL going into NCLT, we think fundamental issues on VIL remain. Our checks and discussions with vendors/tower cos indicate that VIL is significantly under invested in fiber, 5G and core telcos infra. It would at least take USD 6-8 billion investment to narrow the gap," BofA Securities said.

"With limited visibility on any massive cash injections, we expect VIL to lose market share to Bharti and Jio - especially as its peers start improving 5G network. We hence maintain our underperform rating on VIL and Indus (as a struggling VIL is also negative for Indus)," it pointed out.

Recent moves by Bharti of increasing entry level prepaid tariffs to Rs 155 in 9 circles and VIL launching an entry level recharge pack of Rs 99 indicate that the low-end users can absorb tariff hike.
"With government support also coming for VIL, we reiterate our earlier stance of smartphone tariff hike in the next few months," it said. It expects 5G capex to increase, smartphone sales to slowdown and estimates next tariff hike to be post general elections.
Morgan Stanley believes the announcement of the conversion of dues into equity by the government increased the chances of base/bull case scenarios (no imminent consolidation) and opens up the possibility of a tariff hike this year.
While the dues conversion to equity is in line with reforms and the telecom support package communicated by the government earlier, "this event finally happening would alleviate investors' concerns and reinforce the alignment of regulation and competition in industry," Morgan Stanley report said. Goldman Sachs, however, felt that the dues conversion move would have limited bearing on competitive landscape. "At the issue price of Rs 10 per share, this amounts to Rs 16,100 crore (USD 2 billion) in debt reduction for Vodafone Idea, which is about 7 per cent of the company's Rs 2.2 trillion (USD 27.5 billion) outstanding debt as of September '22," Goldman Sachs said.

According to its calculation, this would result in no immediate free cash flow savings for Vodafone Idea, and limited savings starting in FY26.
The government has the option of converting the principal due into equity in FY26/FY27, which could result in significant dilution for existing shareholders.

"Our view remains that until there is clarity on whether the Government of India will exercise this option and thus dilute the stakes of other shareholders, Vodafone Idea could find it difficult to raise new capital," Goldman Sachs said.
Citing recent conversations, it said investors believe Vodafone Idea's ability to raise external capital could improve post clarity on the government's dues conversion into equity.

"However, given the still elevated debt profile, continued market share erosion (Vodafone Idea has lost 22 million active subscribers, or 10 per cent of its base, in the last 12 months) and meaningful network gap vs peers (USD 3.3 billion lower capex vs Bharti in the last 2.5 years), we see a low probability of Vodafone Idea raising a meaningful amount of external capital," Goldman Sachs note said.

According to J P Morgan, the development and a subsequent capital raise should help IDEA (Voda Idea) improve its competitiveness and limit share gains for Bharti/Reliance Jio.
The latest move, it believes, will provide a lifeline to IDEA "as it should now be able to raise funds that are critical for debt and vendor payments and also to invest in 4G and 5G capex," it said. 

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