This may be a good example of corporate elephantiasis - the rush for scale at the expense of innovation. But then, as Vodafone is an established income stock, for some time now management has been under pressure to deliver cash flow above all else.
In its most recent half-year results, management was keen to emphasise that earnings before interest, taxation, depreciation and amortisation (Ebitda) were growing faster than revenues in 19 out of 26 markets, as cost efficiencies encouraged the benefits of scale. Its 'fit for growth' programme, launched in 2014, sought to raise cash profit margins wherever possible by standardising networks, and improving procurement and sales efficiency. This effort has been redoubled.
The proposed merger of its Vodafone India operations - excluding a stake in telecom tower company Indus Towers - with listed rival Idea Cellular (NSE:IDEA) should be seen in this context. The combined company would have 400m customers and a 41 per cent market share by revenue.
The deal allows Vodafone to confront two challenges. The first is leverage. Deconsolidating the joint venture will take around €7.8bn (£6.8bn) off the group's net debt, which was €40.7bn at the half-year. At 3.6 times cash profits, the current burden looks top heavy compared with a global sector average of 2.4 times.
It should also put trading in India on a firmer footing. Increased mobile competition there triggered a €5bn non-cash impairment in the first half. A new entrant, Reliance Jio - the odd child of the oil group Reliance Industries - spent $25bn on a 4G network with a free introductory offer. The bite this took out of the market was enough to slow Vodafone's overall mobile data traffic growth to 53 per cent in the third quarter, from 59 per cent in the second.
But the logic is more than simply defensive. India's mobile data landscape is separated into 22 circles: the combined group would have the largest or second-largest market share in 21 of them. Vodafone India's strength in metro areas would complement Idea's strength in rural areas. "This merger will allow us to become a profitable challenger in several circles in which historically we have been generating revenue, but not Ebitda," group chief executive officer Vittorio Colao told analysts.
Under competition rules, the combined group is likely to be required to give up some of its spectrum. But management is not expecting sell-offs to be material. What's more, over the past seven years the group has spent around €3bn a year on spectrum, as auctions in Europe and India have coincided. The latter geography has made up close to half of that spend: indeed, after spectrum payments, India does not currently generate cash flows. This is one reason why the deal is expected to be immediately cash-accretive in the first full year after completion, which is expected in the 2018 calendar year.
Given the $10bn of cost and capex synergies, shareholders would be forgiven for hoping for a big cash windfall. To begin with, this is unlikely: excess cash flow will be held in the newly created company to reduce its leverage. Mr Colao argues that the deal affords "more freedom at the group level to consider other strategic developments". But he went on to cite the usual: data growth, technology convergence, the 'internet of things'. This deal looks like a smart play, but one that does not change the rules of the game.
