By Kate Holton and Sankalp Phartiyal
LONDON/MUMBAI (Reuters) - Britain's Vodafone Group <VOD.L> confirmed on Monday it was in talks to merge its Indian subsidiary with local rival Idea Cellular <IDEA.NS> in an all-share deal that would create a new market leader better able to contest a brutal new price war.
Vodafone, the world's second-largest cellphone operator, has endured a tumultuous ride since it entered India in 2007, with fierce competition and a high-profile tax battle making a business contributing more than 10 percent of its revenues and profits its most unpredictable by far.
"There is no certainty that any transaction will be agreed, nor as to the terms or timing of any transaction," Vodafone said on Monday of its talks with Idea.
Last year the market was thrown into fresh turmoil with the launch of Reliance Jio Infocomm, the new 4G mobile broadband network built at a cost of more than $20 billion by India's richest businessman Mukesh Ambani as part of his Reliance Industries <RELI.NS> conglomerate.
Jio has made an immediate impact with the launch of free voice calls and cut-price data services, forcing the country's three biggest operators - Bharti Airtel <BRTI.NS>, Vodafone and Idea - to slash prices and accept lower profits.
Jio's aggressive assault on the market forced Vodafone to take a $5 billion writedown on Vodafone India last year, prompting Chief Executive Vitorio Colao to say at the time that the market would have to consolidate.
"I think consolidation is the answer," he said. "You cannot defy the rules of economics."
According to analysts at Berenberg, a combined Vodafone-Idea group would have around 375 million subscribers and around a 36 percent market share, well ahead of Bharti with around 260 million subscribers.
Berenberg also said the two firms would complement each other geographically, although some overlaps could require divestments to satisfy the regulators.
Shares in Vodafone were up 2.7 percent at 199 pence by 1211 GMT. Shares in Idea Cellular were up 25 percent, its biggest gain on record, adding 71 billion rupees ($1.05 billion) to its market value, while shares in Reliance Industries were up 2 percent and Bharti Airtel was up 7 percent.
Idea said that the initial talks were based on equal rights between its owner, Aditya Birla Group and Vodafone, with Vodafone getting shares in Idea.
Analysts have long expected consolidation in India's telecoms industry, where the market is divided into 22 geographical areas, or circles. Under the rules, companies are restricted on the percentage of airwaves they can own in each circle to prevent any one group becoming too dominant.
Shares in market leader Bharti Airtel surged on hopes for reduced competition after saying last week its net profit for the December quarter slumped to its lowest level in four years because of competition from Jio.
"The immediate benefit for the next one to two years for Idea and Vodafone would be to extract synergy values," said a telecoms industry analyst at a domestic brokerage not authorized to talk to the media.
He added that a smaller field would also make it easier for Jio to "get a decent market share and make profits."
As with some other joint ventures that Vodafone has, a merger would enable the firm to deconsolidate the business, leaving it as a shareholder benefiting from dividend payments.
Vodafone also said on Monday that a deal with Idea would not include Vodafone's 42 percent stake in Indus Towers, the radio masts owner created by Bharti, Vodafone and Idea.
Analysts at Morningstar said if successful the deal would reduce Vodafone's subscriber base by about 40 percent and lower its revenue growth rate. However it would lead to a small increase in its core profit margin because India has lower margins than the wider group.
Less than a year ago Vodafone was still planning to float Vodafone India on the local stock exchange, despite a long-running battle with the government over a $2 billion tax claim related to its acquisition of the unit from CK Hutchison <0001.HK> in 2007.
For Vodafone a sale of the Indian business to Idea could reignite speculation about an eventual tie-up between Vodafone and John Malone's Liberty Global <LBTYA.O>.
The two have held merger talks before but analysts say Vodafone's ownership of numerous assets in emerging markets had complicated valuations for Liberty, which is mainly interested in the European operations.
(Additional writing by Paul Sandle; Editing by Louise Heavens, Greg Mahlich)