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The grab for Hutch
The fight for India’s third largest private mobile telco is now on in full earnest

Emerging markets will be the main growth areas for global telecom companies.'' When Arun Sarin, CEO, Vodafone, made this statement at the 3GSM Congress in Barcelona in March last, few would have imagined that the chief of the world's largest mobile phone operator would have his Christmas holidays cancelled to work on a bid to buy India's third-largest private mobile telco. Ever since the news spread in mid-December that Hong Kong-based Hutchison Telecommunications International Ltd wants to sell its 67% stake in Hutchison Essar, media has been rife with reports of Vodafone's interest in it. Yet, Sarin has a tough job at hand. For one, a slew of savvy competitors, from Anil Ambani's Reliance Communications to Hutch's current joint venture partner Essar group to international players like Maxis of Malaysia and Orascom of Egypt, has shown interest in the deal. Also, according to reports, the premium Li Ka Shing, the Chinese billionaire who owns the Hutchison Whampoa empire, demands for parting with his Indian pie would make Hutchison Essar's valuation significantly higher than those of Bharti Airtel and Reliance Communications and more than what many telecom players may be willing to pay. Vodafone has the money, yes. But having been at the receiving end for the record $41.2-billion loss reported due to write-down of value of Vodafone's businesses in Germany, Italy and Sweden last fiscal, Sarin will probably be cautious about loosening his purse strings too much. Yet, the opportunity to get a firm foothold in the world's fastest-growing telecom market (its mobile subscriber base is projected to treble to 500 million by 2010) may be too good for him to pass up.

Arun Sarin Anil Ambani Ravi Ruia

Without a presence in the Indian market, Vodafone's emerging market strategy is incomplete. CEO Arun Sarin is out to change that

With 41% of the mobile phone market, ADAG Chairman Anil Ambani will replace Sunil Mittal as the king of Indian telecom

A 100% stake will always fetch more money in the longer run for Essar than its current 33%. That seems to be Group VC Ravi Ruia's reasoning

If it manages to clinch the deal, it would be Vodafone's third foray into the Indian telecom space. In 1995, when Vodafone bought the US-based AirTouch, a minority stake in RPG cellular also came along. But Vodafone exited soon after only to re-enter a decade later with an investment of $1.5 billion for a 10% stake in Bharti Airtel. Despite much speculation and declarations of intent to increase its stake further in India's No 1 mobile services provider, little movement has taken place. So will a restless Vodafone be third-time lucky?

The war has begun

Not if Anil Ambani can help it. The head honcho of Reliance Communications (RCIL), India's No 2 private telecom service provider, is keen to wrest control of Hutchison Essar to cut down the roll-out time for his GSM operations and catapult his company to the numero uno position with a consolidated 41% share of the mobile services market, relegating Bharti Airtel with its 24% share to the number two slot. What's more, if RCIL buys Hutchison Essar, the company can possibly overtake Reliance Industries to become the second-biggest Indian company in terms of market capitalisation behind ONGC. This would also put Anil Ambani-led ADAG group's market value at about Rs 2 lakh crore ($44.5 billion) within striking distance of Mukesh Ambani-led Reliance group's Rs 2.1 lakh crore ($46.7 billion) market cap.

But don't think that the younger Ambani's aggressive stance (he announced his intentions to bid for Hutch on the birthday of his late father Dhirubhai Ambani on December 28) is prompted by considerations other than pure business. One reason for greater aggression by the younger Ambani is the ability of RCIL to derive greater value through operational synergies from this acquisition than most others. Brokerage firm Man Financial's telecom specialist Shobit Khare believes that synergies could add 6.5% to EBIDTA margins for the combined entity—taking it up to 41.3% from 34.8% (without synergies).

An under-penetrated Indian telecom market is also attracting others like Malaysian telecom giant Maxis and Orascom Telecom of Egypt. While Maxis already has a presence in the country through its acquisition of 74% in Aircel India (with 4.2 million subscribers in seven circles) for over $1 billion, Orascom has an indirect stake in Hutch Essar through a 19.3% stake in Hutchison Telecom International (HTIL). Maxis has been keen on expanding beyond Malaysia, and in addition to the Aircel stake it picked up in March this year, it has acquired a 51% stake in PT Natrindo Telepon Seluler (NTS) in Indonesia. Having Hutch in its fold will give the company a quick all-India presence. Its initial bid with Texas Pacific Group (TPG), valuing Hutchison Essar at $13.5 billion has been rejected by HTIL. Now it's believed to be readying for another bid without TPG. But it is hard to see Maxis walking away with telecom's most sought-after pug. For one, the high asking price for the deal could pose a problem for this $8-billion market-cap company. Then again, it will have to forego the cash it has already shelled out through Aircel for licenses in 16 circles across the country.

As for Orascom, money may not be an issue for this near $14-billion telco (by market value) that has 50 million subscribers across Algeria, Egypt, Pakistan, Iraq, Bangladesh, Tunisia and Zimbabwe with a plan to exceed the 100-million subscriber mark by 2009. But regulatory hurdles could quell its ambitions. Orascom's operations in certain regions, especially in Pakistan, had brought the company under the radar of Indian security agencies. And despite the company CEO, Naguib Sawires, making a plea during his visit to India in December not to link security issues with commercial investments, the going will be tough for it. Besides, the Essar group (a 33% stakeholder with the first right of refusal on a stake sale in Hutchison Essar) had also expressed displeasure when HTIL brought Orascom on board without consulting them. It is also unlikely Hutchison Whampoa would wish to get caught up in a political wrangle over security issues in India over its stake sale that might hold up the process indefinitely.

Then there is Essar. The company officials have maintained that if the valuations

Growth rates in India's telecom market makes even the $21 billion sought not seem outlandish

are right they might also consider selling their stake or buying out Hutch. Ruias have offered $11 billion for the remaining HTIL stake and have been in talks for funds from Morgan Stanley, Citibank and other private equity players. They are also said to be negotiating with foreign operators like Telenor and Kuwait Telecom, among others, to take them as a strategic partner. "Essar was not involved in the operational issues of Hutch Essar and will have difficulty in managing the company on their own. They can either sell the entire stake and exit the telecom sector or opt for partial sell off and still be in the company to reap another round of profits at a later stage," says an industry analyst.

Besides that, talk of some private equity players making a bid is also in the air, but it is too premature to comment on the prospects of what's not so much in the realm of certainty as we go to print. So, effectively, Vodafone and Reliance Communications are the real contenders in a Hutch auction.

The valuation metrics

Does it make sense for any player to buy Hutchison-Essar at $20-21 billion (for 100% equity) that Li Ka Shing has reportedly demanded? Before we get there, consider this: most mobile services markets in Europe are growing at low single-digits. Vodafone has been struggling against price erosion in the UK, Germany and Italy, even as it is growing strongly in emerging markets like Egypt, Romania, Turkey, South Africa and Australia.

In the case of Hutch too, revenues from markets like Israel and Hong Kong (accounting for 49% of HTIL revenues) are growing at just 6% and it is looking to make inroads into markets like Indonesia (population 220 million; penetration 23%) and Vietnam (population 84 million; penetration 11%) for growth in the 2G business.

China, a big market with near 425 million subscribers (33% penetration and population of 1.3 billion), has two key incumbents—China Mobile and China Unicom—and any new entrant needs to tie-up with a Chinese company to offer services. This has kept service providers away even as handset makers have found a big market in the country. The other potential markets are in Africa. Though these markets are high in subscriber growth numbers, in terms of revenue these are not the easiest to operate in today.

All these make India (with its low mobile penetration of 12% and large population of 1.1 billion) the biggest frontier of growth that nobody would want to miss. And Hutch is the best bet to enter the market. "Hutch could be the last big opportunity for a foreign player to enter the Indian market," contends Harish HV, Partner, Grant Thornton, and that says it all.

Businesses, however, are not ready to buy growth if it comes at too high a price. While Hutch seems to indicate that it wants $14 billion or more for its stake (indicating a 100% equity valuation of $21 billion), Anil Ambani hinted during a press meet that the indicated price was on the higher side. How much of this is posturing before getting to the deal table, only time will tell. For now, most analysts peg the indicative price band of $15-18 billion (25-27 times the EBIDTA of $670 million estimated for the year) to be on the higher side. Most believe an enterprise value of about $15 billion (equity value of around $13.5 billion) to be reasonable. On a fair value basis, Macquarie Research has estimated the total Hutchison-Essar equity to be worth about $12 billion (enterprise value of $13.8 billion)—a 10% discount to Bharti Airtel's 2007 expected value. Some others believe that ascribing a higher value-multiple to Hutch could be justified based on its average revenue per minute rate of Rs 1.01 versus Rs 0.95 for Bharti. At Rs 412 Hutch's average revenue per user (ARPU) is also only second to Bharti (Rs 433) and almost 20% higher than Reliance. Using a metric like deal value (enterprise value) per subscriber by ARPU, however, Hutch's asking price looks a little steep—at 49 times against Bharti's current market value of 43 times, which would be even lower (32) if we were to consider only the mobility business.

Grant Thonton's Harish points out that this amounts to capturing anything close to 50 months' revenues. In terms of cash-flows, for most, it would spell a far longer pay-back period. However, recent indicative bids reported by foreign media—pegged in the range of about $17 billion-plus by Vodafone—seem to indicate the willingness of players to pay a sizeable control premium (and, in the case of new entrants, an entry premium). Whether Hutch will demand any further compensation for use of its brand in India also remain to be seen. Where the deal value settles, only time will tell, but Hutch sure will try and extract its pound of flesh for exiting a high-growth market and an extremely profitable business.

The money supply

Even if $15-18 billion is settled as the price (of 100% equity), where will the money come from and at what price? To give you a sense, this amounts to anywhere between Rs 65,000 to Rs 80,000 crore—more than the market capitalisation of many companies in the BSE-30 Sensex and about eight-to-nine times the turnover of an Infosys. Its scale dwarfs any deal we've seen in the country so far. Yet, industry players believe raising funds is not an uphill task, given today's global liquidity scenario.


Here, private equity, an increasingly popular source of funding is likely to play a key role, but such money comes with a high price tag. Most private equity players expect to reap returns of at least 25%-plus on their equity investments, though some accompanying debt can help sweeten the deal. As Anil Ambani indicated, they don't just fund equity, they also provide debt financing. He added that the group had tied up funds for a likely bid and that it would be a mix of debt and equity.

If the younger Ambani's recent meetings with Blackstone India's Akhil Gupta and his recent statement are any indication, money for his bid is already tied up. The PE players can bring $9-10 billion to the table as they estimate returns of almost 20-25% in the next three-to-four years from high growth sectors like information technology and telecom. In fact, speculation is also on about PE funds and banks like ABN Amro Holding, Barclays, and Deutsche Bank forming a consortium to make an independent bid for Hutch. According to analysts, leveraged buy-out (LBO), on the lines of what Tatas did in the case of Tetley and, more recently with their Corus offer, is one of the feasible options for Ambani. "Anil Ambani as a promoter of Reliance Communications India Limited has 67% stake in ADAG and RCIL. On diluting 30-35%, he could possibly raise somewhere between $8 billion and $9 billion. So the total amount they have will be between $16 billion and $18 billion," says Shobit Khare, telecom analyst, Man Financial.

As far as balance sheet strength goes, Reliance Communications has a net debt-to-equity ratio of only 0.28:1 on total shareholder funds of $2.6 billion, indicating some scope for leverage, though a structured SPV route might seem more plausible—funded through equity, subordinate and superior debt.

Vodafone, on the other hand, is cash-rich. It had an investment portfolio of about $7.4 billion on September 30, 2006 and was looking to generate an additional $4.2 billion in free cash in the next six months (annual cash generation of $10.2 billion). What's more, it has a low gearing with a debt-equity ratio of only 0.25:1, which will enable it to easily raise sufficient debt to fund an acquisition of this nature.

Essar too claims to have arranged for funds from bankers and private equity players to fund the near $11 billion it could need to buy-out Hutch.

After the deal

If Reliance Pips Others: Anil Ambani has always harboured the dream of becoming the numero uno in mobile telephony. He didn't mince words when he declared that GSM would be his growth engine—putting CDMA on the backburner. In light of his new ambition, wresting control of Hutchison-Essar would be nothing short of a coup that would catapult him to market leadership with a 41% share, way ahead of current leader Bharti Airtel (24%). A Reliance official says that the deal would not only make the ADAG group a leader in the mobile segment, the company's National Long Distance (NLD) and International Long Distance (ILD) network can also be used to route traffic coming from Hutch subscribers.

If Reliance takes over Hutch, Airtel would need to revise its strategy to counter a bigger integrated player with a presence in GSM, CDMA, wireline and long distance, and thus is in a better position to offer end-to-end services across India. Bharti under the Airtel brand has been offering such bundled services to attract enterprise customers in a big way. They could offer services like global roaming on GSM networks, Blackberry, global bandwidth from a single window. The competition was with Reliance, Tata and BSNL, but everyone was comfortable. With a pan-India GSM presence, Reliance could actually challenge Airtel in any and every segment.

What's more, with a 41% share, the Reliance clout in the market would be huge. It can turn around any negotiation with the vendors, play around with tariffs and also
influence regulations. The company has been having problems with Qualcomm over royalty issues. Though it would not be easy to manage and simply junk the CDMA networks, there is an option with the company to migrate CDMA users to the high ARPU GSM network. "They can actually arm twist Qualcomm to rethink their royalty policies and subsidised handsets," says Harendra Kumar, Head of Research, ICICI Securities.

The regulatory hurdle for Anil Ambani would be that as a group, ADAG would be holding two licenses. The regulation says that no legal entity can hold "equity of 10% or more" in the same service area for the same service. Also, a promoter company cannot have stakes in more than one licensee company for the same service area. To circumvent this clause, Hutch has to be merged in RCIL or has to be maintained as a separate entity with indirect control. "A merger would require the clearance from the Department of Telecom (DoT). Airtel is not likely to let it go easily and may challenge the merger which could prolong the whole procedure," says an analyst.

On the management front, few expect the existing team in Hutch to continue if Reliance bags the deal. "It would be difficult for any company to integrate Hutch with itself, as expectations from this company have been different from others. The working has been more like an MNC with the parent company having lot of influence on the work culture. The transition would not be smooth," says Romal Shetty, Director (Telecommunications), KPMG. Analysts point to the Tyco deal and the kind of churn it faced once Reliance took over. They say that in the case of Reliance the integration might take a little time, even though sources within the group indicate that they have enough management bandwidth to swiftly move their people into key positions.

The Hutch brand is the other big issue. Both Reliance Communications and Hutch are well-established brands with high recall, but a very different positioning in the minds of consumers. To ensure a smooth transition, most analysts believe that Reliance will seek use of the Hutch brand at least for some time. Thereafter, the group could create an alternate brand or create sub-brands under the parent banner for the two services.

Where Reliance scores over players like Maxis in terms of synergies is not just the platform (CDMA) it uses today, but also the fact that there is little overlap with its GSM operations. Consequent to a deal—and as per the DoT mergers and acquisitions (M&A) guidelines, which state that no single telecom player can have more than 15 MHz of spectrum in metros and A category circles and 12.4 MHz spectrum in B and C circles—Reliance Communications will need to vacate additional spectrum in only two circles, West Bengal and Kolkata.

What's more interesting to note is the regulation on market share, which for some baffling reason imposes restrictions on a single entity exceeding a 67% share in any circle. Does 67% offer pricing power that 60% doesn't? This might well become a bone of contention. Here's why. While Reliance's share will not cross this threshold in any of the 23 circles, it will come very close to it in Mumbai, where Hutch along with BPL is the market leader, with a 65% share. The company would also have more than 40% of the cellular market in Delhi, Kolkata, Uttar Pradesh-West and Bihar with Airtel matching it only in Himachal Pradesh.

The market has already started factoring in a possible bid by Anil Ambani and the resultant gains with the stock moving up over 15% in the past month to near Rs 480. Most brokerages have also put a buy on the stock with targets of Rs 500-plus. Some leading investment banking groups are also learnt to have built up big positions on the counter. There's clearly a lot riding on this horse winning the race. And some divine intervention could help—the Ambani family recently visited the Lord Venkateswara at Tirumala in Andhra Pradesh to seek the lord's blessings.

If Vodafone Scores: This could spell the realisation of a long-cherished dream for Vodafone CEO Arun Sarin—-of making a big entry into his native land. A Vodafone victory would mean the entry of a pure-play foreign mobile operator. "Apart from Asian companies, there have been no serious attempts from the European or American operators to enter the Indian market on their own, especially the mobile segment. AT&T and BT are here but more to serve their international clients," says Prashant Singhal, partner and industry leader telecom, Ernst & Young.

Vodafone is considered an early adopter of technology and known for introducing innovative schemes. The Hutch network has been designed for easy migration to 3G services, which combined with the Vodafone experience in other 3G markets, can be leveraged to introduce new services. The company is also seen to adopt different business models for different geographies and given that Sarin seems impressed by the Indian outsourcing model to reduce capex and operational expenses, he could take this route here. The other thing with Vodafone is that it usually exits if it fails to compete in the local market. The most recent exit from Japan is a case study for Indian operators to take on the giant. The company is also under pressure to sell off minority stake in Verizon and has sold off 25% stake in Swisscom for $3.5 billion prior to declaring its intensions to buy Hutchison Essar.

In the case of Vodafone or any other foreign player picking up Hutch, the competitive numbers would not change. However, the marketing strategy would require some tweaking to counter the expertise or working style of the new player. Here Bharti has been closely working with Vodafone for more than a year now and its officials say that more than the money these partners bring in experience and work culture in the company. Both companies know the functioning style of each other. In fact, a few advertisements being aired by Bharti Airtel have been inspired by European ads of Vodafone. Following a Vodafone entry, Bharti may get more aggressive but with little to worry about, at least, in the near term.

On Vodafone, though, Bharti can make a small imposition. As per regulatory requirements, Vodafone will need to offload its 10% Bharti stake under the non-competition clause if they bag Hutch. Bharti is expected to wait for the deal to finalise before taking any action. Sources say that Bharti and Singtel might levy a penalty and let Vodafone go. For Vodafone, getting back its investment, minus a penalty shouldn't pinch much.

But what will Bharti and Singtel do? Will they buy the 10% stake? Taking into account the appreciation, Bharti will need to shell out $1.5 billion or look for another partner or a PE fund or banks or another telecom operator. With Mr Mittal concentrating on the retail business, this news could not have come at a worse time. Though analysts say that Bharti has a good management team in place and sufficient professional resources to handle the situation, some impact could still be felt.

The other issue for Vodafone could be management. Khare of Man Financial says that given Vodafone's aggressive style of functioning, they will have problems with an Indian partner like Ruias of Essar or any one else—as they must have a 26% Indian equity participation in the company as per foreign investment (FDI) regulations. Traditionally, though, the Ruia's have largely kept away from operations and management of Hutchison Essar—though they did end up with a somewhat acrimonious relationship with Hutchison Whampoa. If Vodafone bags the deal, going by Indian norms they would need to appoint an Indian management team—CEO, COO, CFO and CTO have to be Indians—and given this it is quite likely they'll get (as is their usual practice) the Hutch team to stay on. Besides, Vodafone already has its people working at Airtel.

If Essar Surprises: Most analysts and telecom industry players don't see Essar taking the plunge alone. For one, Hutchison Essar is a strategic investment for them—out of which they've created huge value, about $6 billion worth—and they lack any experience in running a telecom business—their key interests are in hydrocarbons, infrastructure, steel and shipping. Two, Hutchison Essar CEO Asim Ghosh and his team are unlikely to stay on if Essar assumes charge, given the acrimony of the past and the vastly different styles of management of the two groups. Thus, the more likely option is that they could stay on as a silent partner and look to create greater wealth for themselves—perhaps with a put option if things don't go as planned. Having the first right of refusal puts them in an enviable position and they could present themselves as a ready and willing Indian partner.

Vodafone HQ in Landon

INDIA IN THE CROSSHAIRS: For the powers that be at Vodafone HQ in London, this is an opportunity that can't be missed

But if a deal is to happen with another, players—as Anil Ambani suggested at a recent press conference—would expect the existing shareholders to work out an arrangement and offer complete control. If Essar were to do this, what would it do with the money? Talk of delisting companies is speculative, indicates a senior Essar group executive. Adding that only a public announcement for delisting Essar Shipping has been made and that has little to do with their stake in Hutchison-Essar. Even if this were the case, it could still be left with a kitty of about Rs 20,000 crore. So what would it do with this—start a PE fund? "Hypothetically, Essar Steel could follow in Tata Steel's footsteps and look at acquiring a company that, even if it is not as big as Corus, is at least something to leverage on the huge pile of cash," suggests an investment banker.

But for now, all the options are with Essar. "The marriage between Essar and Hutch has not been a smooth one and Hutch has been contemplating exiting India for the last two years. Today, Essar is in a win-win situation: they can sell and exit, part-sell and be a stake holder or they can even buy out controlling stake and run the company," suggests a Hutch official.

With Essar announcing its intent to participate in the bid for Hutch, analysts are seeing a lot of back-door diplomacy happening. "Essar has been opposed to Orascom, but that could rapidly change and we might actually see the bitterness vanishing and they joining hands. Similarly, the Essar bid might appear to create problems for Reliance," speculates a telecom analyst, adding that there is also the possibility of Vodafone buying some stake (up to 7%) from the Ruias to make them a sleeping partner and go up to 74% with complete management control. Which way the dice falls is tough to tell, but the Ruias clearly find themselves in a sweet spot today.

The wildcard

Hutchison Whampoa doesn't need the money. It has liquid assets of over $14 billion on its books and a very comfortable net-debt to equity ratio of 0.38—it controls 12% of worldwide container port capacity and is promoted by Li Ka Shing, the wealthiest Chinese in the world. Telecom is also one of its five key businesses and India is a high growth, high potential market that everybody wants to be in. So what gives? The unsavoury relationship with Essar that has soured further in recent times could be one reason it wishes to get out. But given that the company is doing well here and that it is cash rich, there is little likelihood it will sell out cheap.

In fact, the recent indication by an official of the company that places its expectation at $14 billion for 67% stake in Hutchison Essar could be a reflection of this. An earlier statement from the company states in no uncertain terms: "there is no assurance that a sale may result from these approaches," summing up the outside possibility, yet one, that it could stay put.

Some industry trackers, though, are quite confident a deal will happen. Says Ernst & Young's Singhal, "From Hutch's point of view the valuations are good. Chances are that it will rise slightly if they wait for, say, another quarter or two. But after that as the urban circles where the company has maximum presence approach saturation, the already-sliding ARPUs are expected to go down. As a company, Hutch might be able to increase the base but in rural areas and Tier II cities, they might not be able to pick and choose subscribers as they have done in the past. This will reflect on their revenues and valuations might be hit."

The other reason could be no movement on the 3G front in India. This is possibly holding up Shing's plan to migrate his 2G operations to 3G. Others suggest that Hutchison Whampoa is known to create value and exit businesses as it did in the past by creating STAR TV network and later selling it to Rupert Murdoch's News Corp for over $525 million or selling Hutchison Telecommunications Technology Investments (HTTIL) to Pacific Century Cyberworks (PCCW) for $103 million. However, the group in not known to quit growing telecom markets. The company, through HTIL and 3 Group businesses, is operating in 17 countries, including CDMA operations in Thailand, Vietnam and Ghana.

The true motivations will come to light, perhaps, when a deal is done (or not done). But one thing's for sure, this multi-billion dollar deal can change the telecom landscape in the country with one stroke—and alter the fortunes of other players looking to make a go like Idea Telecom and Maxis. It could also spur a fresh round of consolidation in the GSM space. For now, as Analjit Singh of Max puts it (he owns a 6.7% stake in Hutchison Essar, that he bought from Kotak earlier in March 2006): "May the best man win."

With inputs from Rajiv Bhuva in Mumbai

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