The Hindu Business Line : Decoding the telecom buzz on deal street

"Vodafone needs a true operating and controlling interest in an Asian operator to re-vitalise its shareholder value." — MR ROMAL SHETTY, DIRECTOR, TELECOMMUNICATIONS, KPMG

The battle for Hutch is brewing. A key player in the race for acquiring the stake of Hutchison Telecommunications International Ltd in Hutchison Essar Ltd, is the world's largest mobile phone company, Vodafone, based in the UK. Predictably, therefore, the British media is abuzz with reports about the buy-in-the-works. Such as, that Vodafone CEO, Mr Arun Sarin, is to meet the Indian Prime Minister, Dr Manmohan Singh, today, even as the company sent in a team to study the books of the Indian mobile phone operator Hutchison Essar, as part of due diligence exercise.

`Now: Make the most of now,' urges the telecom giant's homepage www.vodafone.com. "It's the most precious thing in the world. It only exists for a moment. It's here. Then it's gone. Whatever you do, make the most of it." The latest press release of Vodafone is about `broadband with no limits' commercially launched in the UK, on Monday.

"The service costs just £25 per month including the landline rental. Vodafone At Home customers will receive up to 8 MB unlimited broadband, free 24/7 support and inclusive calls at anytime to UK landlines. In addition, customers will have a 25 per cent discount versus BT (British Telecom) standard rates for call to mobiles."

About Hutch Essar, the only announcement on Vodafone's site is dated December 22, that the company's board continues to believe the mobile market in India has great potential, and is therefore considering the acquisition of a controlling interest in Hutch Essar. "Such a transaction would be consistent with its stated strategy of seeking selective acquisition opportunities in developing markets. The process is at an early stage and may or may not lead to a transaction. A further announcement will be made in due course."

Soon enough, it may be, because of rumblings on deal street. For instance, Ms Elizabeth Judge wrote last week, on http://business.timesonline.co.uk, that State Street, which holds about 1.7 per cent of the world's biggest mobile group, has sounded an alert — that "Vodafone risked repeating past mistakes of overpaying in an overheated situation such as the 3G licence sale." In response, Vodafone is reportedly seeking to allay investors' fears, by saying that it will not overpay for the Indian mobile player, as www.marketwatch.com captures in a recent posting.

The Vodafone Group has ownership interests in 26 countries across five continents, and partner networks in a further 34 countries, informs the company's site. "Based on ownership interests at September 30, 2006, the Group had 191.6 million proportionate customers in its subsidiaries, joint ventures, affiliates and investments." And `venture customers' numbered more than half a billion.

As you may be aware, there are other players, too, in the Hutch race. Such as, Reliance Communications, Essar, and the Hinduja Group. What are the relative strengths of these companies as suitors for the Hutch hand? To know the answers, Business Line contacted Mr Romal Shetty, Director (Telecommunications), KPMG. He has over ten years of extensive risk consulting and revenue assurance experience in the field of telecom consulting. Mr Shetty, a qualified Chartered Accountant and a Certified Information Systems Auditor, has been involved in managing revenue assurance engagements that have resulted in identification of revenue leakages and potential opportunities to maximise revenues for a significant number of telecom organisations in India and abroad. Here are his answers to a few questions on what may well be the hottest issue in the telecom space.

Why India, for Vodafone?

Considering the slowdown in Vodafone's European markets, India seems to be the only viable option for the company to kick-start its earnings growth. India represents a `very significant' working population market with ever increasing disposable incomes. This can be a market where the company can unveil its highly successful `Vodafone Live!' 3G service.

It is expected that 3G service will be the next `explosive' growth phase for Indian telecom companies, and Vodafone would be perfectly placed to use its expertise and take the market lead. Let's not forget that Vodafone has a negligible presence in Asia: 3.3 per cent in China Mobile, and 10 per cent in Bharti. And that it sold Vodafone Japan to Softbank after trying a variety of unsuccessful strategies there. So, Vodafone needs a true operating and controlling interest in an Asian operator to re-vitalise its shareholder value.

What are the negatives that can weigh upon Vodafone's decision?

There are at least four negatives. One, Vodafone has had bad experiences with `aggressive' investments; it had to write off £20 billion on the European investments acquired in the heady days of the dot-com boom.

Two, Vodafone might have to give up its 10 per cent stake in Bharti on account of the non-competing clause, or Bharti would have to remove its non-competing clause from its agreement with Vodafone.

Three, Vodafone has set internal investment guidelines and the required IRR (internal rate of return) to be considered before investment; only, the Hutch valuation may not pass their internal investment guidelines.

And four, going by the regulatory provisions, Vodafone will have to go with an Indian partner and its stake in the acquired company cannot exceed 74 per cent. Looking at the current stake holding of Hutchison Essar — 67 per cent owned by Hutchison Telecom International Ltd, a subsidiary of Hong Kong-based Hutchison Whampoa Ltd and 33 per cent by domestic diversified Essar Group, the swing vote is in the hands of the latter.

How are things for Reliance?

Reliance Communications represents the only Indian telecom bidder. It is probably looking at key points such as that Hutch's ARPU (average revenue per user) is significantly higher than Reliance's. And that it can use the target's telecom infrastructure to maximise cost and operational synergies unlike any other operator in the country. On the technology front, Reliance can use Hutch's GSM base as a bargaining chip to get better prices from their CDMA licensors.

Interestingly, Reliance has been pushing its entire muscle to become `numero uno' private operator in the country, though Bharti's strategies seem to be one step ahead of Reliance. Hutch, perhaps, would give Reliance an extra push to become No.1 with a comfortable margin.

With 3G services on the anvil, the Hutch brand is better positioned with high-end users as compared to Reliance's current low-end positioning. 3G will be first unveiled to the high-end users and once economies of scale are achieved, only then the low-end users will have access to 3G. Considering Reliance's current positioning, though, it has to work the hardest in the 3G market unless it acts as the price-killer again, which is unlikely.

Any other hurdles for Reliance?

Reliance has reportedly managed to gain financial support of several private equity and global investment banks to fund the Hutch purchase. Though Reliance can get good funding rates from these investors, other current public investors in Reliance will look at the exit options provided to private equity investors. Current status is that Reliance has not been given a chance to look at Hutch's books, indicating that Vodafone may be the first preferred candidate. Over the last few weeks, the steam with Reliance seems to have gone down a bit with Mr Anil Ambani making press statements about the `uncertainty of such deal'.

The outlook for Essar Group?

Essar already has a stake of 33 per cent in the run. Like Reliance, Essar is said to have several sources of financial support — reportedly going up to even $24 billion. But it lacks the management focus and expertise that the other bidders possess. Though Essar has reportedly obtained financial support for this deal, it may not be able to raise enough capital for future expansion of Hutch, which is something that Hutch lacks as compared to the Bharti and Reliance.

Essar seems to be sitting tight until the first bidder unveils its valuation. The `right of refusal' clause will definitely be challenged in the courts if Essar is not comfortable with the first bidder. Word of Essar trying to tie up with Vodafone is also on. Considering Vodafone has started its due diligence, Essar seems to have provided a `tacit' approval of Vodafone, unlike Reliance.

And we have the Hinduja Group too, vying for Hutch.

Among the recent entrants, the Hindujas are interested in nothing less than a 51 per cent stake. Hindujas have had some transactions with Hutch-Essar in the past. They are supposed to start their due diligence next week. But they may not be `serious' players, unlike Vodafone and Reliance.

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