The Hindu Business Line : Understanding joint venture valuations

Of late we read a lot about windfall profit being made by Indian promoters of new telecom companies in divesting part ownership to foreign partners. The latest news was about Unitech making a whopping profit by placing 60 per cent of its interests with Telenor of Norway. A few days ago there was a similar report about Swan Telecom’s divestment of 45 per cent stake.

While these news reports are directionally true, the method adopted for quantifying the profit requires refinement. In most of these cases, the foreign partners are being inducted into the business.

For this purpose the foreign partners bring in cash to the joint venture (JV) and take part ownership. Various reports we read relating these developments try to compare the value paid by the Indian promoters and the money the foreign players are bringing in. A few adjustments are required to be made before making such comparison. This is where the JV valuation principles come in handy.

What is valuation?

Before coming to JV valuation it is useful to note some of the special features in any valuation exercise. To my mind, valuation is an art as well as a science. There are a few well-defined methods used for valuation. But they all depend on large number of variables and, hence, are capable of giving varying answers. That is where the art part of valuation comes into play. Also, the result will be a range of value and not one answer.

In mergers and acquisitions and JV deals, there are always two valuations — mainly the enterprise value and shareholding value. This distinction is important when we want to understand what is happening in the telecom industry.

Further, there are a few special features required to be factored in where the incoming partner brings in money to take a share in the business.

Interestingly, when a partner brings in money to the JV he continues to have ownership on the money he parts with. However, his ownership on the value reduces from 100 per cent before payment to a lower percentage (equivalent to his ownership percentage in the JV) after payment.

Telecom licence

In addition to the above special aspects of valuation, we also need to bear in mind time value of money when it comes to comparison of money paid by Indian promoters for telecom licence and the payment to be received from the foreign partners.

First and foremost when the Indian promoters paid the licence fee the amount goes out of their hands. Also this payment represents part of the enterprise value. On the other hand, the amount to be received from the foreign partners is for part ownership of the JV. And hence it is the value for share and not for enterprise. As stated earlier, the foreign partner continues to have part ownership of the cash injected into the JV.

To illustrate the point let us look at the Unitech-Telenor deal. It is reported that Telenor is paying Rs 6,120 crore for 60 per cent stake in the JV. What it means is that Telenor will be parting with 40 per cent ownership of this amount for gaining 60 per cent interest in the assets and liabilities of the company.

Assuming that the JV company doesn’t have any other assets/liabilities other than licence, it means Telenor is paying Rs 2,448 crore (40 per cent of Rs 6,120) for 60 per cent ownership of telecom licence. This value of Rs 2,448 crore for 60 per cent ownership represents enterprise value of Rs 4,080 crore for the licence for which Unitech paid only Rs 1,650 crore.

Even after correcting the time value of money (which is necessary as Telenor will be injecting the cash over a period of time) the gain for Unitech is substantial.

Hence the conclusion that the Indian promoters of new telecom companies are making windfall profit is directionally correct but quantification of the same requires a bid analysis.

If Telenor has acquired 60 per cent interest in the telecom company by purchasing the shares from Unitech for Rs 6,120 crore (as happened in the case of Vodafone acquisition from Hutch) then the enterprise value of the licence will be in excess of Rs 10,000 crore ( against Rs 4,080 crore as explained above) as wrongly implied in some of the reports.

(The author is Director, ICL India Ltd.)

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