Vodafone shops in the bazaar

Citation

Curwen, P. (2007), "Vodafone shops in the bazaar", info, Vol. 9 No. 5. https://doi.org/10.1108/info.2007.27209eab.001

Vodafone shops in the bazaar

Vodafone shops in the bazaar

A regular column on the information industries

In some respects, the extraordinary bidding war for Hutchison Essar that broke out in early December 2006 is a classic example of changing fashions among telcos. India, after all, has always been a potential growth market second only to China, yet telcos’ behaviour suggested a uniformly negative view until quite recently. For example, in mid-2003 Vodafone sold its stake in RPG Cellular while AT&T Wireless (subsequently Cingular Wireless and now AT&T) sold out of BPL Mobile in 2004 and disposed of its 32.9 per cent stake in Idea Cellular in September 2005. Meanwhile, France Télécom also sold off its stake in BPL Mobile in December 2004. Indeed, the only telco that appeared to be happy with its Indian holding was Singapore Telecom which had an “effective interest” of 28.5 per cent in Bharti Televentures which it raised to 30.8 per cent in May 2005.

Just how big a prize is currently represented by India can be seen from the raw subscriber numbers, which for the first time exceeded 100 million for GSM alone in November 2006. According to the COAI (www.coai.in), Bharti Airtel had 32.0 million subscribers at the end of 2006 compared to 23.6 million for state-owned BSNL, 23.3 million for Hutchison Essar and 11.8 million for Idea Cellular.

One year can be a long time in mobile telecommunications and disinterest has rapidly turned into a feeding frenzy, partly driven by an increase in the permitted foreign ownership cap from 49 per cent to 74 per cent. This frenzy is not entirely concerned with Hutchison Essar. Thus, for example:

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  Maxis Communications of Malaysia bought 2.7 per cent of Aircel during 2006;

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  Sprint Nextel was reported as negotiating a stake in Shyam Telelink during 2006;

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  SK Telecom was reported as negotiating a stake in Tata Teleservices during 2005 and in Shyam Telelink during 2006;

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  Telekom Malaysia bought a 49 per cent stake in Spice Telecom in June 2006 having failed to buy Aircel in December 2005;

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  TeliaSonera was said to be interested in Shyam Telelink during 2006;

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  T-Mobile was said to be interested in Shyam Telelink during 2006; and

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  Vodafone bought 10 per cent of Bharti AirTel from Warburg Pincus in November 2005.

There is also competition from non-telcos. For example, Providence Equity Partners (PEP) acquired a 16 per cent stake in Idea Cellular in October 2006 and this was followed by a further, unspecified stake taken by TA Associates. Furthermore, the Indian operators are themselves undergoing a process of restructuring. Thus, for example, the stake in Idea Cellular was sold because the Aditya Birla conglomerate had fallen out with its partner, the Tata Group, and had resolved the conflict by buying it out, thereby raising its stake in Idea to 98.3 per cent. However, it needed to part-finance this transaction (costing $969 million for a 48.1 per cent stake) through selling-on up to one-third of Idea. The PEP sale raised $400 million which meant that from a total enterprise value of $2 billion at the time of the buy-out, Idea was now worth $2.5 billion a mere six months later. Meanwhile, the Tata Group made do with a 90 per cent stake in CDMA operator Tata Teleservices.

There was considerable confusion in the media about the ownership of Hutchison Essar. In practice, it had two primary owners. The first was Hutchison Telecoms International (HTIL) which owned a 47.54 per cent direct stake together with a 37.25 per cent stake in a joint venture that owned a further 19.54 per cent. Its total stake was accordingly 54.73 per cent. The Essar Group owned a further 33 per cent with the rest held by the other members of the joint venture. In all probability, the latter would sell out at the same time as HTIL but technically there was no single 67 per cent stake up for grabs even though the offers all appeared to be based on buying a stake of that size. HTIL was itself 49.8 per cent owned by Hutchison Whampoa, which therefore owned only a 27.25 per cent indirect stake in Hutchison Essar, and 19.3 per cent by Orascom of Egypt, which therefore owned a 9.61 per cent indirect stake. The rest was listed.

The critical restrictions governing ownership at the end of 2006 were, firstly, that an operator could not own more than 10 per cent of two separate operations in the same “circle”, and second, as noted above, that aggregated overseas stakes could not exceed 74 per cent of an operator (raised from 49 per cent in 2006) of which 22 per cent was already accounted for by part of the Essar Group stake. In addition, the government was seeking to block investments that it saw as a security risk and, more importantly, foreign operators would be obliged in principle to build data centres in India to store information on telephone and internet activity taking place there.

The interested parties in acquiring all or part of Hutchison Essar were (alphabetically) as follows:

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  Altimo Group. The Russian group, the telecoms subsidiary of which is known as Altimo (but formerly traded as Alfa Telecom), is not a telecoms operator as such but regards itself as an investor that seeks to acquire blocking stakes rather than controlling stakes. It indicated its interest in Hutchison Essar only at the end of January 2007 and appeared to want to part-finance any bid by either the Essar Group or the Hinduja Group in return for a minority stake in Hutchison Essar. It was backed by Japan’s Nomura.

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  Essar Group. The Essar Group is controlled by the Ruia family and already held a 33.01 per cent stake, although 15.76 per cent of this was held by subsidiaries based overseas and hence counted as part of the foreign-owned cap. Essar was said to have offered $11 billion to buy out the other shareholders. However, its relationship with HTIL was somewhat strained, not least because of Essar’s opposition to the stake sold to Orascom which was done without its approval. Essar claimed to have first right of refusal in relation to any bid from another domestic operator as well as in relation to any bid by any operator that would reduce HTIL’s stake to below 40 per cent. The latter was denied by HTIL, which claimed that Essar would only have the right of first refusal if the HTIL stake were to fall below 40 per cent and the buyer was Bharti, Reliance or Tata, and hence the matter had the potential to end up in court, which would mean considerable delays. Essar also claimed to have “tagging rights” that would permit it to sell at the same price as that offered for the majority stake. Due diligence by Essar’s banks was completed by mid-January 2007.

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  Hinduja Group. The Hinduja Group, which in 2006 had sold a 5.11 per cent stake in Hutchison Essar to HTIL, submitted an undisclosed indicative bid during the second week of January 2007 which was claimed to be in the region of $17 billion, and was authorized to do due diligence on 24/25 January. It claimed to be happy to work alongside Essar if necessary although Essar had allegedly declined to take up the Hinduja stake in 2006 after offering $600 million for it. It was reported in the media in February 2007 that the Hinduja Group had teamed up with Qatar Telecom, which had previously been rumoured to be forming a partnership with the Essar Group.

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  Maxis Communications. The Malaysian operator, supported by private equity house Texas Pacific, was reported to have been the first to table a bid worth $13.5 billion for the 67 per cent stake. This was immediately rejected and nothing further was heard from the bidder.

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  Orascom Telecom/Qatar Telecom. As noted, Orascom, controlled by the Sawiris family, already held an indirect 9.6 per cent stake in Hutchison Essar, and it approached the latter informally in conjunction with Qatar Telecom, an increasingly acquisitive operator based in the Middle East. However, it rapidly lost interest in a bid as valuations rose.

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  Reliance Communications. The second-largest Indian operator, controlled by Anil Ambani, unofficially entered the takeover battle in early December 2006 when it was rumoured to be ready to make a bid, in conjunction with Blackstone Group (the world’s largest private equity company), of $8 billion for the 54.7 per cent HTIL stake. It was partly motivated by the desire to acquire GSM networks to add to its existing CDMA ones. It officially entered the takeover battle on 27 December 2006 with the backing of private equity houses, stating that it made more sense for Hutchison Essar to be owned domestically. However, given that Essar had first right of refusal if a bid was made by a domestic company, Reliance was unable to proceed until Essar had withdrawn. It accordingly refused to put a price on its target, but in any event it would be obliged to buy all or none of Hutchison Essar since the regulations imposed this choice upon any operator wishing to buy another in the same circle. A successful takeover would propel Reliance into top spot among mobile operators.

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  Vodafone. Vodafone entered the fray with an offer initially representing roughly $17-18 billion for the whole of Hutchison Essar. Vodafone would be obliged to dispose of part of its 10 per cent stake in Bharti AirTel to avoid the single circle ownership cap rule. It would also be unable to retain more than a 74 per cent overall stake. The stake would be partly financed through the proceeds from the sale of minority stakes in Belgium and Switzerland, but question marks were raised over whether it would breach its recently announced investment criteria. Due diligence began on 6 January 2007.

Valuations

The value of Hutchison Essar spiraled during the period to February 2007 as follows:

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  When the Hinduja Group bought Sumitomo Corp.’s 1.23 per cent stake in Hutchison Essar in March 2006 it paid $67 million, equivalent to an enterprise value of roughly $5.5 billion.

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  When Telecom Investments India – the joint venture involving HTIL mentioned previously – bought an 8.33 per cent stake from Kotak Mahindra Bank in March 2006 it paid an amount in rupees roughly equivalent to an enterprise value of $6 billion.

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  When the Hinduja Group sold its 5.11 per cent stake for $450 million in June 2006, this was equivalent to an enterprise value of $8.8 billion. However, the cancelled offer by Essar of $600 million was equivalent to an enterprise value of $11.7 billion.

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  Maxis/Texas Pacific offered roughly $13.5 billion.

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  Market analysts put the enterprise value at the time (end-December 2006) at $14 billion.

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  Hutchison Whampoa then said that it would only accept offers “well in excess of $14 billion”.

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  The Essar bid was equivalent to an enterprise value of $16.4 billion.

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  The offers by Vodafone et al. subsequently appeared to be in the region of $17-18 billion, but with several parties still in the frame this looked to be a little too low for a knock-out blow.

It was observed that, at this valuation for its Indian assets in relation to its total enterprise value, HTIL’s other assets were worth rather little and hence that it might be more sensible to make a bid for HTIL rather than for Hutchison Essar. According to the Wall Street Journal in January 2007, both Vodafone and Reliance were considering this option. However, Orascom had an agreement with Hutchison Whampoa that required the latter to offer Orascom the right of first refusal if the HTIL stake was put on the market prior to the end of 2007, and Orascom had made it clear that it would avail itself of that right if the opportunity were to arise.

It was observed that the domestic bidders would be difficult to beat, as they tended to be more flexible about the amount of control to be acquired and had a cost structure geared towards the Indian market. In addition, partnering with a local operator was seen as a strategy strewn with potential pitfalls for a Western operator since it would be sharing its expertise while the local operator used its political contacts to place itself in an advantageous position.

On 7 February, HTIL asked bidders to submit offers by the following weekend but gave no details about the bidding process, probably because Essar was waiting to see who would be bidding before deciding what action to take. On 12 February, it was announced that Vodafone had proved to be victorious with a bid valuing Hutchison Essar at almost $18.8 billion although its actual bid comprised $11.08 billion in cash plus $2 billion of assumed debt for the 67 per cent stake on offer. Furthermore, its direct stake would be limited to 52 per cent with the same consortium holding the other 15 per cent in order not to breach the foreign-owned stake cap. Vodafone CEO, Arun Sarin, stated that “We have concluded this transaction within our stated financial investment criteria”. Vodafone went on to sign a Network Partner Agreement with Bharti AirTel, thereby helping it to meet these criteria, while granting the Bharti Group an option to buy out its direct 5.6 per cent direct stake in Bharti AirTel for $1.6 billion (twice what Vodafone paid for it). The indirect 4.4 per cent stake held via Bharti Infotel Private would be retained.

Consequences

The fall-out from the bid – overwhelmingly supported by HTIL shareholders on 9 March – was interesting. In February 2006, HTIL had traded at HK$12 per share. Just prior to the auction this had risen to HK$20. On 18 February it stood at HK$16.7, equivalent to an enterprise value of over $10 billion. HTIL now held net cash equivalent to HK$16.4 per share, but even on a pessimistic view of the value of HTIL’s other holdings the company was surely worth HK$20 per share. The difference appeared to be accounted for by fears that a good part of he cash would be reinvested in new assets to no very good effect. According to HTIL, $4.1 billion would be returned to investors via a special dividend and a further $5 billion set aside for re-investment.

The Sawiris family had complained that the Hutchison Essar sale violated the spirit of its right of first refusal over the sale of a stake in HTIL in its entirety, but were nevertheless prepared to support the sale given its 50 per cent profit margin on its stake. The prevailing view was that the Sawiris family would subsequently sell out of HTIL, thereby further depressing its share price.

Vodafone offered to buy out Essar’s minority stake for $5.8 billion, claiming that they nevertheless found Essar easy to work with – which the Sawiris family promptly contradicted. Essar rejected this, stating that it did not wish to be a financial investor but rather to be an equal partner in decision-making with Vodafone, possibly by increasing its own stake in Hutchison Essar. If this was rejected, it would seek to unwind the December 2005 purchase by Hutchison Essar of BPL Mumbai and might also go to court to enforce its alleged right of first refusal over the Vodafone stake. It also pressurized Vodafone to cancel its proposed network sharing deal with Bharti – which Vodafone refused – claiming that this contravened Essar’s shareholder agreement with HTIL and requested an increase in its allocation of board seats (at the time four out of 12).

In early March, the New Delhi High Court directed the Centre and Foreign Investment Promotion Board to complete a two-month inquiry into whether Vodafone would breach the foreign ownership cap in Hutchison Essar if it acquired a 67 per cent stake, and Vodafone subsequently admitted that it would not be able to exercise its option to buy the 15 per cent held by Asim Ghosh and Analjit Singh since doing so would indeed breach the cap. Shortly thereafter, Vodafone announced that it would be renaming the network as Vodafone Essar. For its part, Essar would be granted a option, exercisable between the third and fourth anniversaries of completion, either to sell its entire stake to Vodafone for $5 billion or to sell between $1 billion and $5 billion worth of shares in Vodafone Essar at “fair market value”. HTIL would also pay Essar $415 million to refrain from obstructive behaviour and to do its best to bring the deal to fruition. However, the cash windfall accruing to HTIL appeared to be much diminished when it was alleged that profits tax of nearly $2 billion would be levied on the transaction.

Implications

In recent months, unusually high valuations have been placed upon both equity stakes and new licences, especially in developing countries. The Hutchison Essar stake has undoubtedly taken place near the peak of the market although this may take some time to subside significantly. Vodafone has not overpaid – or so it says – and the financial markets seem happy enough but still have a few things to sort out with Essar. As for the other bidders, they can either scramble – and overpay – for other assets in India, look to (a shrinking pool) of other developing markets or accept that they do not have the resources to be major players on the international stage.

Peter Curwen Visiting Professor of Telecommunications in the Department of Management Science, Strathclyde University, Glasgow, UK. E-mail pjcurwen@hotmail.com