Telecom Frenzy

The bidding war for the 67 per cent stake of Hutchison Essar, India’s fourth largest mobile operator, came to a close on February 11 with the British company, Vodafone, outbidding Reliance Communications, the Hindujas and Essar. The company has been valued at $ 18.8 billion according to the deal and Vodafone will pay $ 11.1 billion in cash and $ 2 billion in debt to assume the controlling stake, amounting to a price of $ 794 per subscriber. The astronomical price the company has paid for the acquisition is explained as being driven by Vodafone’s strategy of expanding its presence in high-growth emerging markets, as compared to mature markets in western Europe where its operations are now concentrated. In India, the total cellular phone subscriber base has grown 10 times in three and half years and stood at 130 million in September 2006, of which 70 per cent is occupied by GSM technology in which Hutch is active. In contrast, telecom penetration in developed markets is already high and the battle is mostly for market share.

However, the question is whether Vodafone paid too much and the computed future returns to its investment are realistic. The company shelled out more than its own estimated enterprise value of $ 16.5 billion to bag the deal; and it is banking on ratcheting up Hutch’s market share in India to 20 per cent, from the present 16 per cent, by 2011 as well as on rising margins. This might be an ambitious proposition given that with falling tariffs, average revenue per user in India has shown a declining trend – in September 2006 that for GSM had shown a fall of 10 per cent over the previous year – and that more tariff cuts can be expected as competition heats up. Plus there is the additional capital cost of rolling out networks and catering to price sensitive rural areas where Vodafone plans to increase its footprint. Some estimates suggest that Vodafone paid a premium of 35 to 40 per cent for Hutch as compared to the current valuation of Bharti Airtel. The picture could be further complicated by the Ruias of Essar, who own 33 per cent of Hutchison Essar and had claimed first right of refusal and who will want to extract their pound of flesh. The telecom drama in India, however, is still far from over – with volumes projected to triple by 2011, the incumbents’ ability to expand and tap new markets will ultimately separate the winners from the losers.