Hutch-Reliance deal can alter market dynamics

The last few days have seen the stock of Reliance Communications (RCom) gain a good 15.7% on the bourses as compared to a mere 6.7% rise in Bharti Airtel’s share price.

The main reason is RCom’s anticipated bid for Hutchison Essar (HE), which its Hong Kong-based promoter Hutchison Telecommunications International (HTI; 66.99% holding) is believed to have put on the block. The Ruias of Essar are the other promoters.

Although RCom is not the only potential candidate (Maxis of Malaysia and even the Bhartis of Airtel could be in the race), the street is trying to stay a step ahead.
Equity analysts are already trying to figure out who will gain from this deal and by how much. And, how it will alter the stakes for various players in the telecom space. The answers though are not simple, and could mean different things for different players.

For instance, a takeover would mean a lot for Reliance Communications, the second largest mobile player (largely CDMA-based services). RCom is seeking to expand its presence in GSM-based technology in a big way and has reportedly earmarked an investment of over Rs 30,000 crore. This acquisition would help RCom achieve near market leadership in one step - something that could have taken the company three or more years to do the organic way. A Hutch deal offers RCom a ‘big’ and ‘profitable’ presence in the fast growing GSM space. It would also enhance its total wireless market share to over 35%, or 50% higher than Bharti’s share of 23.7%. Although the acquisition route would cost more than the organic route, the market feels it makes sense, unless the valuations cross the limits of prudence.

Importantly, unlike the case with CDMA, for most GSM-based players, including Hutchison Essar, the average revenues per user (ARPUs) are higher at over Rs 400-450 per month. Says an analyst: “Hutch also has premium clients, which is one key reason for higher ARPUs.” Adds Deepak Jasani, head of retail research, HDFC Securities: “In the case of RCom, lower ARPUs are the main reason for lower valuations as compared to Bharti. And if this acquisition happens, then the gap in valuation between the two could narrow down.”

Currently, RCom trades at a discount to Bharti. To put it in numbers, Bharti’s enterprise value works out to Rs 121,550 crore, whereas, even after the recent run-up, it’s about Rs 100,000 crore for RCom. An analyst said: “Technology and profitability are two key reasons for the gap in valuations.” In profitability, while margins are largely comparable, higher revenues have resulted in higher profits for Bharti (Rs 933.8 crore as against Rs 702 crore for RCom for the second quarter ended September, 2006). Secondly, in the case of CDMA, the payment of royalties to Qualcomm and the high cost of handsets have acted as deterrents. No wonder, RCom is keen to expand its GSM operations in a big way.

The acquisition will give the buyer - Bharti or RCom - higher clout in business and scope to extract operational synergies, both of which should lead to improved profitability. For example, companies can avoid duplication with regard to advertising, staffing, sharing of infrastructure and would also be better placed while negotiating with distributors, vendors, etc.

Lastly, for RCom, if it fails to buy Hutchison, it would obviously have to put in substantial efforts and money to increase its GSM share, which could also lead to a blood bath in the telecom space-not a good sign for any player.

On the other hand, it may not be as interesting a deal for Bharti Airtel (GSM-based services), which is the leader in the mobile space with a market share of 23.7% and growing at a fast clip. Marketmen also say that the Bharti group has a lot on its plate viz., investments to be made into retail, agriculture, insurance, etc and hence, may not be as keen as other players to buy Hutchison Essar.

Whenever the deal happens, it could trigger a consolidation in the telecom space and may not be as good for the customer. Says Jasani: “Consolidation is always welcome in any industry. But, how it will impact the consumers in the immediate term is not clear. The total mobile subscriber base is over 14 crore and there is still a lot of ground to be covered for players. However, one or two more consolidation moves could improve the pricing power of mobile service providers, which may not necessarily be good for consumers. Otherwise, three years down the line, when the growth rate declines, players could look at increasing mobile charges to push revenue growth.”

It effectively means higher profits for the larger players, if they manage to gobble up Hutchison Essar. Also, although the Tatas and Idea (Aditya Birla group) are growing fast, the top three players, including Bharti, RCom and BSNL, will end up controlling anywhere between 75-80% of the market, which is unlikely to be good for consumers.

Anil seeks divine help

Anil Ambani’s Reliance Communications may be among the top hopefuls for Hutchison Essar, but there’s no reason why God cannot be roped in along with private equity to give the bid a leg up.

On Sunday, Ambani dashed off to the Tirupati temple along with his mother Kokilaben to seek the blessings of Lord Balaji. He didn’t tell waiting newsmen anything. The speculation was on whether he had come for the Lord’s blessings or thank him for being reckoned as a frontrunner. The Reliance bid has already been sent to the right quarters with Hutch reported to have appointed Goldman Sachs as the merchant banker for the deal.

BPL lowers Hutch margins

The fourth largest player in India, Hutichson Essar reported a 50.9% rise in revenues to HK$ 7.085 billion (1 HK $ = Rs 5.7) and a 46.7% rise in earnings before interest, depreciation, tax and amortisation (Ebidta) to HK$ 2.316 billion for the six months ended June, 2006.

The fall in profitability can be attributed to the merger of relatively lower-profitable BPL (three telecom circles; revenues of HK$ 570 million and Ebidta of HK$ 82 million) with Hutchison Essar in January, 2006. Excluding BPL, its Ebidta margins moved up to 34.3% as compared to 32.4% for June, 2005.

In short, on an annualised basis, it works out to over Rs 8,000 crore in revenues and over Rs 2,600 crore in Ebidta.

These numbers will only rise as Hutchison Essar recently received permission to start services in six new circles, which would enhance its presence to 22 Indian states.