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Monday, February 12, 2007
Heavy volumes accompany post Novelis acquisition setback in Hindalco
Worries that Hindalco will not reap the benefits of the $5.9 billion deal to buy Novelis Inc for some time, knocked down its shares nearly 14% today to Rs 149.05.
The stock declined on a heavy volume of 72.8 lakh shares on BSE, much higher than the average daily volume of 15.4 lakh shares in the past one year.
Hindalco's scrip was relatively firm over the past few weeks despite weak global copper prices. The stock moved between Rs 173 and Rs 183 since late-January 2007.
Hindalco said on Sunday, the deal will make it the world's largest aluminium rolling company, doubling its turnover to $20 billion, but it will boost earnings only by 2010. Hindalco will pay $3.5 billion in cash and take on debt of $2.4 billion under the agreement. Novelis is the largest flat rolled products player in the world, with a 19% share of the global market.
Novelis has entered into certain `can body’ (material for beverage cans) contracts that do not allow it to pass on commodity price rises to such customers. These contracts expire in January 2010, which in turn will impact the profitability of Hindalco’s consolidated financial performance. Novelis posted a net loss of $102 million during the third quarter of 2006.
Hindalco said it will fund the Novelis acquisition through a recourse debt of $2.8 billion. Hindalco’s treasury will contribute $450 million, while SL Iron Ore Mining, another group company, will contribute $300 million as debt.
Market men were also concerned about the impact of the debt on Hindalco's balance sheet, although the company said on Sunday it would maintain its debt-equity ratio at a "comfortable" level.
Hindalco’s net profit jumped 92% in the December 2006 quarter to Rs 643.90 crore, on 62% growth in net sales to Rs 4656.20 crore.
Sensex sheds 348pts, Hindalco slumps 14%
The Sensex opened marginally (10 points) lower at 14,529, and continued to drop as the day progressed.
Concerns over rising inflation, coupled with profit-taking following a seven-week rally, saw the index plunge to a low of 14,146. The Sensex finally settled with a huge loss of 348 points (2.4%) at 14,191.
The Metal index plunged 5.5% to 8616. The BSE Bankex, Auto, Healthcare and Oil & Gas indices also declined sharply today.
While the BSE Mid-cap index dropped 4% to 5821, the Small-cap index slipped nearly 5% to 7127.
Declines beat advances 7:1, i.e there were seven declining stocks for every advancing share. Out of 2,668 stocks traded, 2,303 declined, 338 advanced and the rest were unchanged.
INDEX MOVERS & SHAKERS
Hindalco tumbled nearly 14% (Rs 24) to Rs 149 after agreeing to a $6 billion deal to buy US-based Novelis. BHEL plunged 6.5% to Rs 2,345, and Gujarat Ambuja slumped nearly 5% to Rs 132.
Reliance Communications shed over 4% to Rs 455, and Reliance Energy dropped nearly 4% to Rs 535.
Tata Motors, Bajaj Auto, Larsen & Toubro, HDFC, Bharti Airtel and Maruti slipped over 3% each to Rs 874, Rs 2,944, Rs 1,659, Rs 1,757, Rs 729 and Rs 912, respectively.
ICICI Bank and TCS were down around 2.7% each at Rs 965 and Rs 1,254, respectively.
Grasim, Reliance, Tata Steel, Wipro and ONGC declined over 2% each to Rs 2,760, Rs 1,356, Rs 444, Rs 629 and Rs 866, respectively.
VALUE & VOLUME TOPPERS
Global Broadcast topped the value chart with a turnover of Rs 247 crore followed by Hindalco (Rs 112 crore), debutant Technocraft (Rs 101 crore), Akruti Nirman (Rs 108.50 crore) and Reliance Communications (Rs 97.20 crore).
IFCI led the volume chart with trades of around 2.20 crore shares followed by Technocraft (98.65 lakh), Pochiraju Industries (78.60 lakh), Hindalco (73 lakh) and Cambridge Tech (72 lakh).
Fall steepest in two months
The Sensex today registered its biggest one-day fall by points since 12 December 2006.
On this day, the barometer index had lost 404.41 points (3%) after data showed a lower-than-expected 6.2% growth in industrial production for October 2006, sparking concerns of an economic slowdown. The 404-point slide came on the back of a 400-point fall a day before (11 December 2007) caused by the Reserve Bank of India (RBI)’s surprise hike of 50 basis points in the cash reserve ratio (CRR) after trading hours on 8 December 2006.
The Sensex today plunged 348.20 points (2.39%) to settle at 14,190.70. Data showing substantial FII inflow of Rs 560 crore in index-based futures on 9 February 2007, concerns about rise in interest rates and weak Asian markets spooked the bourses. Data released on 9 February 2007 showed that wholesale price index rose 6.58% in the 12 months to 27 January 2007, the biggest rise in more than two years fanning concerns of a further rise in interest rates.
Another major fall happened on 19 December 2006, when the Sensex had lost 349.08 points (2.54%) in a sell-off across Asian emerging markets after Thailand’s central bank adopted currency controls, heightening worries about emerging markets.
A sharp market fall was also witnessed early January 2007, when the Sensex had lost 652.76 points (4.6%) in five trading sessions, to 13,362.16 on 10 January 2007 from 14,014.92 on 3 January 2007. Caution before the start of the Q3 earnings season was behind the fall.
The current market fall has materialized after a solid surge that took the benchmark to all-time highs. From 14,090.92 on 31 January 2007, the Sensex had spurted 561.17 points (3.9%), to a lifetime closing high of 14,652.09 on 8 February 2007. Strong Q3 results and the stepping up of buying by FIIs, following an upgrade in India’s rating to investment grade by Standard & Poor's, triggered this solid surge.
The market-breadth was extremely weak today. For 2,312 shares that declined on BSE, 334 rose. Just 27 stocks were unchanged. Losers outpaced gainers by a ratio of nearly 7:1.
Sensex hurtles 348 points lower
The Sensex plunged sharply for the second straight day, today’s fall being more profound and painful compared to Friday's. The BSE benchmark traded in the red throughout on continued selling.
The BSE benchmark also saw a bout of volatility, swinging sharply either ways. The 30-shares BSE Sensex settled 348.20 points (2.39%) in deficit, at 14,190.70, recovering some lost ground after plunging to a low of 14,146.22 on value-buying. The Sensex has thus breached a vital support level of 14,200.
The BSE Sensex began on a highly bearish note, as selling pressure spilled over to this week. The horror show had started on Friday, when the benchmark Sensex tumbled close to 113 points, as a lot of stop losses were triggered due to highly leveraged positions in the derivatives market. Its high for the day was 14,529.28. Traders and speculators exited long positions and chose to sit on the sidelines before the Union Budget. Weak global markets also played spoilsport.
The S&P CNX Nifty lost 129.10 points (3.08%) to 4058.30.
As the market tanked, the market-breadth, indicative of the overall health of the market, did not look good, as a host of small-cap and mid-cap stocks succumbed to selling. There were close to seven losers for every gainer on BSE. For 2,312 shares declining on BSE, only 334 rose. Just 27 shares were unchanged.
The BSE clocked a turnover of Rs 3266 crore.
There was complete pandemonium in the market, and not even a single member from the 30-member Sensex pack was spared the stick.
Aluminium major Hindalco Industries plunged the most after its large all-cash acquisition of US-based Novelis raised concerns about a short-term strain on financials. It was down 14% to Rs 149.05 on high volumes of 72.81 lakh shares. Hindalco Industries and Novelis, on Sunday, signed a definitive agreement for Hindalco to acquire Novelis in an all-cash transaction, which values the US firm at approximately $6 billion, including approximately $2.4 billion of debt.
It may be worthwhile to recall a similar situation, when Tata Steel won the bid to acquire Corus, with analysts worrying about the high price paid by Tata Steel to acquire Corus. Novelis is the largest flat rolled products player in the world with a 19% share of the global market.
The Novelis-Hindalco deal will be financed through a recourse debt of $2.8 billion, Hindalco’s treasury contributing $450 million, while SL Iron Ore Mining, another group company, chipping in with $300 million as debt.
Following the transaction, Hindalco, along with Novelis, will be the world's largest aluminium rolling company, one of the biggest producers of primary aluminium in Asia, and India's leading copper producer.
Novelis posted a net loss of $102 million during the third quarter of 2006. The company has been plagued by high metal prices.
Reliance Communications (RCL) dropped 4.63% to Rs 453.55, on a volume of 21.23 lakh shares, after it lost the bid to acquire the fourth largest cellular services provider, Hutch Essar. Vodafone emerged the top bidder with a $19 billion bid.
RCL recovered from a low of Rs 448.15. Vodafone staved off bids from RCL, the Hinduja brothers and Essar itself, to buy Hutchison's 67% stake for $11.1 billion in cash, and $2 billion more in debt, an enterprise value of $18.8 billion. Vodafone's emergence as a top bidder has dashed Reliance Communications hope of becoming the largest mobile operator in the country.
Bhel (down 6.25% to Rs 2348), Bharti Airtel (down 4.62% to Rs 718), and Gujarat Ambuja Cements (down 4.54% to Rs 132.50) were the other major losers.
Index heavyweight Reliance Industries settled at Rs 1,354, down 2.47% from the previous close of Rs 1,388.25 on a volume of 4.98 lakh shares.
Other heavyweight shares, Infosys (down 0.49% to Rs 2350) and ONGC (down 2.12% to Rs 865) also declined.
Zee Entertainment Enterprises (ZEE) dropped 29% to Rs 257 on 17.66 lakh shares, after the stock went into a no-delivery period ahead of the de-merger of Dish TV, its direct-to-home TV service. The counter clocked 9.30 lakh shares on the BSE. The company has fixed 20 February 2007 as a record date for determining the shareholders of the company eligible for shares in ASC Enterprises, which will be later renamed Dish TV. ZEE will allot 23 fully paid-up equity shares of Re 1 each in ASC to every shareholder for 10 equity shares of Re 1 each held in ZEE.
Technocraft Industries India settled at 100.90 on BSE on its day of debut, notching up a volume of 98.63 lakh shares. It listed at Rs 125 on BSE, a premium of 19.04% over the IPO price of Rs 105. It touched an intra-day low of Rs 97.35, and an intra-day high of Rs 130. The company raised around Rs 87.36 crore at the upper end of the price band of Rs 95 - 105 per share in the IPO concluded recently. The IPO was oversubscribed 10.67 times.
Meanwhile, India's industrial production (IIP) surged 11.1% in December, more than expected, adding pressure on the central bank to raise interest rates. Economists were expecting a rise of just 10.5%.
Most of the Asian and European markets finished in the red, on selling pressure. Hong Kong's Hang Seng fell 84.25 points (0.41%), at 20,593.41, Taiwan's Taiwan Weighted was down 83.17 points (1.06%), at 7,776.36, Singapore's Straits Times plunged 50.43 points (1.57%), at 3,170.46, while South Korea's Seoul Composite index was down 13.39 points (0.94%), to 1,414.29.
US stocks closed lower on Friday after an extensive sell off in stocks inspite of new upgrades announced by Ford Motor and General Motors. The sell-off was prompted by a rise in crude futures, remarks by Federal Reserve officials leaving open the possibility of more rate hikes and concern by Micron Technology executives about memory chip demand and pricing. The Dow Jones Industrial Average closed lower by 56.8 points at 12,580.83, and Nasdaq lost 28.85 points, to 2,459.82.
FIIs were net sellers to the tune of Rs 560 crore in index-based futures on 9 February, the day when the Sensex lost 113 points in a broad decline after a surge in inflation to a more than two-year high. Concerns of a further rise in interest rates grew after the inflation data was released last week. Net buying by FIIs stood at $153.7 million on 8 February 2007. Mutual funds net sale was Rs 193 crore (Rs 1.93 billion) on the same day. NSE F&O open interest was down by Rs 815 crore (Rs 8.15 billion) at Rs 60,052 crore (Rs 600.52 billion).
Oil prices climbed briefly above $60 a barrel on Friday for the first time since the first trading day of the year, as an unrelenting winter across the US led to belief that heating fuel demand will not wane anytime soon. Light, sweet crude for March delivery rose $0.18, to settle at $59.89 a barrel by afternoon trading on the New York Mercantile Exchange, after rising as high as $60.80.
Meanwhile, gold jumped above $668 an ounce on Monday to its highest in seven months, before losing some of the gains to weakening oil prices. Spot gold hit an intraday high of $668.20 an ounce, its best since mid-July on short-covering, before slipping to $665.75/666.50 an ounce, slightly lower than $666.50/667.20 late in New York. Firm oil prices raise gold's appeal as a hedge against inflation.
Market battered amid mega acquisition woes
The market was not prepared to accept the fact that Indian corporates can absorb the huge debts they are creating to acquire companies larger than their own size. The rising inflation and profit taking on every upmove also kept the market in negative territory. The Sensex began the trading session in negative territory at 14529 and fell sharply under sustained selling pressure. In the afternoon the Sensex plunged 357 points, but buying at lower levels saw the Sensex pare some losses. Profit booking dragged down the Sensex to an intra-day low of 14142. It closed the session at 14191, down 348 points. The Nifty shed 129 points and closed at 4058.
All the sectoral indices were battered on relentless selling pressure. The BSE Metal index dropped 5.46% at 8616, the BSE CG index lost 5.17% at 9426, the BSE CD index shed 3.80% at 3777 and the BSE Auto index fell 3.41% at 5554. The broader market was weak. Of the 2,668 stocks traded on the BSE, 2,307 stocks declined, 337 stocks advanced and 24 stocks ended unchanged. Among the major losers Hindalco tanked 13.74% at Rs149, BHEL tumbled 6.36% at Rs2,345, Gujarat Ambuja declined 4.79% at Rs132, Reliance Communications slumped 4.32% at Rs455, Reliance Energy fell 3.74% at Rs535, Tata Motors plunged 3.47% at Rs874, Bajaj Auto dropped 3.39% at Rs2,944, L&T slipped 3.30% at Rs1,659, HDFC was down 3.28% at Rs1,757 and Bharti Airtel lost 3.19% at Rs729. The other front-line stocks were down 1-3% each.
The metal and consumer goods stocks slipped sharply. SAIL tumbled 4.81% at Rs108, Hindustan Zinc slumped 4.17% at Rs636, Jindal Stainless dropped 4.14% at Rs116, Nalco declined 3.76% at Rs222, Sterlite Industries dipped 3.74% at Rs442, Jindal Steel fell 3.66% at Rs2,349 and JSW Steel was down 3.26% at Rs432. Among the consumer goods stocks Alstom Projects, Areva, Laxmi Machine Works, Kalpataru Power Transmission, Reliance Industrial Infrastructure and Bharat Earth Movers slipped 6-8% each.
Hindalco witnessed volumes of over 72.93 lakh shares on the BSE followed by IDBI (43.92 lakh shares), Cairn India (23.13 lakh shares), Reliance Communications (21.28 lakh shares) and Gujarat Ambuja Cements (18.89 lakh shares).
Value-wise Hindalco registered a turnover of Rs111 crore on the BSE followed by Reliance Communications (Rs97 crore), Tata Steel (Rs80 crore), Reliance Industries (Rs68 crore) and Suzlon Energy (Rs52 crore).
Value-buying offers some respite
The Sensex recovered some lost ground after plunging to a low of 14,182.34 on value-buying. At 12:36 IST the 30-shares BSE Sensex was down 247.39 points, to 14,291.55.
The BSE Sensex began on a highly bearish note, as selling pressure spilled over into this week. The horror show had started on Friday, when the benchmark Sensex tumbled close to 113 points, as a lot of stop losses were triggered due to highly leveraged positions in the derivatives market. Its high for the day is 14,529.28.
The market-breadth was quite weak. There were close to 10 losers for every single gainer on BSE. For 2,260 shares declining on BSE, only 272 rose. Just 15 shares were unchanged.
The BSE clocked a turnover of Rs 2077 crore.
All members of the Sensex pack were trading in the red.
Aluminium major Hindalco Industries plunged after its large all-cash acquisition of US-based Novelis raised concerns about a short-term strain on financials. It was down 12% to Rs 152.40 on high volumes of 43.81 lakh shares. Hindalco Industries and Novelis, on Sunday, signed a definitive agreement for Hindalco to acquire Novelis in an all-cash transaction, which values the US firm at approximately $6 billion, including approximately $2.4 billion of debt.
It may be worthwhile to recall a similar situation, when Tata Steel won the bid to acquire Corus, with analysts worrying about the high price paid by Tata Steel to acquire Corus. Novelis is the largest flat rolled products player in the world with a 19% share of the global market.
The Novelis-Hindalco deal will be financed through a recourse debt of $2.8 billion, Hindalco’s treasury contributing $450 million, while SL Iron Ore Mining, another group company, chipping in with $300 million as debt.
Following the transaction, Hindalco, along with Novelis, will be the world's largest aluminum rolling company, one of the biggest producers of primary aluminium in Asia, and India's leading copper producer.
Novelis posted a net loss of $102 million during the third quarter of 2006. The company has been plagued by high metal prices.
Reliance Communications dropped 3.87% to Rs 457.50 on 12.38 lakh shares, after it lost the bid to acquire the fourth largest cellular provider, Hutch Essar, with Vodafone emerging as a top bidder with its $19 billion bid.
ICICI Bank (down 3% to Rs 962), Tata Motors (down 3.20% to Rs 877), and L&T (down 3.38% to Rs 1658) were the other losers.
Index heavyweight Reliance Industries was trading at Rs 1,368, down 1.46% from the previous close of Rs 1,388.25 on a volume of 1.88 lakh shares.
Other heavyweight shares, Infosys (down 0.90% to Rs 2340.50) and HLL (down 0.44% to Rs 201.70) declined.
Zee Entertainment Enterprises (ZEE) dropped 27% to Rs 263.25 on 10.01 lakh shares after the stock went into a no-delivery period ahead of the de-merger of Dish TV, its direct-to-home TV service. The counter clocked 9.30 lakh shares on the BSE. The company has fixed 20 February 2007 as record date for determination of members of the company eligible for issuing shares by ASC Enterprises, which will be later renamed Dish TV. The company will allot '23 fully paid-up equity shares of Re 1 each in ASC to every shareholder for 10 equity shares of Re 1 each held in ZEE.
FIIs were net sellers to the tune of Rs 560 crore in index-based futures on 9 February, the day when the Sensex lost 113 points in a broad decline after a surge in inflation to a more than two-year high. Concerns of a further rise in interest rates grew after the inflation data was released last week. Net buying by FIIs stood at $153.7 million on 8 February 2007. Mutual funds net sale was Rs 193 crore (Rs 1.93 billion) on the same day. NSE F&O open interest was down by Rs 815 crore (Rs 8.15 billion) at Rs 60,052 crore (Rs 600.52 billion).
Hong Kong's Hang Seng fell 54.29 points (0.26%), at 20,623.37, Taiwan's Taiwan Weighted was down 83.17 points (1.06%), at 7,776.36, Singapore's Straits Times plunged 51.60 points (1.60%), at 3,169.29, while South Korea's Seoul Composite index was down 13.39 points (0.94%), to 1,414.29.
US stocks closed lower on Friday after an extensive sell off in stocks inspite of new upgrades announced by Ford Motor and General Motors. The sell-off was prompted by a rise in crude futures, remarks by Federal Reserve officials leaving open the possibility of more rate hikes and concern by Micron Technology executives about memory chip demand and pricing. The Dow Jones Industrial Average closed lower by 56.8 points at 12,580.83, and Nasdaq lost 28.85 points, to 2,459.82.
Oil prices climbed briefly above $60 a barrel on Friday for the first time since the first trading day of the year, as an unrelenting winter across the US led to beliefe that heating fuel demand will not wane anytime soon. Light, sweet crude for March delivery rose $0.18, to settle at $59.89 a barrel by afternoon trading on the New York Mercantile Exchange, after rising as high as $60.80.
Scrambling for Control of Hutch Essar (OLD)
Hutch deal is done, here is a report on Valuations by Raghuram Iyengar of Wharton
It's hard to say where valuation math ends and acquisitive ego begins with the current high bidding levels for Hutch Essar, India's second largest mobile phone services provider, which currently has 22.3 million subscribers and Rs. 5,800 crore in revenues ($1.3 billion). Active bidders include the world's largest mobile telecommunications company Vodafone, the Anil Ambani-led Reliance Communications and the Hinduja Group. Verizon Wireless of the U.S. is also said to be kicking the tires of a potential deal.
Others in the fray are Japan's NTT DoComo, Egyptian telecom operator Orascom and other big-name investment banks, including Goldman Sachs, Blackstone and Texas Pacific. In the past month, Hutch Essar's valuation has doubled to $20 billion -- the enterprise value that Hong Kong parent Hutchison Whampoa likes for its 67% stake with partners. The other 33% is owned by the Ruias of the Mumbai-based Essar group, who seem open to either running the entire company themselves or in partnership with others.
At first sight, it seems obvious why Hutch Essar's valuations climbed so rapidly to such high levels. India's current high economic growth makes it an attractive market for foreign investors. Also, it is not every day that one gets to control a big player in a tightly-regulated policy environment where entry barriers are high.What's more, the country's mobile phone subscriber base is adding six million new subscribers each month and fast approaching 200 million, or a tenth of the world's subscribers. India Knowledge@Wharton interviewed faculty members at Wharton and the Indian School of Business, and other experts to get closer to the valuation metrics and see what's in store for a new owner at Hutch Essar.
At least two theories are floating around as to why Hutchison Whampoa wants to sell its stake in Hutch Essar. One is that the company badly needs the cash since it has committed up to $30 billion in investments across Europe. The other is that Li Ka-Shing, the Hong Kong-based shipping and real estate baron who controls Hutchison, wants to cash out. "He is a fairly astute entrepreneur and, in the past, he has been known to sell when he thinks valuations have maxed out," says Saurine Doshi, partner at consulting firm A.T. Kearney in Mumbai. India's FDI regime prevents Hutch from buying out the Ruias of Essar and gaining complete ownership. Hutchison, however, would have to settle a dispute with Essar that recently arose and now seems headed for the courts. Essar claims that under its partnership agreement with Hutchison, it has the "right of first refusal" in case the latter sells its stake in Hutch Essar. Hutchison says that right of refusal is not a blanket agreement, and is good only in specific circumstances.
Of the several possible configurations under consideration, the two most popular are first, a Vodafone-Ruia partnership and second, Reliance Communications buying out both Hutchison and the Ruias, and merging it with existing operations. India's policy regime doesn't allow much elbow room in those scenarios: FDI rules require Vodafone or any foreign player to have a local partner holding at least 26%; and Reliance or any other company cannot own more than a 10% stake in two different operators.
GSM and 3G
The quicker tempo being set in the race for Hutch Essar is a testimony to the appeal of the Indian opportunity, says Ravi Bapna, professor and executive director of the Center for Information Technology and the Networked Economy at the Indian School of Business in Hyderabad. "This is as strong a signal as you can get -- for the valuation to double in six months [to more than $20 billion] is totally unprecedented; it was $10 billion in June [2006]. Part of what people are responding to is the growth rate of mobile phone subscribers in the market as a while. No country in the planet is adding six million customers a month, and the cost of handsets is going down."
Those higher valuations could be justified only with a couple of significant assumptions, says Bapna. "The key for the underlying valuation is the hypothesis that the Internet is going to be played on the mobile phone in India. This implies higher average revenue per user (ARPU) for the mobile operators, which, coupled with the explosive growth and potential in the subscriber base, is a deadly combination." He says Hutch Essar's new owner will expect the subscriber base to double in two to three years, and also a doubling of the ARPU from current levels of between $10 and $20 a month.
Two other big attractions for international players in Hutch Essar are the opportunity to gain a significant presence on the GSM technology platform, and a 3G opportunity that is coming up soon, says Doshi. GSM is the fastest-growing and most popular wireless standard, with penetration in more than 200 countries, according to the GSM Association, a trade group based in London. Third generation (3G) services on the GSM platform would be made possible when those licenses are issued by the Indian government next year. "Part of the reason the [Hutch Essar] valuation is high is you are [getting] an option to buy 3G licenses in 2007-08 when preference will be given to the existing operators," says Doshi, adding that while the 3G market has been slow to take off in Europe, this technology is the way to go in the future, especially with the convergence of voice, data and video.
A Skeptical View
Wharton marketing professor Peter Fader senses serious disconnects between what he calls the "base behavior of our species" and the valuation assumptions made by both bidders and sellers of companies such as Hutch Essar. The revenue promise held out by Hutch Essar's existing and projected subscriber base is often seen as crucially linked to how the service is priced and the functionalities it offers. Here is where the deal makers may be off-key, says Fader. "When it comes to, 'Should I keep this contract or not?' often it's the silly little things that make you stick around or leave. They are not necessarily big, major, obvious factors like the pricing policy." He says it is precisely because the swings could take place due to seemingly small issues in a mobile phone service -- like "a goofy design aspect" -- that it is difficult to pinpoint specific drivers.
"When you boil it all down to individual behavior, whatever the device is that they are holding in their hand, their tendency to stick with it or switch to a new one -- and other kinds of very basic behavioral patterns -- will still be largely the same in 10 and 20 years as it is today, even though the functionality being delivered is different," says Fader. "That's a point I'm willing to stand by, and it's a fairly radical point."
Fader and Bruce Hardie, a marketing professor at the London Business School, did capture some of those behavioral patterns in a June 2006 study titled, "Customer-Base Valuation in a Contractual Setting: The Perils of Ignoring Heterogeneity." They say in their paper that M&A deal makers have, in recent years, relied increasingly on extending the concept of customer lifetime value (CLV) to value a customer base. "The application of standard textbook discussions of CLV sees us performing such calculations using a single aggregate retention rate," the researchers write. But these retention rates typically increase over time due in large part to a "sorting effect" in a heterogeneous population. "Failure to recognize these dynamics yields a downward-biased estimate of the value of the customer base," they suggest
In making such flawed assumptions, Fader feels sellers are "just being naïve; they're only hurting themselves and they are leaving so much money on the table when they do these valuations." Mobile phone customers are no different in their behavioral patterns than purchasers of other consumer products like magazine subscriptions, he adds. "There is enormous heterogeneity among customers in every contractual database I've ever seen. In other words, for every person who's going to churn the instant he is able to do so, there's another person who's completely, blindly loyal and foolishly will keep his contract forever. And so the real key here is to capture the variability across customers. Too often, what these firms are doing when they make their calculations is they are assuming an average customer. In doing so, and in ignoring the variability across customers, they end up systematically undervaluing the future value of the customer base, which is really what it is all about."
Wharton marketing professor Raghuram Iyengar has closely studied the impact of pricing strategies in the U.S. mobile phone services market. He says the concept of CLV, which combines profits per customer and the retention rate, gained currency as a valuation tool during the tech boom of the late 1990s. At that time, "a lot of companies in this space were not making profits, but they had big customer bases."
The key factors in analyzing the enterprise value of a mobile phone services provider include the ARPU, the retention rate of customers, the cost of capital and the costs of customer acquisition. With a natural limit on the number of minutes each customer could conceivably use each month, the best opportunity to increase revenue per subscriber is in providing value-added services that command a premium. Having said that, it is the retention rate that has the maximum impact on the company's valuation, says Iyengar.
Pointing to a November 2006 report from Verizon for its latest quarter, Iyengar says the company is "extremely happy about the fact that its churn rate is 1.3% per month -- one of the best in the industry -- because it ensures that their customer lifetime value will be high." Verizon had posted the fourth consecutive quarterly drop in its churn rate, which measures defecting customers. The churn rate in the U.S. wireless phone services market is between 1.5% and 2% per month. Cingular Wireless last quarter reported a churn rate of 1.8%, up slightly from 1.7% in the prior quarter; T-Mobile's churn rate also edged up, from 2.2% to 2.3%, over the past two quarters.
Keeping Customer Churn Low
A. T. Kearney's Doshi says that, as with other global majors, customer retention will be the top challenge Hutch Essar's new owners will face. "Customer churn is high across the world for mobile users, but higher in India," says Doshi. "The only way [mobile phone services companies]do it globally is by strengthening customer relationships; price becomes a factor, in addition to service levels and dropped calls. Once you have parity on those dimensions with all others, you need to adopt an end-to-end customer touch model." Doshi says at that stage, the key issues include convenience in the billing and payment cycle, the resolution of customer problems and "customer reach" -- how companies proactively reach out to customers on an ongoing basis with new options and offers. "In sum, the big challenges facing Hutch Essar will be how to reverse the ARPU decline and how to put in place a leading end-to-end customer relationship model," says Doshi.
He tempers an optimistic outlook with other, more sobering considerations. In the short term, he says, the challenges a new owner faces will be in customer retention and ARPUs. "While everything started with a bang [a few years ago], most operators have seen a decline in their ARPUs," he says. Hutch Essar's ARPUs of Rs. 375 a month ($8.50) compares with industry averages of Rs. 325 ($7.30), according to Doshi, who adds that Hutch Essar's current ARPU levels have actually fallen from levels of Rs. 450 about 18 months ago, and that they have declined at a faster rate than those of others. "Initially, customers were thrilled with the mobile phone, but now they have started optimizing their use," says Doshi. "That is one thing that [any potential buyer] will have to deal with."
If trends in the U.S. mobile phone services industry could point to things to come in the Indian market, a simple expression that Iyengar employs to arrive at customer lifetime value is useful: 'M' multiplied by 'R,' divided by 1+I-R, where 'M' stands for the margin per customer, 'R' for the retention rate and 'I' for the cost of capital. The ARPU in the U.S. market is currently around $50 a month, Iyengar says. Assuming a margin of 45% and the churn rate at 1.5% a month (or 18% annually, meaning a retention rate of 82%), Iyengar arrives at $790 as the customer lifetime value.
If one applies those ARPU numbers, profit margins and retention rates to Hutch Essar's 22.27 million existing customer base, the total value works out to $17.6 billion. That, incidentally, is close to the $17.4 billion that Goldman Sachs believes is the appropriate break-even price its client Vodafone should keep in mind. Goldman Sachs further said that Vodafone would be overpaying if it valued Hutch Essar at more than $20 billion. Hypothetically, if one assumed a higher customer retention rate of 90% (instead of 82%), the enterprise value shoots up to $26.75 billion. In contrast, with other things being equal, a lower capital cost of say, 7%, pushes up the enterprise value to $19.5 billion.
Doshi feels Hutch Essar's price tag is on the high side: "At $20 billion, that's almost $1,000 a user," he says. He points to China Mobile's failed bid last July to acquire Millicom International Cellular SA of Luxembourg, a provider with then about 10 million subscribers across Latin America, Africa and South Asia. (Its current subscriber base is closer to 13 million, and like Hutch Essar, it, too, is adding about a million subscribers a month.) By the time the deal talks failed, China Mobile had offered $5.3 billion for Millicom, or about $500 a customer. The company had the added attraction of licenses in 16 countries including Chad, Bolivia, El Salvador and Cambodia, with a combined market of 400 million people.
Hutch, Hunch, IRR or Instinct
Fader suspects the valuation math in deals like Hutch-Essar is far from scientific, basing his assessment on statements in corporate financial documents. "I've never seen a case where a company has estimated customer retention -- or at least admitted to doing it -- in a manner that their shareholders should insist upon," he says. "They are using very crude estimates of retention; they are assuming that they are constant across customers or over time rather than capturing the huge dynamics that take place there."
India's mobile phone services market is quite different from that in the U.S., says Bapna, and he points to India's higher growth in data traffic as one example. "Voice usage levels aren't likely to increase dramatically; you can make more money from data and multimedia applications and from residential middle-class and enterprise users," he says. "Startup businesses are developing software for seamless video conferencing and other applications for the mobile phone. It's like taking a salesforce.com application and pushing it on the mobile phone."
Fader agrees that the mobile phone industry is in "a time of unique change," but is equally skeptical about the long-term projections floating around. "People who sit around and say what the landscape will look like, say, 10 years from now are fooling themselves," he suggests. "I think a lot of people have placed the wrong bets, if you look at the U.S. side. People talking about the nature and speed of convergence have been way off. It's really, really hard to say how it's going to play out."
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