Indus Towers - JV of Bharti Airtel, Vodafone and Idea

The Bharti Group, Vodafone Essar and Idea Cellular on Saturday agreed to form Indus Towers Ltd to provide passive infrastructure to other mobile operators.

The new company will go for an initial public offering later. The independent company, which starts off with about 70,000 towers, is expected to roll out another 50,000 towers over two to three years.

Speaking to Business Line, Mr Akhil Gupta, Joint Managing Director, Bharti Group, said: “Our aim is to get the new company listed over a period of time. We want it to be a totally independent venture with its own management and that is the reason why none of the partners has been given a majority stake.”

While Bharti and Vodafone Essar will each own 42 per cent stake in the tower company, Idea Cellular will hold the balance.

Indus Towers will be operational across 16 circles including Andhra Pradesh, Delhi, Gujarat, Haryana, Karnataka, Kerala, Maharashtra, Mumbai, Punjab, Rajasthan and Tamil Nadu.

Apart from leveraging on operational efficiency, the merger is aimed at getting a bigger valuation for their countrywide mobile infrastructure.

“Merging their tower business would naturally push up the valuation. It will also bring down the cost of operation drastically for the operators, as they will be able to ride on each other’s network,” said a market analyst.

It will also result in additional revenues for the three companies as the infrastructure can also be offered to other mobile operators.

Outside the 16 circles, Bharti will continue to have its own independent tower company— Bharti Infratel.

The mobile subscriber base is expected to touch 500 million by 2010 for which at least 3 lakh more towers are required.

Other pan-Indian telecom players such as Reliance Communication have already hived off their infrastructure into separate tower business.

Exclusive mobile infrastructure companies such as American Tower Corporation and GTL have also jumped into the fray.

Anil Ambani attacks GSM operators

Amid the ongoing telecom tangle, Reliance ADAG Chairman Anil Ambani has accused GSM operators of "hoarding" surplus spectrum and sought Prime Minister Manmohan Singh's intervention to ensure that service providers like Vodafone and Bharti Airtel surrender the excess airwaves.

In a scathing attack on GSM players, who are demanding auctioning of spectrum and have moved telecom tribunal TDSAT on new spectrum norms, Ambani said even sector regulator TRAI, fair trade practices watchdog MRTPC as also TDSAT have issued notices to Bharti and Vodafone for "anti-consumer practices".

It is essential that the future of telecom industry is "not undermined by a few vested interest for their narrow personal interests", Ambani said in a letter to Singh days before the Diwali festival.

The letter comes after GSM lobby Cellular Operators Association of India challenged the new policy of allowing dual technology for mobile telephony and new spectrum allocation norms as recommended by telecom engineering centre. ADAG firm Reliance Communications is a key CDMA player and was the first one to apply for GSM spectrum under the new norms.

Ambani asked the government to "see through the motivated agenda of a few existing GSM operators and not succumb to their pressure tactics", and said there should be "a transparent framework for surrender of spectrum in a time-bound manner, wherever not utilised, as per guidelines".

As if supporting communications minister A Raja, who has clarified to Prime Minister the issues relating to spectrum, Ambani opposed the auction of spectrum. He said such a route would benefit a close club of few large existing GSM players who remain free to indulge in anti-consumer practices like cartelisation and price fixation.

Vodafone planning on infrastructure sharing

Vodafone, the world's largest mobile operator, will spend $2 billion a year in India for expansion and infrastructure sharing instead of creating it or buying into others.

"Since the entry into India, our capital expenditure has doubled. We are now spending $2 billion a year," Arun Sarin, chief executive officer, Vodafone told reporters.

The company, which got a foothold in India earlier this year through the acquisition of Hutch, seeks to extend its coverage to 90% of the market (currently 50%) by bundling affordable handsets to reach out to the masses.

The company is adding 1.6 to 1.7 million customers a month. "Before we came to India, the company was adding 800,000 customers (per month)."

Sarin said Vodafone had no plans to buy into the infrastructure business of its erstwhile partner Bharti, but may share its facilities with peers so that companies need not put up their own towers everywhere.

"We are looking at ways to piggyback on each other's infrastructure to reach out to the masses quickly," Sarin said, adding: "It is completely unlikely that we would be buying into Bharti Infratel because we have our own infrastructure. There is no reason for us to buy."

On the burning issue of spectrum auction on which the industry is divided, he said it is a theoretical issue and up to the government to take a decision.

Vodafone expands rapidly

Vodafone Group Plc.’s Indian operation, Vodafone Essar Ltd (until recently Hutchison Essar Ltd), has, in the four months ended August, signed on more customers in the 16 licensed areas in which it operates than its bigger rival and India’s largest mobile telephony firm, Bharti Airtel Ltd.
Bharti Airtel, which runs operations in 22 Indian telecom circles, on Monday announced that its customer base at the end of September had crossed 50 million, including some three million fixed-line phone subscribers. Latest figures for Vodafone Essar, which unveiled the Vodafone brand in India last month, will be available in a week’s time. Last available figures put Vodafone Essar’s subscribers (all mobile) at 34.11 million at the end of August.
Hutchison Essar, until March, was India’s fourth largest mobile phone services firm.
Vodafone Essar is now the third largest (only Bharti and Reliance Communications Ltd are ahead of it), and nearly five months after the Newbury, UK-based Vodafone Group bought a controlling two-thirds stake in Hutchison Essar mid-March and renamed it Vodafone Essar, the Indian operations are clearly setting the pace for Bharti Airtel and other large phone firms such as state-owned Bharat Sanchar Nigam Ltd.
Vodafone acquired the controlling stake in the company at a time when Hong Kong-based Hutchison Telecom International Ltd, the earlier parent of the Indian mobile phone firm, was spending just about enough on network expansion and having to put up with friction with local partner, the Mumbai-based Essar Group.
Hutchison Essar was lagging far behind Bharti Airtel in terms of net addition of subscribers in the 16 common circles, with the market leader adding around 300,000 and 380,000 customers more in January and February, respectively.
Vodafone, which is the world’s largest mobile phone services company, announced its intent to acquire a 67% stake in the Indian firm owned by Hutchison Telecom in a $11.1 billion deal on 11 February. By 15 March, it had won over the support of Essar, which holds 33% stake in Vodafone Essar.
The acquisition won regulatory approval in early May, by when the Arun Sarin-led Vodafone was clearly in charge. That month Vodafone added just more than 1.5 million subscribers, about 108,650 more than what Bharti Airtel added in the same 16 licensed areas (or circles) in which Vodafone Essar operates. Vodafone Essar is awaiting licences in other circles.
Vodafone has committed $2 billion in network expansion this financial year, nearly double the amount spent in fiscal 2007. “Hutch has not been the first mover; it has been a follower,” said a Mumbai-based telecom analyst, who did not wish to be identified. “Vodafone has brought more aggression compared to Hutch.”
Since May, Vodafone Essar has added more subscribers than Bharti Airtel in the common circles every month. The New Delhi-headquartered Bharti Airtel has been able to bring down the difference to 28,112 in August; Vodafone Essar added 1.68 million customers in August.
“(The) global expertise of Vodafone in managing telecom business has started reflecting in terms of subscriber growth post acquisition,” said Sumit Modi, an analyst with Emkay Share and Stock Brokers Ltd. “The (Indian unit) was lacking management focus before the acquisition by Vodafone.”
Vodafone Essar managing director Asim Ghosh declined comment.
“We should look at long-term trends in the telecom market to asses realities,” said Sanjay Gupta, chief marketing officer, mobile services, Bharti Airtel.
India, the fastest growing mobile phone market in the world by customers with about eight million additions a month, has around 200 million wireless phone subscribers; as a percentage of the country’s population, that is less than one-fifth.
“Given the supply driven nature of the market and aggressive coverage expansion plans of operators, we believe that (the) peak in net additions is yet to come,” Citigroup Global Markets Inc. analysts Rahul Singh, Gaurav Malhotra and Anand Ramachandran wrote in a recent research note.

More cheap cellphones coming soon

It’s official now. Along side the Nokias, Samsungs, Motorolas and Sony Ericssons there’ll be a new mass cellphone brand in India — Vodafone! Vodafone Essar, which will spend nearly Rs 250 crore on a high-profile brand transition from Hutch to Vodafone being unveiled on Thursday, is poised to launch cheap cellphones in India under the Vodafone brand. It will also launch co-branded handsets sourced from major global vendors.

“On the heels of the brand change from Hutch to Vodafone, Vodafone Essar will launch an array of low-cost cellular handsets in India which will be directly marketed under the Vodafone brand or co-branded with select overseas handset makers,” a Vodafone Essar director told ET on condition of anonymity. “The objective is to leverage Vodafone Group’s global scale in bringing millions of low-cost handsets from across the world into India and use Vodafone Essar’s famed cellphone distribution reach to maximise sales,” he added.

With Reliance Communications (RCOM) recently launching ultra budget handsets with prices starting at Rs 777, the industry buzz is that Vodafone would lower the entry barrier to an unbelievable Rs 666. There’s also speculation that Vodafone may follow the pricing model of Rs 666, Rs 777, Rs 888 and Rs 999 for its ultra-cheap handsets.

The Vodafone director refused to confirm this: “I cannot share pricing details but there will be no discounts or subsidised handset offers. Instead, Vodafone Essar may come up with innovative handset-bundled schemes for its 35 million consumers.” Company sources also said that the bundled handsets will primarily be distributed through Vodafone Essar’s four lakh-odd distribution outlets. “Vodafone Essar is also entering collaborative arrangements with some of the top vendors to achieve unprecedented sales,” a top company official told ET.

While CDMA players like RCOM and Tata Teleservices have adopted handset-driven expansion strategies to drive up subscriber base, this is the first time that a GSM player is venturing into this space on a pan-India level.
China’s ZTE, which is looking to set up a cellphone manufacturing unit in India, is expected to provide many Vodafone handsets in India. Early this year, Vodafone inked a global low-cost handset procurement deal with ZTE.

ZTE global vice-president (handset systems) He Shiyou told ET that as per the deal, Vodafone would offer ZTE’s handsets to its subscribers in India. “ZTE hopes to ship over 10 million of these to India. Though, we ship high-end phones to the West, our plan for India revolves around low-cost phones, which we offer in collaboration with operators there,” Mr Shiyou added.

The company will unveil the Vodafone brand on Thursday in one of the biggest brand transition exercises in the recent times. According to PTI, Vodafone will keep in-tact its predecessor’s assurance of following customers wher-ever they go, but will replace Hutch’s ‘Wherever you go our network follows’ catchline with ‘Make the most of now’.

India is SMS Crazy

With an average 1.5 billion SMSes generated nationally every week, the Indian SMS saga is already the stuff of legend. If anything, the marriage of reality TV shows and mobile telephony now promises to set the national SMS turf on fire. Check this out — an 11-hour voting window (between 9 pm and 8 am) during last Friday’s Gala Round in Sony Entertainment TV India’s popular Indian Idol 3 music contest raked in well over three million SMSes from across India and key overseas locations like London, Dubai and Singapore. This was confirmed by a senior SET India official.

But here’s the juicy bit. The unofficial number doing the rounds is that at least five million votes hit Sony’s SMS gateway. Neither SET India nor the mobile guys are willing to confirm this. But at a flat Rs 3 per message, the SMS revenue alone during that 11-hour voting slot would work out to a cool Rs 1.5 crore. Add to that revenues from a few million voice message votes at Rs 6 each which also hit home. SET India circles confirmed that “bulk of the SMS traffic stemmed from Hutch and Airtel networks”.

Top honchos at SET India are truly gung-ho. “The total SMS-driven voting levels during the September 7 Gala episode itself was far in excess of three million. And these SMS votes came in just 11-hour voting window. Now that we’re down to the wire and people have to make a choice between the two finalists, Amit Paul and Prashant Tamang, I anticipate SMS-based voting to be 8-to-10 times the three million-plus SMS levels scaled last Friday. This is since the voting will be spread over two weeks till the Grand Finale on September 23,” said Mr Albert Almeida, who is executive vice-president and business head at SET India.

ET also spoke to a cross-section of the mobile flock, including Hutch, Airtel and BSNL, to get a fix on the real SMS impact of Indian Idol 3. While there’s a tight lid on all Indian Idol-related SMS numbers, leading mobile operators confirmed that SMS volumes were huge. It’s a different matter that SMS data trickling in from mobile operators tended to be more conservative than SET India’s projections.

Even as Indian Idol 3 hits the final stage, mobility circles expect voting lines to nationally generate five million SMSes in the final stretch from September 14-to-23 which will see several face-offs between the two finalists — Shillong’s Amit Paul and city cop, Prashant Tamang. For instance, a director at one of the country’s biggest cellular service providers said: “The two-and-a-half month long Indian Idol 3 context is likely to generate a shade over 15 million SMSes nationally, which is huge for a single TV show, but merely a drop in India’s SMS ocean, given that the national mobile market generates over 1.5 billion SMSes every week. In ARPU (average revenue per user) terms the increase will be a tiny 10 paise in gross revenue terms for mobile operators.”

Bharti, Vodafone hike mobile tariffs

Faced with declining average revenue per user (ARPU), mobile operators are now increasing their tariffs.

Bharti Airtel and Vodafone Essar have increased local charges for calls within their own network by 20 per cent. All pre-paid and post-paid subscribers using the low-end tariff pack with rentals less than Rs 150 per month will have to pay Rs 1.20 per minute instead of Re one a minute for Airtel-to-Airtel calls and Hutch-to-Hutch calls.
New SMS rates

The two operators have also increased local SMS rates to Rs 1.20 per message for all users — both pre-paid and post-paid — from Re one earlier. This comes within a few weeks of an increase in STD rates in Delhi. Both Bharti Airtel and Hutch had increased their STD rates to Rs 2.60 per minute from Rs 2.40 per minute and Rs 2 per minute, respectively.

The increase in tariff comes even as the operator’s revenue per user continues to dip over the past year. The national average is hovering around Rs 300 per user per month, which is among the lowest in the world.

Though operators such as Bharti Airtel have stopped using ARPU as a measure for checking the financial health of the company, the increase in tariff targeted especially at low-end users clearly indicates the operator’s concern about declining ARPUs. Other operators are also likely to follow suit given that the two largest cellular operators have taken the lead.

Consumer groups, however, pointed out that the operators have not given any publicity to the increase in tariffs to create awareness among users. They said that the telecom regulator should take a look at the revised rates. The operators, on the other hand, said that advertisements were issued to inform the subscribers. The increase comes even as the Communications Ministry has made lower tariffs as one of its primary goal this year.

Vodafone - Sabotage was on the cards

Vodafone chief executive Arun Sarin on Saturday said his hopes that India’s regulatory bureaucracy had modernised were shaken by last-minute moves to derail his company’s $11-billion takeover of Hutchison Essar.

Mr Sarin called for greater transparency in India’s merger approval process to defeat backroom efforts by vested interests to manipulate the political bureaucracy.

“I really did not expect people—the ‘good and great’ of India—to be calling cabinet secretaries and ministers to say ‘You have to unwind this deal because we want a piece of it’,” Sarin told a conference of Indian business and academic leaders taking place in Silicon Valley this weekend.

He was speaking to hundreds of fellow alumni from the Indian Institutes of Technology. Vodafone edged out some powerful Indian business groups with an $11-billion bid for Hutchison Telecommunications’ majority stake in India’s fourth-biggest mobile firm in January.

It then underwent a three-month regulatory wait, rapid by US or European standards, he noted.

Mr Sarin said he was confident the deal would sail through until the regulatory process in New Delhi entered its final weeks and he became aware of behind-the-scenes lobbying by competitors attempting “to crater the deal”.

“The billionaire losers’ club was trying to unwind the deal,” Mr Sarin said. “What was fascinating was that there was absolutely no transparency in the process.”

What I didn’t count on was that the bureaucracy would kick in with this kind of evil spirit from our competitors who had lost,” the Vodafone chief said at a news conference after his speech.

Despite his criticisms of India’s regulatory environment, Mr Sarin said he was confident throughout the government approval process that political and economic forces at work in the country would allow Vodafone’s bid for Hutchison Essar to prevail.

Before entering the bidding for Hutchison Essar, Mr Sarin said he had spent time with government leaders to gain assurance that Vodafone’s entry into India would be welcomed.

“I was completely confident from a political standpoint that we would have the blessing and air cover to get the deal done,” he told reporters.

Despite the resistance, Vodafone’s bid gained approval in April. Previously known as Hutchison Essar, the Indian company has been renamed Vodafone Essar. Vodafone owns two-thirds while Indian company Essar owns the remaining stake.

Vodafone, the world’s biggest mobile phone operator by subscribers outside China, aims to be the top wireless carrier in India, where the customer base is expected to rise to 500 million in four to five years from around 150 million now.

Vodafone-Essar looks at mass market

Announces 50% cut in prepaid monthly recharge.

Vodafone-Essar, India’s fourth largest mobile service provider, is looking to add over 1.5 million subscribers a month in this financial year or 18 million new customers in a year, Vodafone CEO Arun Sarin told reporters today.

Simultaneously, the company announced a 50 per cent reduction in the minimum monthly recharge required for a prepaid customer to Rs 99 from the earlier Rs 199 effective June 16, 2007.

This is the mobile service provider’s first board meeting since Vodafone acquired a 67 per cent stake in the company, formerly called Hutchison-Essar, from Hong Kong-based Hutchison Whampoa earlier this year.

To support the move, which marks a strategic shift from its focus on revenue per customer to the mass market, the board has approved doubling investment for the current year to $2 billion.

To gain consumers and market share, Sarin said the company would also introduce low-cost handsets.

The company’s new monthly target, which would translate into 65 per cent growth in subscriber numbers, is larger than last year’s 1-1.2 million. The company has over 28 million subscribers and operations in all 23 telecom circles in the country.

The target would also be the same as India’s leading GSM operator, Bharti Airtel’s, a former Vodafone partner. The Sunil Mittal-owned company has over 40 million subscribers in the 23 circles.

On the integration of Vodafone with Hutchison-Essar, Sarin said, “Whether it is on the network, marketing or human side, the integration is going on smoothly.”

Vodafone-Essar MD Asim Ghosh said the formal integration would take place by the end of September, and after that it would be an ongoing process.

On the constitution of the board, Sarin said there would be 12 members on it, with eight from Vodafone and four from Hutch. Ravi Ruia is the chairman of the new company, with Arun Sarin as vice-chairman and Asim Ghosh as managing director.

There will be two independent directors, Analjit Singh, who owns a stake in the company, and C R Dua. Prashant Ruia, Anshuman Ruia, Vittorio Colao and Vikash Saraf will be board directors representing Essar. Paul Donovan, Gavin Darby and Robert Barr will represent Vodafone.

Reiterating an issue he had raised earlier, Sarin said the company was looking at infrastructure-sharing in the country and was in talks with other mobile firms.

“Infrastructure sharing is the best possible way to reach the 1.1 billion people living in India. We are setting up a platform with whoever wants to join us, so that we can build our network in India in a cost-effective way,” he said.

What Vodafone will collect from the Hutch call

Vodafone Plc, the world's largest mobile operator, has landed a prize catch in Hutchison Essar, marking the British telecom major's full-fledged foray into the Indian mobile market. In a bidding war that lasted over two months, Vodafone clinched the deal (subject to formalities), pipping Reliance Communications and the Hindujas at the post. At an equity value of $11.1 billion for a 67 per cent equity stake (implied enterprise value of $18.8 billion), Vodafone will be paying a steep control premium.

Clearly, for Vodafone, the control premium is linked to entry into the "largest growth market in which we can acquire control" and 67 per cent will give the company a controlling stake in Hutchison Essar. As Mr Arun Sarin, CEO of Vodafone Plc, said at a press conference immediately after the deal: "It is fundamentally at the heart of our emerging market strategy of extracting growth. India is only 13 per cent penetrated, China is 40 per cent penetrated and Europe is 100 per cent."

Strategic intent

For the world's largest mobile service provider, the rationale for this deal springs from:

Emerging market focus: Vodafone has lacked a cohesive emerging market strategy, especially in India, the fastest growing mobile market. Considering that the monthly mobile subscriber addition in India, at over 6 million, overtook China's in September 2006 and is likely to stay that way for the next few years, there was no choice for Vodafone but to place India as the centre-piece of its emerging market strategy.

In outlining Vodafone's strategic priorities in May 2006, Mr Sarin had highlighted that it would pursue "selective opportunities to extend footprint" in the emerging markets. Following up on this strategy, Vodafone has snapped up Hutchison Essar, which opens the gateway into the Indian market. Fourth largest player: The acquisition of Hutchison Essar will make Vodafone the fourth largest operator in the Indian mobile sweepstakes. Since mobile penetration in India, at 13 per cent , is likely to exceed 50 per cent (at 500 million subscribers) by 2012, the sector is probably at the starting block of a serious battle for mobile market share.

Hutchison Essar's subscriber base, at 24 million, is only 1.5-2 million lower than the state-owned Bharat Sanchar Nigam (BSNL) and 7-9 million lower than Bharti Airtel and Reliance Communications. Considering the four-fold rise in market opportunity and 6-7 million subscribers expected to be added every month, the competition, which will ride on scale economies and innovative value-added services, will be keenly watched.

Bharti Airtel, in which Vodafone had acquired a 10 per cent effective equity stake in late 2005, did not meet its objective. SingTel, which is Bharti's existing and dominant foreign partner, with over 30 per cent equity stake, has remained firmly in the saddle, with no intention of selling out. For that matter, it recently stated that it is willing to buy what Vodafone will have to offload in Bharti if it succeeded in buying Hutchison Essar.

Aggressive deal dynamics

Considering that Hutchison Essar was the only asset available for acquisition, the price tag and valuation attached to this deal are stiff, with a sizeable control premium. Taking three commonly employed valuation yardsticks to compare the Vodafone-Hutch Essar deal with its key mobile peers, Bharti and Reliance Communications, reveals the following:

EV/Subscriber: On an enterprise value (market capitalisation plus debt) per subscriber basis, the Hutch-Essar deal is at a 15-20 per cent premium to its peers, Bharti and Reliance. For instance, based on Hutch Essar's implied enterprise value of Rs 85,000 crore, applied on a mobile subscriber base of 23.3 million as of December 31, 2006, the EV/subscriber works out to Rs 36,300 vis-à-vis Rs 31,800 for Bharti's mobile segment. EV/subscriber is a popular metric for valuation in high growth markets as it reflects the potential for cash-flows.

EV/EBITDA: From an EV/EBITDA (earnings before interest, depreciation, tax and amortisation) standpoint too, the deal works out to a premium of 25-35 per cent to Bharti and Reliance. Compared to the EV/EBITDA of Bharti's mobile business, at 21 times, Hutch Essar's works out to 28 times. This metric reflects the operational cash flows that can be reinvested for growth.

EV/ Revenues: Based on this metric too, the Hutch-Essar deal works out to a 20-30 per cent premium over its peers.

Why control premium?

Vodafone's willingness to pay the control premium stems from some key advantages that it perceives from this deal. It is encouraging to note that the deal meets the investment criteria set by Vodafone in the interest of its shareholders.

The two criteria Vodafone provided are ROIC (return on invested capital) to exceed local adjusted cost of capital within three to five years and IRR (internal rate of return) to exceed cost of capital by 200 basis points. This acquisition meets the Vodafone ROIC criteria only in the fifth year and the IRR is expected to be 14 per cent.

The key elements of the deal that are likely to play to its strengths are:

Infrastructure sharing with Bharti: Concurrent with the Hutchison Essar deal, Vodafone has entered into a memorandum of understanding for infrastructure sharing with Bharti Airtel. This will include sharing towers, shelter, civil works and back-haul transmission. And Vodafone expects savings in capital expenditure and operating expenditure (opex) for Hutch Essar to the tune of $1 billion over the next five years; the opex savings are likely to improve the EBITDA margin by 1.5 per cent.

These are the tangible savings this MOU can extract on an ongoing basis. Essars, however, are threatening to play spoilsport, having indicated their unhappiness at not being consulted on this issue. How this relationship with the Essar group plays out will have to be watched closely.

Value-added services: In terms of value-add, Vodafone can plug Hutch Essar into its global procurement chain, especially in the area of ultra-low-cost handsets. Moreover, as the world's largest mobile service provider, with 200 million subscribers, Vodafone can contribute significantly to Hutch Essar's economies of scale in procurement or operations.

As Hutch Essar commences operations in six new licensed circles (through Spacetel) in 2007, efficiencies in network build-outs, low-cost handsets and bundled packages can play a key role in new subscriber additions. In saturated markets such as the metros, it can launch its popular Vodafone Live! services, which give value added access to entertainment, sports and pictures.

3G foray: Since the telecom regulator is likely to announce the policy for 3G (third generation mobile telephony) in India, Vodafone's 3G experience in Europe will come in handy for growth initiatives. This is expected to help Hutch Essar get a competitive advantage in the 3G market place. Though the benefits from these variables cannot be quantified now, they are likely to pay off in a big way in the long run.

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."

Big-gest deal: Vodafone bags Hutch for $19.3 bn

UK telecom major has finally bagged the big telecom battle. In an intense battle Vodafone is understood to have emerged as the winner for majority stake in India's fourth largest mobile player Hutch-Essar, pipping Anil Ambani group's Reliance Communications, Essar and Hinduja Group.

Vodafone’s winning bid stood at $19.3 bn.

The fate of suitors, who submitted their bids on Friday, was decided at a meeting of the Board of Hutchison Telecom which had put its 67 per cent stake on the block a few months ago, on Sunday.

Officials of either HTIL or any other suitor could not be contacted for comments on the details of their respective bids.

As per sources, Vodafone has offered to make Essar partner which is being evaluated by Essar.

Vodafone's hiked bid values HEL over $20 bn

The bidding war for the country’s fourth largest mobile phone company Hutch-Essar (HEL) has gained momentum with leading contender Vodafone slated to make a fresh bid this week. According to sources, the UK telecom major has assigned a value of over $20 billion for the entire company. At this valuation, Hong-Kong based Hutchison Whampoa’s 67% stake in HEL is pegged at about $14 billion. In addition, Vodafone is also expected to incur an extra cost of about $2 billion for control of the company.

Vodafone, the world’s largest cellphone firm, is believed to have earlier valued the Hutch at $17-18 billion. Sources confirmed that Vodafone was likely to table its fresh bid for the 67% stake this week through its advisor. When contacted, the Vodafone spokesperson Bobby Leach told ET: “I’m afraid this is all speculation and we have no comment to make.”

Hutchison Whampoa, owned by Hong-Kong tycoon Li Ka-shing, holds 67% stake in HEL, with the Ruias of the Essar group holding the remaining 33%. As reported by ET, the Ruias, last week had offered to buy Hutchison Group’s 67% stake for $11 billion, at an estimated enterprise value of about $17-18 billion for the company. The offer was made through the group’s advisors Morgan Stanley and Bear Stearns.

However, Vodafone’s proposed bid raises the enterprise valuation of the company to over $20 billion. Vodafone’s new bid will also be in line with the Hong Kong conglomerate’s stance that it will sell its 67% stake only for $14 billion plus, and would not ‘consider any offer below this figure’.

Even as some shareholders have objected to the high valuations being assigned to HEL, Vodafone’s top management appears to be going ahead full steam with the bid. Also, its principal share holder Standard Life, which in the past has openly criticised the company’s acquisition moves has endorsed the move to bid for HEL. (Standard is among the company’s three major stakeholders.)

Last week, Reliance Communications (RCOM) chairman Anil Ambani moved the battle to the next level by officially confirming his RCOM’s interest in acquiring HEL.

At the moment Vodafone, RCOM and the Ruias are the front runners to buy out the Hutchison Group’s stake in HEL.
Meanwhile, fresh speculation is doing the rounds that the Ruias were having different views on their strategy, with chairman Shashi Ruia, wanting to sell-out and exit the telecom business, while Ravi Ruia wanted to continue by acquiring the remaining 67%.

However, when contacted, Essar sources rubbished these rumours as ‘utterly baseless’.
If Vodafone acquires Hutch, India will account for its third largest customer base. The UK-based company operates in 27 markets, globally. Germany is the largest market for Vodafone with 29 million subscribers while the US (where it has 44.4% stake in Verizon) is the second largest. If the deal goes through, India would become the country with most potential for expansion for Vodafone, with only 11% teledensity. Most countries where Vodafone operates currently are reaching the saturation point. Switzerland has a teledensity 96% followed by Germany (80%), US (76%), France (78%), Turkey (67%) and Romania (70%).

Vodafone’s strategy clearly is to concentrate its resources on emerging markets. In a statement issued earlier this month, the company states that its focus will now be markets of EMAPA — Eastern Europe, Middle East, Africa, Asia Pacific and affiliates.

Vodafone’s move to join the war for Hutch Essar, and in the process sellout its 10% stake in Bharti Airtel, is in line with its global exit strategy. Vodaone’s recent history reveals that the telecom behemoth has exit markets, where it did not command a leadership position. And, it has been shedding stake in operators, where all doors to pick up controlling stake remained closed.

Why global cos are keen on Hutch Essar

No other acquisition in the Indian telecom space has managed to get so much interest as Hutchison Essar has. And one does not have to go too far to know the reason for at least three large telecom majors lining up to pick up Hutchison's Indian mobile operations.

As per the number available with the Cellular Operators Association of India (COAI), Hutchison Essar's ARPU (average revenue per user) is among the highest in the Indian industry at Rs 373, compared to Rs 348 for Bharti.

It also has the highest revenues per minute, beating rivals Bharti and Reliance Communications.

The minutes of usage per subscriber per month for Hutch are also higher compared to other operators.

No wonder that Vodafone, the world's second largest mobile company in terms of subscribers, is willing to bet nearly 10 per cent of its market capitalisation in acquiring Hutch Essar.

At $15 billion, which is what industry sources believe that Vodafone is willing to fork out to acquire 74 per cent stake in Hutch Essar, the British telecom company would pay about $682 for each of 22 million Hutch Essar subscribers.

In contrast, Cingular bought AT&T Wireless for $41 billion, acquiring 21.98 million subscribers at $1,891 a subscriber.

If Vodafone gets the deal, it will get a direct foothold into the largest growing market in the world at a lower price.

The company has had to face severe losses in the recent past and this may be its last chance to get into a rapidly growing market.

On the other hand, for Reliance Communications, acquiring Hutch Essar would fast-forward its plans to foray into the GSM cellular space.

The company is already the largest CDMA operator in the country with 25 million users and adding 20 million more subscribers would catapult it to the largest telecom operator in the country.

For Malaysia-based Maxis, Hutch Essar would give it a pan-Indian presence, which it has been looking to do ever since it acquired Chennai-based Aircel.

While Aircel has cellular services in the North-East and Tamil Nadu, Hutch Essar covers the other circles in the country.

Though Maxis has applied for fresh licences, it will have to wait for spectrum before it can roll out a network. Acquiring Hutch Essar would save the company a lot of time in investing in a new network.