Reliance Communications, Vodafone and Essar are the frontrunners in the race for Hutch-Essar for an enterprise value of around $21 billion. What are their real interests and are they willing to pay too much?

Hutchison Essar has suddenly become the hottest telecom asset on the block, anywhere in the world, and for very good reasons, too. India is the hottest telecom market in the world, having overtaken China in monthly subscriber additions, and Hutch is one of the larger players in the country. Hutch also enjoys a premium brand image and has the highest average revenues per user (ARPU) among all domestic telecom companies.

Hutchison Telecommunications, the telecom arm of Hong Kong-based Hutchison Whampoa, has announced its intention to sell off the majority stake it holds in Hutch-Essar. It has invited bids from potential buyers, which include global telecom giant Vodafone, US-based private equity funds, domestic major Reliance Communications and the Essar group, which currently owns 33 per cent of Hutch-Essar.

Hutchison has reportedly rejected indicative bid of around $13.5 billion from Malaysia's Maxis Communications and US-based private equity firm Texas Pacific.

Hutchison has set a minimum cut-off of $14 billion for its holdings in Hutch-Essar, which would value the company at nearly $21 billion. But that has not deterred the potential suitors who have already lined up billions of dollars from international banks for their bids.

Though names like Singtel, Deutsche Telecom, France Telecom, Telstra, NTT DoCoMo and Telenor are also doing the rounds, the frontrunners are Reliance Communications, Vodafone and Essar. Maxis may consider a higher bid but may not be willing to take it very high. Egyptian company Orascom had ran into a security controversy in India over its indirect minority holdings in Hutch-Essar as Orascom also has a presence in Pakistan.

Reliance's dream to be the biggest
Anil Ambani was the first to make serious moves to bring up a bid for a majority stake in Hutch-Essar. Even the early rumours about Hutchison's plans to sell its stake mentioned Reliance Communications as the frontrunner for the buyout.

Though Reliance Communications has not made any formal announcement about its interest in Hutch-Essar, industry observers believe that the company has already picked its partners and has received firm offers from global banks for the debt component.

Well aware that it would be risky, if not very difficult, to make such a large bid all alone - especially when his own telecom company Reliance Communications has large capex plans of its own - Ambani has reportedly roped in large US-based private equity investors. Blackstone Group, the world's largest buyout fund, and Carlyle Group are rumoured to be backing Reliance Communications. UBS and Citigroup are arranging the debt component from a clutch of global banks.

Why is Anil Ambani so eager to acquire Hutch-Essar? Reliance Communications is the largest CDMA segment service provider, with nearly 25 million subscribers.

The company also has a small GSM operation limited to the Eastern states, under Reliance Telecom, with a subscriber base of close to 4 million. There has been considerable speculation about Ambani's mega plans in the GSM segment. Even last month, there were strong rumours that Reliance Communications is ready to place an order worth more than $7 billion for a nationwide GSM network of 75 million lines.

Acquiring Hutch-Essar would be a better option for Reliance Communications than trying to expand its GSM network. Though the cost would be higher, an acquisition would make Reliance Communications the undisputed leader in the domestic market with an aggregate customer base of close to 50 million spread across both CDMA and GSM. The company would be in a much better position to sustain its growth by expanding at the lower end while creaming the premium customer base of Hutch-Essar.

For Anil Ambani personally, there could another factor that could explain an aggressive for Hutch-Essar. Despite being one of the largest domestic corporate groups by market capitalisation, Anil Ambani's R-ADAG is not a market leader in any of its businesses while elder brother Mukesh's Reliance Industries is the undisputed leader in petrochemicals and refining with global-scale capacities.

After the family split, the younger Ambani had announced several mega plans for Reliance Energy, while Reliance Capital is aggressively expanding its private equity, fund management and insurance businesses. But these businesses would take time to substantially increase their size and there are not many acquisition opportunities to grow inorganically in those sectors.

Reliance Communications, which came to him after the split and is now his crown jewel, was actually started by elder brother Mukesh. It was Mukesh Ambani who set up the telecom business and made it a major player in a short span of five years through aggressive strategies and pulling all the right political levers in Delhi.

Acquiring Hutch-Essar would transform Reliance Communications completely from its days under Mukesh as a predominantly CDMA player. It would allow Anil to establish his own mark and give him a global scale business and leadership in the domestic telecom industry. But he would be sorely tested and would be forced to shell out a huge sum. He would have to buy out Essar's minority stake as well, since it would be unlikely to be willing to play second fiddle to Anil.

Vodafone's emerging market interests
Vodafone is another frontrunner in the race to acquire a majority stake in Hutch-Essar. It is the largest telecom player globally in revenue terms with dominant positions in many large markets. The telecom giant was built up through a series of high profile, but very costly, acquisitions during the era of the dotcom boom. Performance of some of these acquisitions has been sluggish and Vodafone has not been able to establish a meaningful presence in the US.

Current CEO Arun Sarin has been consolidating the company's global empire by selling-off minority stakes in ventures operating in developed markets and increasing exposure to emerging markets. The company has withdrawn from some of the mature markets in Western Europe and Japan and has spent more than $6 billion over the last year for acquiring companies in Eastern Europe, Turkey and Africa.

Vodafone picked up a nearly a 10-per cent stake in Bharti Airtel, the largest domestic mobile telecom player, for $1.5 billion to get a toehold in the Indian market. At that time, it was speculated that it would buy out either the Bharti group or Singtel to acquire majority control of Bharti. Vodafone is clearly not willing to wait till either of the major shareholders in Bharti decide to sell out and has announced its intention to bid for Hutchison's stake in Hutch-Essar.

It will not be easy for Vodafone to acquire Hutch-Essar, even though it would be the least concerned among all contenders about raising finances to fund the acquisition. Vodafone, like all other contenders, will have to first deal with the Essar group.

Being a foreign company, Vodafone cannot acquire more than 74 per cent of Hutch-Essar and needs a domestic partner. If rumours are to be believed, Vodafone is ready to allow the Essar group to retain its 33-per cent sake in Hutch-Essar. Essar group and other minority investors would have the option to dispose their stake, either fully or partly, through an IPO at a later date. Vodafone may also buy them out if regulations are changed to allow 100 per cent foreign investment in telecom.

If successful, expect Vodafone to pump in many more billions to become the market leader. Being a global leader, it will not be prepared to acquire Hutch-Essar and be satisfied with it in the fastest growing telecom market. In future, it may also look at other possible acquisitions like Idea Cellular or Aircell.

But, Vodafone needs the consent of Bharti Airtel to go ahead with the Hutch deal. As per the agreement between Bharti and Vodafone, signed when the latter picked up its 10-per cent stake, Vodafone cannot start domestic operations or pick up stakes in other domestic telecom companies without the Bharti's consent.

The fact that Vodafone has gone ahead with its bid indicates that there is already some verbal agreement with Bharti. Officials of Bharti have reportedly said that the company would start the disengagement talks with Vodafone, if the latter's Hutch bid is successful.

In any case, the 10 per cent investment by Vodafone in Bharti has been very profitable. At current valuations of close to Rs1.2 lakh crore for Bharti, Vodafone would make a cool $1.2 billion profit on its investment of $1.5 billion.

Essar's Ambitions
The Essar group finds itself in the most envious position as it holds the right of first refusal to acquire Hutchison's stake in Hutch-Essar. For any bidder to succeed, the Essar group has to either agree to sell its own stake or continue to remain a minority partner. But going by the latest reports, they want Hutch-Essar all for themselves and are willing to bid aggressively.

Essar group has a chequered past as its inability to execute highly ambitious projects had led to time and cost overruns. Its companies, Essar Steel and Essar Oil, started implementing large-scale projects at the height of the last investment boom in the '90s. Essar Steel completed its steel mill after many delays and took many years to become profitable. Essar Oil's refinery is nearing commercial launch, more than a decade after the project was floated.

But telecom has turned out to be a goldmine for the group, though not because of its own efforts. Its struggling telecom businesses in metro circles were merged with Hutch, enabling Essar to became a minority partner.

After lying low for a few years, the group acquired BPL Communications, which had a good presence in Mumbai and a few other circles, and merged it with Hutch to form Hutch-Essar. The group's holdings in Hutch-Essar went up to 33 per cent after the BPL merger.

If Essar can gain majority control of Hutch-Essar by buying out its majority partner, the group would finally have a profitable business with very high growth potential and brand visibility. The group can acquire the majority stake by matching the best possible offer. Money would not be a problem as there are many global bankers willing to finance such deal, as long as it is not too costly.

But can the Essar group manage a large telecom business in a highly competitive market, considering its track record? The performance of Essar Telecom, before the merger with Hutch, was sub-par. The group's performance in other sectors is very patchy and it is not well known for hiring exceptional talent. Can it now build the management bandwidth required to run a successful telecom business? Most analysts are not very hopeful.

Industry observers believe that the Essar group's real interest is to push up the valuations of Hutch-Essar so that its minority stake would fetch a tidy sum. At the latest valuations reported to have been indicated by Hutchison for a deal to happen, Essar's 33 per cent stake would be worth nearly $6 billion.

That is more than the total asset size of the group's other businesses and would be quite helpful in improving the financial strength of both Essar Steel and Essar Oil. Apart from Vodafone, Essar is also rumoured to be in discussions with other potential bidders like Orasscom and Qatar Telecom for an arrangement where the group would retain its stake and would have the option to exit at a later date.

If the offer is very tempting, Essar may also decide to sell out to any of the other bidders instead of holding on.

Are they willing to pay too much?
At the rumoured minimum enterprise value of $21 billion set by Hutchison, Hutch-Essar is valued very close to Reliance Communications, which has a current market capitalisation of Rs97,000 crore. This is despite the fact that the gap between Reliance and Hutch-Essar in subscriber numbers is around 10 million and, unlike Hutch-Essar, Reliance has a pan-India presence and owns an international sub-sea cable network. The asking valuation is just around 25 per cent lower than market leader Bharti's market cap.

This valuation is just the minimum indicated and bidders may take it up higher. The obvious question is: would there be any value left for the buyer after paying so much.

Hutch-Essar has the highest ARPU among all domestic players and has probably the most premium brand positioning and image in the industry. It has a dominant position in Mumbai and is strong in Delhi as well. But all these do not explain the real value of Hutch-Essar.

For anybody looking for a possible buyout in the world's fastest growing telecom market, there are not many good options available apart from the very small regional players. Bharti Airtel is unlikely to be on the block even in the longer term while the government is in no hurry to sell BSNL or MTNL.

Anil Ambani will not even think of selling his crown jewel Reliance Communications and the Tata Group would hold on to Tata Tele even if it is only for pride. Maxis may not exit Aircell so soon after acquiring it. That leaves only Idea but it looks like the Aditya Birla group has decided to build the company instead of an exit.

That is where the real value of Hutch-Essar is. It is the last sizeable acquisition target that would be available in the Indian telecom market in the short to medium term. Any global player looking at entering the Indian market or a domestic player looking to would be willing to give his right hand for such an asset.

So don't be surprised if the winning bid is much higher!