Vodafone's acquisition of Hutchison Whampoa's 67-per cent stake in Hutch Essar creates opportunities for Bharti while mounting pressure on Reliance Communications' GSM plans. By Rex Mathew.

Finally, Vodafone is all set to establish a major presence in the world's fastest growing and the most promising telecom market. Vodafone emerged as the highest bidder for Hutchison Essar in the bidding process, which concluded last Friday. The telecom major has agreed to acquire the stake held by Hong Kong-based Hutchison Telecom International (HTIL) and its associates in Hutch-Essar.

The deal was finalised by the HTIL board on Sunday and an agreement has been signed, bringing the deal close to completion after nearly three months since HTIL announced its decision to exit Hutch-Essar.

Vodafone would buy out HTIL and its associates, who hold a combined 67- per cent stake, in Hutch-Essar for $11.1 billion in cash. It would also assume Hutch-Essar's net debt of $2 billion, taking the enterprise value to $18.8 billion. The final deal size is smaller than $21 billion – the amount speculated to have been set by HTIL as the minimum enterprise value. Vodafone expects the acquisition to be earnings accretive after five years.

Other major bidders were R-ADAG flagship and the largest Indian CDMA mobile operator Reliance Communications, London-based NRI business group Hinduja in partnership with Qatar Telecom and Essar group, which controls 33 per cent of Hutch-Essar. Though there was some speculation about another possible bidder – either US company Verizon Wireless or a Russian telecom company – it is unclear whether there was a fifth bid.

Vodafone is the largest telecom operator globally in terms of revenues with 2006 revenues of around $58 billion. The group earned EBITDA of over $23 billion during last year and has a market capitalisation of close to $160 billion. The company is present in 27 countries – either directly as an operator or as an investor in other telecom companies – and has a total customer base of close to 200 million, excluding Hutch-Essar. The company employs nearly 60,000 people worldwide.

The acquisition is a major strategic move for Vodafone as it gives the company a strong presence in a fast growing market. Hutch-Essar is the third largest GSM mobile operator and fourth largest overall in India with a premium customer base and average customer revenues, which are much higher than industry average. Though the Hutch brand has a very premium positioning and is one of the most recognisable in the industry, Vodafone is likely to gradually replace it with its own brand.

Vodafone would not surely rest satisfied as the fourth largest mobile telecom company in the country and has already stated that it is planning to raise its market share to over 20 per cent. Hutch-Essar currently has a market share of around 16 per cent with a customer base of 23 million. In the long run, Vodafone would surely try to emerge as the dominant player in the domestic telecom space. The company may be open to more acquisitions in the future, though the number of potential targets is very small.

Vodafone offer to Essar
A statement by Vodafone said it would make an offer to buy out Essar's 33 per cent stake in Hutch Essar at the same price offered to HTIL. However, reports indicate that Vodafone has invited Essar to remain the minority partner and the latter is said to be evaluating the offer. If Essar also decides to sell out, as is widely speculated, Vodafone would have to find other local partners to meet Indian regulatory requirements.

According to current FDI regulations for telecom companies, telecos can have only 74 per cent foreign ownership and hence Vodafone would have to find local investors for the remaining 26 per cent. The statement went on to add that "Vodafone's arrangements with other existing minority partners in Hutch-Essar will result in a shareholder structure post acquisition that meets the requirements of India's foreign ownership rules."

Other minority shareholders of Hutch-Essar are Analjit Singh of Max India and Hutch-Essar CEO Asim Ghosh. The holdings of these two minority shareholders are listed as part of the 67 per cent that Vodafone has agreed to buy from HTIL, which means they are also selling out. It is unclear how these shareholders would buy back a combined 24 per cent stake in Hutch-Essar, if Essar sells out, to satisfy FDI norms.

Vodafone – Bharti partnership
In a related development, Vodafone has reached an agreement to sell a 5.6- per cent stake in Bharti Airtel to a Bharti group company. It would hold on to the remaining 4.4 per cent in Bharti but would not have any board representation. Vodafone had acquired a 10-per cent stake in Bharti last year and there were reports that SingTel, which holds more than 30-per cent of Bharti, would acquire that stake.

The strategic investment in Bharti has been a very profitable one for Vodafone. The company had paid around $1.5 billion for its 10-per cent stake and is likely to receive close to $1.6 billion from the Bharti Group for the 5.6 per cent being sold to them.

In another significant move which could alter the competitive landscape of the mobile telecom industry, Vodafone and Bharti have teamed up to share telecom infrastructure. This would mean Bharti and Vodafone would have access to each other's infrastructure like telecom towers and other equipment for future expansion needs, mostly in rural areas, which would bring down costs.

Vodafone said it is expecting savings of up to $1 billion every year from this pact with Bharti. In a separate announcement, Bharti said it would share a range of infrastructure - including around 70,000 towers - with Vodafone. Bharti would be the preferred vendor for Vodafone for NLD, ILD and leased line services and would also handle 50 per cent of Vodafone's incoming roaming traffic into India for three years under the agreement.

It is not clear if Bharti is also planning to share that part of its network infrastructure, which is operated by service providers like IBM and Nokia under long-term management agreements.

Pressure on Reliance Communication
After losing out in the bidding war, Reliance Communications now has no option but to build its own GSM network as announced earlier as there are not many reasonably sized players in the mobile telecom space for possible acquisitions. After Hutch, the next big players are Idea Cellular and Aircel. Idea Cellular, owned by the Aditya Birla group, is currently in the process of raising funds through and IPO to fund its expansion. Malaysian company Maxis controls Aircel, and having acquired it just last year is unlikely to exit the company anytime soon.

Reliance Communications would have to make large investments and even larger efforts to build its presence in the GSM space. Its GSM operations would surely bleed for quite some time as the new subscribers can only come from the lower end of the market with low average revenues and profitability.

The alliance between Bharti and Vodafone would add a completely new dimension to this battle for growth. Both Bharti and Vodafone would enjoy far better pricing power and other advantages than Reliance Communications and it should come as no surprise if Anil Ambani drops his GSM plans altogether and sticks to CDMA.