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India telecom: Heating up!

Feb 12, 2007

A lot is brewing in the Indian telecom space. On one hand, Idea Cellular* will begin it initial public offering (IPO) today, expecting to raise almost Rs 21 bn (US$ 480 m), and on the other, HTIL (Hutchison Telecommunications International Ltd.) will announce further details of the bids put in for its 67% stake in Hutchison Essar, which is India's fourth largest cellular services provider. At per initial information, Britain's Vodafone Group, the world's largest mobile services company, has put in a bid of US$ 12.7 bn for acquiring HTIL's stake in Hutch Essar (thus valuing the entire company at US$ 19 bn).

Telecom: Valuations running high!
AcquirerAcquiredWhenStake acquiredCost (US$ m)Subscribers of
acquired (m)
EV/Subscriber
(US$)
Hutch-EssarBPL MobileSep-05100.0%1,154 2.8 412
VodafoneBharti AirtelOct-0510.0%1,500 15.0 1,000
MaxisAircelJan-0674.0%1,080 4.4 332
Telekom MalaysiaSpiceMar-0649.0% 393 1.8 446
TemasekTata TeleservicesMar-069.9% 335 8.9 380
VodafoneHutch-Essar200767.0% 12,730 23.3 815
Source: Company reports, Equitymaster Research

As a matter of fact, Vodafone was one of four groups in the race to buy HTIL's stake in Hutchison Essar. Also bidding were India's Reliance Communications (RCL), and the Hinduja and Essar groups, the latter of which owns 33% of Hutchison Essar. Also, as reported by Vodafone, the company has granted a Bharti group company an option, subject to completion of the Hutch Essar acquisition, to buy its 5.6% listed direct interest in Bharti Airtel for US$ 1.6 bn, which compares with the acquisition price of US$ 0.8 bn it acquired in 2005. If the option is not exercised, Vodafone will be able to sell this 5.6% interest in Bharti. Also, Vodafone will retain its 4.4% indirect interest in Bharti, thus underpinning its ongoing relationship with the Indian telecom bellwether.

India's telecom industry has experienced heightened consolidation activity over the last 12 to 18 months (see above table), sparked by new guidelines for foreign direct investment (FDI) in the sector, which raise the foreign shareholder ceiling to 74% from 49%. However, none of the transactions to-date remotely compares with this proposed sale of Hutch, either in terms of acquisition values, strategic significance or implications for the industry.

For Vodafone, Hutch represents a high-quality asset and a rare opportunity to own a piece of India's compelling telecom growth story. Jointly-owned by Essar Teleholdings Limited (33%) and HTIL (67%), the company is a pure play wireless company with operations in 16 out of 23 mobile circles in India, commanding a leading market share in the metropolitan cities and the fourth largest position on a pan-India basis. Given its entrenched presence and well-managed operations, we expect Hutch to be one of the biggest beneficiaries of telecom industry growth in India, which is expected to remain strong in view of the still-low penetration rates, declining cost of handsets and reducing tariffs (which are anyway the lowest in the world).

We believe that the strategic value of Hutch would be significant to Vodafone. Although Vodafone has an impressive footprint spanning 27 countries, it has limited exposure to Asia, which boasts some of the fastest growing emerging telecom markets (like India). Not only would Hutch be a good fit for Vodafone's portfolio, the robust growth in India could also help offset slowing growth in the group's traditional West-European markets. For RCL, another frontline bidder, Hutch would have been extremely attractive from a technology standpoint, as the former has made very clear its intentions of strengthening its GSM presence. In addition, there would have been the obvious scale benefits of operational and capital expenditure savings from a potential merger with Hutch, albeit this would have also entailed significant integration challenges.

Overall, we believe that telecom valuations seem a little stretched from a medium term perspective. As calling rates continue to fall and ARPUs (average revenues per user per month, which are currently in the range of Rs 200 to Rs 350) remain under pressure, volumes (subscriber additions) will have to take the mantle of carrying the sector's growth. As such, we are of the belief that the easy money in telecom is probably behind us and the risk of being in telecom stocks is fairly decent in the short to medium term (though returns are still expected to be good in the long-term).

As for retail investors, options to be a part of the telecom growth story will increase once Idea is listed on the bourses. And it might mean less of 'scarcity premium' for existing players like Bharti and RCL. However, in these times, when there are heightened expectations of all things to go right for the sector, keeping a close watch on the valuations of telecom stocks will be the key to investment decisions. With competition heating up, risks might be severe than what they appear at first glance.

  • We shall soon put up our IPO analysis on Idea Cellular.


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