The market reacts to Vodafone's purchase of Hutchison Essar

Vodafone values Hutchison Essar at $18.8 billion. Vodafone investors cheer but analysts are more cautious and telecom shares across Asia feel a trickle-down effect.
When the deal was announced early Monday morning it almost seemed anti-climatic. Given the media frenzy leading up to the announcement, VodafoneÆs acquisition of a controlling interest in Hutchison Essar, India's fourth-largest mobile-phone company, was devoid of much controversy.

The deal implies an enterprise value of $18.8 billion for Hutchison Essar, squarely in the range of the $18-$20 billion that was being estimated. Hutchison will assume $1.96 billion of net debt - $1.33 billion at the Hutchison Essar level and the balance of $630 million at a holding company level. That means Hutchison Telecom International (HTIL) will receive a net cash consideration of $11.1 billion for its 67% stake in Hutchison Essar.

John Bond, Vodafone chairman, says: ôIndia is destined to become one of the largest and most important mobile markets in the world and this acquisition will enable our shareholders to benefit from our increased investment in this market.ö

Vodafone will make an offer to buy the Essar groupÆs 33% stake in Hutchison Essar at the same price it has agreed with HTIL. Vodafone's CEO, Arun Sarin, told media that Vodafone would welcome Essar as a partner and further that it was the view of Vodafone, its lawyers and HTIL, that Essar does not have a first right of refusal on the shares. No reaction from Essar has - as yet - contradicted this understanding.

Neha Gupta, senior research analyst at Gartner, says through the deal Vodafone aims to ôraise its exposure to high-growth emerging markets and offset prospective Ebitda declines in Europe.ö

Analysts were generally guarded in their reaction, saying that the pricing was at the top of the range for the asset and India would need to continue to demonstrate high-growth rates for Vodafone to earn a return. Macquarie research estimated the price valued Hutchison Essar at a forward enterprise value to Ebitda multiple of 16.4 times, significantly higher than Bharti which trades at 13.6 times and Reliance which trades at 11.7 times.

The valuation of $18.8 billion suggests a per subscriber value in the $850-$900 range (depending on the base), an aggressive number for a country where ARPU (average revenue per user) is already declining and expected to decline further.

GartnerÆs Gupta explains why the ARPU decline does not seem to be factored into the valuation. "The dip in voice ARPU is expected to be compensated (though not fully) by an increase in ARPU from data and value-added services, thus helping sustain the overall ARPU. The volume growth in wireless subscribers that is expected along with this is in the range of 28% to 30% a year."

There are other reasons which make Vodafone bullish on India. GartnerÆs Gupta elaborates: ôTeledensity grew steeply by 50% in 2006 to reach 17.16% in December 2006 as compared to 11.43% in December 2005. Subscribers are expected to grow to 250 million by 2007 and 500 million by 2010. Most of this growth will come from the wireless segment. Hutch has a strong brand value and sits on a customer base that yields a higher ARPU than customers of other wireless operators.ö

Pursuant to the deal, Vodafone has given a Bharti group company the option to buy its 5.6% listed direct interest in Bharti for $1.6 billion, double the price of $0.8 billion at which the stake was acquired in 2005. If Bharti chooses not to, Vodafone has the right to sell the stake. Vodafone will retain its 4.4% indirect interest in Bharti, and will now account for it as an investment.

Bharti and Vodafone announced an MOU on a range of areas including infrastructure sharing, roaming and long-distance services. Sunil Bharti Mittal, chairman and managing director of Bharti, says: ôToday, the Indian telecom sector is one of the most sought after in the world and the (Vodafone) bid is a strong endorsement of the government policy to promote the telecom sector.ö

Despite all the bonhomie, telecom shares across Asia lost ground in trading on Monday.

Bharti shares gained initially but then mirrored a broader market trend and fell 3.44% on the NSE to Rs726 ($16.53). The market lost 3% dragged down by metals and capital goods stocks.

The other frontrunner in the race for the HTIL stake, Reliance Communications saw its shares fall 4.4% to Rs455. Reliance had been hopeful bidder - confident that it could benefit from synergies between its CDMA technology and HutchÆs GSM base.

Elsewhere in Asia, Singapore Telecommunications shares fell 2.3% to S$3.34 ($2.18). Analysts commented that investors had hoped SingTel would buy Vodafone's stake in Bharti.

China Mobile shares fell 1.6% to HK$75.20 ($9.62) on speculation that Vodafone would liquidate part of its China Mobile stake to finance its India bid. The stake had been acquired by Vodafone between 2000 and 2002.

Hutchison Telecom was suspended from trading in Hong Kong early on Monday pursuant to an announcement regarding a substantial asset disposal. HTIL issued a statement that it expected to realise a pre-tax profit of $9.6 billion from the deal though it did not comment on the use of funds. Going by Hutch's past dividend policy, shareholders are likely to receive a healthy share of the proceeds.

Despite the notes of caution sounded by analysts and the drag effect the deal seemed to have on telcos in Asia, it did not rain on Sarin's parade. Vodafone shareholders supported the acquisition and seemed to share his bullish outlook on the country of his birth. In early trading, Vodafone's shares were up 2.5% at ú1.53 ($2.98) before profit-taking forced it down to close around ú1.52.

UBS advised Vodafone and Goldman Sachs advised Hutchison on the transaction.
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