Vodafone India IPO needs big equity story

The telecom carrier faces multiple operational risks including ongoing tax litigation, rising costs and growing competition.

British telecommunications giant Vodafone will have to pull out all the stops and produce a compelling and comprehensive business plan if it is to entice investors in the run-up to the initial public offering of its Indian operations later this year.

Bankers familiar with the situation said Thursday that Vodafone India is set to begin meeting investment banks early next week to select underwriters for the IPO that could raise about $2 billion, although the precise size could vary depending on deal structure and valuation.

The deal will almost certain draw massive attention from local and foreign investors alike, given the relatively low mobile penetration rates in India, the massive potential size of the Indian market, and the high-profile name involved.

But Vodafone India also faces various onerous hurdles, ranging from mounting operational costs and increased competition to nagging tax issues.

One looming threat is the highly-anticipated entrance of Reliance Jio Infocomm into the 4G broadband market. The telecom unit of Reliance Industries was scheduled to launch its services commercially early this year but the plan was pushed back to the end of the year.

Vodafone India and Idea Cellular, India’s second-largest and third-largest telecom operators, are expected to suffer the most from the entrance of Reliance Jio Infocomm into the telecoms market, according to analysts. That is because Reliance Jio already possesses a wireless network to cover 80% of the Indian populace, while Vodafone India and Idea Cellular are only able to offer 4G-LTE services regionally.

As such, Reliance Jio’s 4G launch later this year will limit their scope for expansion beyond their existing locations.

In contrast, the impact on India’s largest telecoms operator Bharti Airtel will be limited because it already owns enough airwaves to offer 4G services nationwide.

Rising costs

In order to expand its 4G-LTE service before Reliance Jio enters the market, Vodafone India will have to acquire additional 4G spectrum from the government in the annual spectrum auction scheduled for July this year.

The costs of acquiring the spectrum are much higher this year compared to last year’s auction. According to Standard & Poor’s estimates, India could fetch as much Rs5.4 trillion ($81 billion) from the auction this year, more than four times the $18 billion received in 2015.

The Telecommunication Regulatory Authority of India has set the reserve price for the 700 megahertz spectrum, which is a common frequency for developing a 4G-LTE network, at $1.7 billion per Mhz.

London-based consultancy GSM Association has warned that the price is too high and might deter interest from telcos.

Vodafone is also disgruntled over India's spectrum auction system.

"While India represents an excellent long term investment opportunity, the present regulatory challenges are hampering economic development." group chairman Gerard Kleisterlee said in a statement to shareholders last year. "Spectrum auction structures combined with the piecemeal release of new spectrum, leaves less capital available for investment in bringing high quality services to more of the country, and this is exacerbated by other ongoing regulatory challenges." 

Should Vodafone India decide to bid for new spectrum, it will add to the already huge financial burden at the group level. According to Vodafone’s 2015 annual report, the India unit is required to settle a £1.85 billion ($2.7 billion) payment for purchasing mobile spectrum at the annual auction last year.

In addition to that, Vodafone India had outstanding bank loans of $7 billion as of the end of March 2015, representing an increase of 13% compared with a year earlier. 

With cash held offshore standing at $1.6 billion as of the end of March last year, the company will need more than $8 billion to settle the auction payment and refinance the bank loans. That might mean resorting to further equity financing after the IPO since it has already used up all its credit facilities for the 2014/15 financial year. 

Tax litigation

Vodafone is involved in a prolonged tax dispute with the Indian tax authority over its acquisition of the Indian operations of Hong Kong-based Hutchison Telecommunications nine years ago.

The Indian government claims it failed to pay a $2.5 billion withholding tax when it bought the business in 2007, although there is uncertainly over whether India has the authority to levy withholding taxes on transactions between two overseas companies.

In the latest development, the government has appealed against a high court verdict to exempt Vodafone from the tax payment.

The government has said that it will charge Vodafone $4.5 billion in taxes and fines. In its annual report, Vodafone said its Indian unit is involved in a number of tax cases with claims totaling more than $2.1 billion and penalties that could be worth up to 300% of the principal.

Potential upside

Give these considerable challenges, the senior management of the British telco will have to come up with a clear business development and, perhaps, debt restructuring plan to help engage investors in the Indian IPO.

One positive would be its good track record of steering the business towards profit growth. Earnings before interest, taxes, depreciation and amortisation rose at a compound annual growth rate of 10.2% between 2013 and 2015 and is faster than in the majority of Vodafone's key European markets, including UK and Germany.

For the 2014/15 financial year, Vodafone India's Ebitda grew by 16.3% year-on-year to $1.84 billion, while revenue rose 12.6% to $6.2 billion. Ebitda margin gained 0.8 percentage points to 29.6%.

Looking at the bigger picture, India is also a good destination for telecommunications investment because of the fast-growing market and low mobile penetration.

“India's smartphone penetration of 19% is still very low but the market is seeing an expanding range of both affordable and high-end devices,” CLSA said in a report in November. “While the current 4G handset population is estimated at around 10 million, we expect this to increase to nearly 180 million by 2018.”

India is Vodafone's biggest market in terms of subscriber numbers. Vodafone India has 185.5 million mobile customers in the financial year 2014/15, more than double the 68.5 million users in South Africa, the group's second-biggest market.

¬ Haymarket Media Limited. All rights reserved.
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