Hutchison-Essar: Mad About Hutchison-Essar

Why Hutchinson India has suddenly become so vulnerable of being
scooped up? The reasons could be many, but it has become a merger target because
of its inability to show it can grow its subscriber base substantially, while
facing technology glitches. Secondly, with all big players foraying into other
telecom businesses like IPTV, fixed line and broadband, Hutch still has only
cellular service to offer. But perhaps the most significant reason for Hutch's
intended departure from India is the prolonged uncertainty over its ownership
structure, that has delayed its IPO also. Undoubtedly, the merger of Hutch with
any big operator will completely change the business dynamics in this region.

Horse Race Begins

So close, yet so far, as the cliché goes, Reliance is the front runner in
the bid for Hutchison-Essar stake, as it has already roped in all the possible
investors for the deal. Reliance along with Blackstone has bid for it in the
range of $15 bn to $17 bn, the amount that would automatically leave small
bidders out of the race. But still, even after coming so close to cracking the
deal, the Essar's 33% stake is becoming a major stumbling block for them. It
would be interesting to see how the three (Reliance, Hutchison and Essar) would
pass this litmus test.

The increase in the stake in Hutch Essar illustrates the
advantage that Reliance, Essar or any other player will have in terms of the
strength of their balance sheets and subscriber base, relative to its
competitors. They could outmaneuver others, if it ever came to a battle for
funding. It is a horse race to gain control of the asset, which can change
Indian telecom landscape eventually.

Reliance's intentions to make another round of foray in GSM
arena had not been taken seriously by its peers earlier, but Hutch's deal has
come as a shot in the arm for Anil Ambani. The merger, if happens, will give
Reliance an extra edge over other players. With 49 mn-subscriber base, and a
major player in both CDMA and GSM, Reliance would have influence on governments
policy related issues and decisions. The company has already formed a consortium
of equity giants Blackstone and KKR and is considered as a front-runner for $15
bn Hutch.

Triangular Fight

Undoubtedly there are some regulatory glitches in the deal and icing on the
cake is that Reliances will have to deal with Ruia's also in this triangular
fight as Ruia's too seem to be interested in Hutch's stake and has already
roped in Morgan Stanley as its advisor. Ambani group has already initiated talks
with Ruias in this regard through its financial services firm UBS. But since
Ruia's Essar is already out in the market to raise funds for the remaining
stake in Hutch. Ruia's already have 33% stake in Hutch. But, still Ruia's
are not averse of buying its 33% stake, if they get better valuation.

Regulatory hurdles are the main areas of concern for any bidder.
When any domestic buyer in the same circle intends to acquire another player, it
will have to buy either the entire 100% stake in it or else only 10%. Hence,
Reliance cannot buy only Hutch's or Essar stake, as it is already present in
the same circle. The Hutch's acquisition for Essar is a bit easy as it already
has one-third stake in the JV. It only needs to raise money to acquire the
remaining stake in the JV, which is held by Hutch, Orascom, Analajit Singh and
Asim Ghosh. But, relationship between the Hutch and Ruias are passing through
testing times due to Essar's refusal to sell Mumbai circle to Hutch and the
case is still subjudice. However, the recent meeting of Ruia's with HTIL head
has sparked of speculation of better times ahead.

Apart from these two contestants, Bharti and Orascom too are
interested in Hutch's stake. Bharti has already clarified that it will not
make first move for Hutch's acquisition, but if Hutch or Ruia's make an
offer voluntarily, it might consider the buy, though raising money could be a
major hurdle for Bharti.

But Bharti's business partner Vodafone is keen on buying stake
in Hutchison. It doesn't intend to bid along with Bharti and wants to buy the
entire stake with its consortium of investors. This could spur off another
debate on the future of Bharti-Vodafone relations. Vodafone is a 10% partner in
Bharti Airtel.

Orascom on the other hand has always been very keen to enter
Indian market in a big way. It already holds 19% in HTIL which reflects 10% to
its holding in Hutchison's Indian arm. But, since Essar had earlier objected
to Orascom's entry into the Indian market citing security reasons, it will
have to fight a tough battle not only with Ruia's, but also with government
officials if it intends to buy 100% in Hutchison-Essar, though government gave
Orascom green signal when Essar objected to its stake in Hutch.

Maxis too is trying to enter this horse race. But with bigger
players like Reliance and Essar are already in race, it's going to be an
uphill task for a player like Maxis. Secondly, investors too would like to go
with a bigger player and with a player who already has presence in India.

But still, Hutch hasn't opened its cards yet, though several
rounds of meetings are going on with several investors, keen on buying its
stake. The delay in announcement in this regard could be due to the complex
shareholding pattern of Hutchison-Essar, which is a mix of small and big
investors and since individual interests are going to play a major role in this
deal, Hutch too is passing through the testing phase.

Get it Right

Today, Indian telecom industry is comprised of too many players struggling
to gain share in a market that is growing at a rapid pace. Since margins are
down in India, players have diversified themselves into other line of telecom
businesses to raise capital expenditures required to deliver the next generation
of services. And, with very few exceptions, the industry is not earning its cost
of capital.

Whether a good or rotten deal for Reliance, Bharti and others,
the Hutch acquisition certainly is a welcome development for private operators
as well as Indian telecom. To a certain extent, Hutch has dominated the Indian
cellular market in recent times with its PAN India presence and having players
like Bharti grabbing its share, it could get a deal it is looking for. The
mobile competition in India is poised to become more intense in coming days with
Indian operators and foreign operators are committed to increase their share in
mobile market in India.

Although Hutch has managed to increase its subscriber base
dramatically, the rate of customer acquisition is slowing down, as it is a pure
play mobile operator in India, while other players have diversified themselves
into other line of telecom businesses. Hence, it is continuously focusing on
increasing its ARPU.

The company could be playing hardball needlessly. As India's
second largest private GSM player behind Bharti, the company has been one of the
quickest to benefit from a telecom revolution under way. Almost 46% of Hutch's
global revenues come from India.

Telecom marriages are rarely made in heaven and this type of
mega-mergers don't work unless they are focused and disciplined. Mega-mergers
in the telecommunications industry, in fact, have a spotty record at best.
Typically, synergies heralded at transaction announcement time have remained
elusive. Promises of price rationalization were rarely realized, and competition
yielded continued price declines, benefiting consumers at the expense of the
financial health of surviving carriers. Then there are post-merger complexities
of retiring legacy systems and moving to common business processes.

The success of Hutch buy out by any player will depend on how
rapidly the buyer can articulate the strategic intent. Secondly, it would be
imperative to blueprint the one-company business model and articulate the
transition roadmap early in the process and reenergize the management team of
the acquired carrier. Later it will have to outline plans to deal with customer
defections or management talent loss.

Such large-scale merger in the telecommunications industry is a
high-risk event, particularly when the acquisition price puts pressure on the
need to capture value. Hutch merger with any operator in the country will lead
the consolidation drive. Consolidation in the industry is driven by a number of
factors, including industry competition, deregulation, and technological
advancements.

The deal will definitely benefit the buyer. The merger will give
it a larger presence in the market, making it easier for them to compete with
incumbents like BSNL. Apart from this, new party brings something to the table.
Since players like Bharti and Reliance have diversified telecom portfolio, they
can leverage on these services. The deal makes the Indian market even more
inhospitable for the remaining smaller operators. India's 2.5G service has
progressed to multimedia services and now the country is gradually moving to 3G.
This situation will make it difficult for newcomers who don't have any
subscriber base in the country.

Declining prices and lower ARPUs are anyway endangering the
survival of the weaker players, forcing them to enter into strategic alliances
and divest equity in favor of stronger players. For investment hungry big
operators, Hutch is a good prospect and now that the government has raised the
FDI cap to 74% bigger players Bharti, Reliance will not only be able to raise
funds in the international markets through the equity route, but they can also
exit more easily, if they want to.

But, only time will tell whether Hutch buyout be a coup de grace
for operators in the country. Though the stake is eye-popping for all operators,
it's not going to be a cakewalk. But, stage is set for battle royale between
the operators to grab big fish in the pond.

Rahul Gupta

rahulg@cybermedia.co.in