Chapter 4- Data analysis and interpretation
Is the deal justified?
- Vodafone’s payment for Hutchison Essar might not appear to be justified using conventional analysis tools, but most of the growth in the future will come from the lower end of the market in rural India. The best way to justify these valuations is not to base them on how many subscribers [the acquiring company plans] to have. The numbers are justified based on a prediction of higher value-added services, and also some sense of how mobile phones can be used for marketing. Will the mobile handset be a device that will be used to send ads — perhaps video ads — to subscribers Can you add more services and more value at the lower end, with somebody else subsidizing the cost of the phones. These value-added services could go beyond ring tones and text messaging to bringing television and advertising to handsets
- Much of India growth is expected to come from more than 600,000 villages where millions of Indians live. Vodafone has signed a deal with India’s biggest mobile operator, Bharti Airtel, to share the costs of infrastructure development in rural areas. In the developed world, there is guaranteed power supply, but [in India] the power supply to your base station battery is uncertain and that adds to the cost. The fact that Vodafone and Bharti Airtel are sharing their base stations in rural areas is a good sign because it has a multiplier effect
- Vodafone’s infrastructure joint venture with Bharti and Idea – Indus Towers – has steadily increased its operations. The independent tower company provides passive network infrastructure to all operators.
- Vodafone will face me-too competitors as it attempts to increase revenue and profitability with value-added services in the face of the lower ARPUs (average revenue per user) that industry analysts predict. ARPUs for Indian mobile phone service providers range from $10 to $20 a month, and Hutchison Essar currently occupied the top slot. Vodafone sets itself apart from the competition with “above-average customer service
Why India/Hutch is important to Vodafone strategy
- Vodafone needed to raise exposure to high-growth emerging markets and offset prospective fall in EBITDA(earnings before interest, taxes, depreciation, and amortization) in Europe.
- Inability to grab the majority stake in the country’s largest telecom player Bharti Airtel
- More than 6 million new subscribers are signing up for mobile services each month, making India the world’s fastest growing mobile market. Cell phones are not just a way to keep in touch with loved ones in a country that loves to talk, but in a booming economy they also become workstations for millions in India’s unorganized sectors
- Mobile penetration is still relatively low in a country with a population of 1.1 billion. Only three in ten of all Indians have a mobile, demonstrating the long term growth possibilities for the company in the sub-continent
Is the deal justified?Highlights of Vodafone-Hutch transaction details
Acquisition of a controlling interest in Hutch Essar
- Vodafone acquired companies that control a 67% interest in Hutch Essar from Hutchison Telecom International Limited (“HTIL”) for a cash consideration of US$11.1 billion (£5.7 billion)
- Vodafone assumed net debt of approximately US$2.0 billion (£1.0 billion)
- The transaction implied an enterprise value of US$18.8 billion (£9.6 billion) for Hutch Essar
- The acquisition meets Vodafone’s stated financial investment criteria Infrastructure sharing MOU with Bharti
- Whilst Hutch Essar and Bharti will continue to compete independently, Vodafone and Bharti entered into a MOU relating to a comprehensive range of infrastructure sharing options in India between Hutch Essar and Bharti
- Infrastructure sharing is expected to reduce the total cost of delivering telecommunication services, especially in rural areas, enabling both parties to expand network coverage more quickly and to offer more affordable services to a broader base of the Indian population
- The Essar Group (“Essar”) had a 33% interest in Hutch Essar and Vodafone bought this stake at the equivalent price per share it has agreed with HTIL
- Vodafone’s arrangements with the other existing minority partners resulted in a shareholder structure post acquisition that meets the requirements of India’s foreign ownership rules
- Vodafone 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 for US$1.6 billion (£0.8 billion) which compares with the acquisition price of US$0.8 billion (£0.5 billion)
- If the option is not exercised, Vodafone would be able to sell this 5.6% interest
- Vodafone will retain its 4.4% indirect interest in Bharti, underpinning its ongoing relationship
10% economic interest in Bharti
Key strategic objectives
In the context of penetration that is expected to exceed 40% by FY2012, Vodafone is targeting a 20-25% market share within the same timeframe. The operational plan focuses on the following objectives:
- Expanding distribution and network coverage
- Lowering the total cost of network ownership
- Growing market share
- Driving a customer focused approach
The MOU outlines a process for achieving a more extensive level of site sharing and covers both new and existing sites. Around one third of Hutch Essar’s current sites are already shared with other Indian mobile operators and Vodafone is planning that around two thirds of total sites will be shared in the longer term.
The MOU recognises the potential for achieving further efficiencies by sharing infrastructure with other mobile operators in India.
The MOU envisages the potential, subject to regulatory approval and commercial development, to extend the agreement to sharing of active infrastructure such as radio access network and access transmission.
As part of the operational plan, Vodafone expects to increase capital investment, particularly in the first two to three years, with capex as a percentage of revenues reducing to the low teens by FY2012. The operational plan results in an FY2007-12 EBITDA CAGR percentage around the mid-30s. Cash tax rates of 11-14% for FY2008-12 are expected due to various tax incentives and will trend towards approximately 30-34% in the long term.
As a result of this operational plan, the transaction meets Vodafone’s stated financial investment criteria, with a ROIC exceeding the local risk adjusted cost of capital in the fifth year and an IRR of around 14%.