Kripa Raman

The telecom sector, silent for quite a long spell on the merger and acquisition front, is showing signs of crackling back to life. eWorld takes a look at factors that have been slowing down deals. Will the latest one keep the sector happily en gaged?

IT is growing, growing big and growing fast. — This is about all that everyone involved with the telecommunications industry in India seems to agree on.

And sealing the sentiment is the days-old mega deal of BPL Mobile with Hutchison Essar.

The promoters (and co-investors) of BPL Mobile have inked a deal involving the sale of their 64 per cent equity stake to an associate company of the Essar group, which is to transfer the assets to Hutchison-Essar subsequently.

This all-cash deal, said to be the biggest merger and acquisition deal in the Indian telecom space so far, puts the enterprise value (equity and debt) of BPL Mobile at over $1 billion (Rs 4,400 crore).

To top it all, this deal breaks a long dry spell on the telecom merger and acquisition (M&A) scene, for sure.

Not a single substantial M&A equity deal had happened for at least one year in the Indian industry, prior to the latest move.

An exception (of sorts) was the surprise acquisition by the Essar group of 9.9 per cent in BPL Mobile for an undisclosed amount from France Telecom (Orange SA).

This, explained Essar at that time, was a purely financial investment.

The last substantial deal to be closed, before the latest M&A development, was Idea Cellular's acquisition of Escotel which was wrapped up in June last year. From then, up to before the latest M&A, the story had not been good.

It raises questions of what factors have been holding back telecom marriages, by and large, in the Indian scenario, despite the latest silver lining.

And will this latest deal break the stalemate that has slowed down deal making in this sector?

The Hutch group, which formally announced last year that it was acquiring Aircel's operations in Chennai and Tamil Nadu from the Sterling Infotech group, had to drop its plans for reasons that were not fully clear.

Interference by an influential third party, regulatory problems on intra-circle mergers (that stipulate that the merged entity cannot have more than two-thirds market share of subscribers), and perhaps differences on valuations — these were some of the reasons doing the rounds. Informed sources now indicate that Aircel is also at an advanced stage of entering into a deal with a few US-based private equity investors.

Another significant announcement, the acquisition of 47.7 per cent stake in Idea Cellular by Singapore Technologies Telemedia (STT) and Telekom Malaysia, was called off too.

The Department of Telecommunications said that SingTel (stakeholder in Bharti Tele-Ventures) and STT had a common investor company, Temasek Holdings.

Regulations do not permit the same investor to have more than 10 per cent investment in two companies operating in the same telecom circle.

Officials at Idea Cellular, a three-way equal joint venture between Cingular, the AV Birla Group and the Tata group, are still in complete disagreement with this interpretation.

"If they are taking into account non-direct foreign stakeholding in calculating FDI, then there should be many other operators in the country who should be pulled up too."

As M&A decisions get delayed, valuation can keep eroding, says an investment banker who handles telecom for a large foreign banking group.

And, as valuations erode, the promoters of companies are more and more reluctant to let go, ever hoping for a better deal.

For, "25 per cent plus 15 per cent does not equal 40 per cent market share in this game," says a senior group executive of one of the Idea Cellular promoters.

"Just because an operator has a lot of subscribers there is no guarantee in these prepaid-dominant times that those subscribers will move over and add to one's base."

The problem, he says, is that promoters have got carried away by the success of Bharti Tele-Ventures, which quoting at Rs 250-plus on the stock exchanges has a market capitalisation of over Rs 46,000 crore. They have become greedy.

To add to this, the all-India success of public sector player Bharat Sanchar Nigam, could make things even more difficult for other operators.

Says Shailesh Shirali of Rabobank: "BSNL has been performing well, more than was expected by the industry ever since they launched wireless services.

The market had raised questions on whether quality of service would be managed effectively as also whether they would be able to stand up to the marketing of the private sector.

They have proved themselves over the past couple of years as a force to be reckoned with.

MTNL has proven to have resolved any initial teething problems and are demonstrating strong growth now.

"Our view is that the main contribution of the two providers is the fact that while providing acceptable quality of service, they manage to keep pricing low on a sustained basis — the private sector has to keep their pricing in line with these providers in order to retain market share.

This has resulted in the telecom industry expanding significantly and all operators showing strong subscriber growth."

But, says the investment banker with the foreign bank, lower pricing means slower average revenue per user (ARPU) growth and this has also affected valuations. "I think the Indian market is overvalued. Of course there is large growth when one looks at the developing markets.

But what are ARPUs, of $7 and $8 per month to an interested foreign investor? They have hardly been coming the last few years, in fact, they have been exiting."

And if you are looking at 200 million subscribers by 2008, then one must add around six million a month, not the two million-plus wireless that we are adding today. Adding at these volumes will mean bringing one's ARPUs even lower."

Competition at these ARPUs would whittle them down further. Competition such as not seen perhaps in any other country.

"Any circle will have at least five operators," says T.V. Ramachandran, Director-General, Cellular Operators Association of India (COAI).

"Bharti, Reliance, BSNL/(MTNL), Hutch, and one more large player, they are not going to shut down. Then there might be one strong regional player too."

Intra-circle regulations are also preventing, in some measure, big-ticket M&A deals.

So, with competition abounding in a market that is headed for lower and lower ARPUs, the haul is going to be a long and rugged one for operators, never mind that the market is going to explode in number terms, notes the investment banker.

"Our view is that while the benchmark for valuations has moved over a period of time from pure Discounted Cash Flows to US $ per subscriber to a multiple of existing EBIDTA (Earnings before interest, depreciation, tax and amortisation) levels, the valuations being seen now are a better reflection of the past performance and future potential of the companies," says Shirali.

"Valuations have been marginally tempered down after the entry barriers have reduced, post the introduction of Unified Licence."

He is unsure of why M&As are not easily happening. However, a possibility could be on account of shareholder-related issues that need resolution rather than pure valuations, he says.

"Valuations now are a factor of the EBIDTA levels — we have seen valuations ranging from EBIDTA multiples of 6x to 10x but this depends on various factors such as the quality/potential of the circle in question, the quality of subscriber base and network, the strategic importance of the circle to the buyer, the bargaining power of the buyer and the seller, etc."

That leaves a large panorama open to anybody who wants to justify his valuations.

Analysts have been working backward from small equity deals happening to arrive at how unlisted companies value themselves.

Reliance Infocomm's (which has a subscriber base of over 12 million) equity has been valued at between Rs 22,500 crore and Rs 30,000 crore after Reliance Industries converted its preference shares in RIC into equity shares last month. The Hutch-Essar group has been valued at around Rs 8,500 crore after the Essar group recently raised its stake in it by buying out Usha Martin Telematics' 3.43 per cent stake in the Hutch-Essar combine.

To add further confusion, Essar Teleholdings (which has an over 30 per cent stake in the Hutch-Essar group) has applied for new licences in some circles. So has Dishnet, which is part of the Sterling Infotech group (which almost sold Aircel to Hutch). Most of these licences are for circles that are just showing potential growth, such as the North-East, Orissa and the like. More licences in a crowded market where existing licensees are looking to sell out? What will happen to valuations if operators come by new licences so cheap?

The Sterling group probably feels it is good at building companies to later sell off. And the Essar group is possibly looking for a large footprint (remember it has a foot in the BPL group too) that will look attractive, say insiders.

Kishore Chaukar, Managing Director of Tata Industries who looks after the group's telecom interests, sums it up like this: "Value, that is, the intrinsic value of a company and Price, that someone is willing to pay, are two different things."

"Is the investor the kind that wants to build a business? Then he will look at the quality of the promoter, the discounted cash flows, synergies that can be added, and so on. Financial investors might look at growth over a specified period of time. Price depends considerably on the intention of the investor."

kripram@thehindu.co.in

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