Hutch's Asim Ghosh: He's on shortly

It needs to prove that its pure-play mobile-telephony business model is as good as the integrated one preferred by most telcos. And it needs to disprove the theory about its inability to grow in smaller cities and rural areas. At stake are a shot at telecommunication greatness and a slice of the second most happening telecommunications market in the world. By Priya Srinivasan

It sounds more complex than the shareholding pattern in reliance," laughs the telecom analyst at a Mumbai-based brokerage. His reference is to the centrepiece of the spat between the Brothers Ambani, the 29 per cent stake in Reliance held by a web of holding companies-the stake that one brother implies he controls. And he is talking about Hutchison Essar, the company whose creation has just been cleared by the Ministry of Finance. "The company will probably spend the entire analysts' meeting explaining it," he adds.

The facts first: the finance ministry comes into the picture because Hutch is a foreign company (Hutchison Telecom International Limited or HTIL, promoted by Hong Kong-based tycoon Li Ka Shing) and Indian laws are very particular about how much of a telecom company a foreign corporate can own (the ceiling for foreign direct investment is 49 per cent). The government chooses to turn a blind eye to indirect ownership-for instance, company A can own 49 per cent in telco T directly; the remaining 51 per cent can be held by a joint venture in which Indian company B owns 51 per cent and A owns 49 per cent; thus, the total 'economic' stake of A in T becomes 73.01 per cent-but with HTIL set to own 42 per cent in Hutchison Essar directly, and 14 per cent indirectly, the new structure needed to be cleared by the Ministry of Finance.

And the bit about the analysts comes into the picture because Hutchison Essar plans to make an initial public offering (IPO) in the next six to eight months. Already, discussions on new public offerings on online bulletin boards of brokers and traders in India are dominated by talk of the impending Hutchison Essar IPO. Everyone's appetite has been whetted by the disclosure of the financial details of the Indian subsidiary necessitated by htil's recent IPO (it was listed on the Hong Kong exchange in October), numbers impressive enough for stock traders, analysts, investment bankers, lead managers and sundry entities allied to the stock markets to embark on their own number-crunching exercises to make a pitch for an offering that would make their books look good. "Every lead manager in the business is preparing a pitch," says a telecom specialist at a local investment bank.

The Rivals

Mukesh Ambani Reliance Infocomm Subscribers as on November 30: 9.8 million He and his company have been in the news for other reasons, but Reliance Infocomm remains India's biggest mobile telephony company. That, and money-power, make it a formidable rival. Sunil Mittal Bharti Tele-Ventures Subscribers as on November 30: 9.41 million He has outsourced key functions such as network ownership and management, and IT, and Bharti has the enviable record of having its investments in infrastructure pay off in record time. A.K. Sinha BSNL Subscribers as on November 30: 8.15 million His company operates in 22 circles, but is strapped for resources given that its primary businesses still remain national long distance and fixed line telephony. Ratan Tata Tata Teleservices, VSNL Subscribers as on November 30: 2.1 million He was late to the CDMA-party but his company has since made some gains. The acquisition of Tyco's undersea cable and the effort to target enterprises with a bundled service could catapult it into the big league.

The numbers warrant that: in the six months ended June 30, 2004, Hutchison Essar registered a turnover of Rs 1,888 crore, 46.5 per cent of HTIL's revenues of Rs 4,064 crore for the same period (the single largest chunk). And in 2003, the company (Hutchison Essar) did business worth Rs 2,652 crore. The IPO, when it happens, will be everyone's chance to grab a piece of the most happening market in India, mobile telephony; that's a rare opportunity. Barring Bharti Tele-Ventures, VSNL, MTNL, and part of Tata Teleservices, there are no investing opportunities for equity investors in telecom.

Paradoxical as it may sound, the new holding structure is far simpler than the old. Hutchison Essar, explains an investment banker in the know, "will be a listed company" in which all partners (HTIL, the Hinduja Group, the Max Group, Essar and financial investor Kotak Mahindra) hold shares and the other companies, the ones operating across circles under the Hutch umbrella, will be "100 per cent subsidiaries". The old structure involved six independent companies, Hutchison Max, Hutchison Essar, Hutchison Telecom East, Fascel, Hutchison Essar South and Aircel Digilink, with HTIL's stake (direct and indirect together) ranging from 42 per cent to 56 per cent (then, the company's service offering in Mumbai, its single biggest operation, is branded Orange). And as the name of the new entity indicates, the Essar Group is the second largest shareholder in the company, with a 30 per cent stake. Indeed, the Ruias of Essar seem to be getting their second wind in telecom, as their acquisition of France Telecom's 9.9 per cent stake in BPL Mobile Communica-tions, the company that provides mobile telephony services in Mumbai shows. That, though, is another story. And complex holding structure or not, there can be no arguing the fact that Hutchison Essar (Hutch, for short) is a company to watch.

The obvious reason behind the interest in Hutchison Essar is its impressive numbers. Telecommunications is still a nascent enough industry in India to be measured by EBITDA (earnings before interest, taxes, depreciation and amortisation)-the logic being that companies operating in sectors that are as capital intensive as telecom will, in their early years, find their post-tax profits weighed down by interest (on debt that funds capital expenditure), depreciation and amortisation. "It will be at least another year before we start valuing telecom companies purely on net earnings," says Prahlad Shantigram, Managing Director (Corporate Finance and Advisory), Standard Chartered, who, in his previous avatar as head of investment banking at DSP Merrill Lynch, lead-managed Bharti Tele-Ventures' January 2002 IPO.

On the basis of this parameter, Hutch's operating margins currently stand at around 34 per cent while Bharti's, for its mobile telephony business (the company is also into national and international long distance telephony, although mobile telephony accounts for 70 per cent of its revenues), is comparable at 34.25 per cent for the six months ended September 30, 2004. While Hutch still hasn't publicised its detailed profit and loss account (something that would make a more elaborate comparison of the two telcos possible), investment bankers in the know suggest that its net profit margins could be a couple of percentage points higher than Bharti's. That is only to be expected given the latter's integrated play. "Companies such as Bharti have much higher depreciation and interest costs, and these show up in their net margins," says another investment banker. "I wouldn't be surprised if Hutch's net profit margins are better." Then, there are analysts who are convinced that better isn't better enough. Priyanko Panja of Edelweiss Capital is one such; he believes Hutch's costs are higher than they should actually be because it doesn't own its own NLD (national long distance) and ILD (international long distance) infrastructure, choosing instead to buy bandwidth from companies in this business. That opinion is just the tip of the unresolved debate on the better business model: some insist it is integrated play; others, an equal number, are certain it is pure play.

Hutch's Deputy Sandip Das: Hutch, Orange, whatever it takes to get close to customers

Creating Solid Business

Hutch's distinguished-looking Managing Director-that's what a mane of shocking white hair does to most people-Asim Ghosh, for one, is convinced that both fly. "Ours is a solid business in its own right and I don't see much merit in (Hutch) being compared with the competition that has a fine business in its own right." The man's right, of course: ILD and NLD are high margin services; then, they require substantial investment. "We clearly do not view the situation as one where 'If it's telecom, we have to be in it'," says Ghosh. "I am interested in creating a solid consumer business." There are enough buyers for that argument. "End-customer businesses where you can determine price points and offer differentiated services always command a premium over intermediary businesses," says Salil Pitale, Vice President, Enam Financial Consultants. "In a geographically vast and competitive market like India, there is an edge that integrated players have, but that is not to say a company cannot thrive as a mobility player, and companies such as Vodafone are standing examples of this," adds Kobita Desai, Principal Analyst (Telecom Services and Mobile & Wireless Communications), Gartner.

Strangely enough, the one argument that challenges Hutch's pure-play business model comes from its greatest strength, marketing. At the boardroom at Hutch's snazzy central Mumbai headquarters, there are five awards on display; three of these have to do with marketing and advertising. "Hutch recognised early on that it is in a service industry and not a technology industry," says Renuka Jaypal, National Business Director, Ogilvy & Mather, the agency that handles all the company's advertising. The results of that understanding are evident in two things: the preference corporates have traditionally shown for Hutch, and its high average revenue per user (ARPU), the highest in the industry.

The problem is, rivals such as Bharti, Reliance Infocomm and the Tata Group, all integrated players, are aggressively targeting corporates with the kind of bundled offerings that only an integrated player can offer. And that could hurt Hutch although Ghosh says that, "we will do whatever it takes to service customers".

National-level Player?

The other challenge that Hutch faces also has to do with its high arpu. This, reason competitors, has been built on the back of a metro and large-city focus. "The real question is, does Hutch stand a chance of being a national player in the league of Reliance, Bharti or bsnl with a pan-Indian footprint?" asks an executive at a rival telco. "Can it compete with its limited metro A and B profile?"

Thus far, it has. Hutch currently operates in 13 circles and hopes to grow its subscriber-base at the same rate as the industry (85-100 per cent). And with 6.85 million subscribers (as on November 30, 2004), it compares favourably with Reliance (9.8 million), Bharti (9.41 million) and BSNL (8.15 million).

The future, though, could be an entirely different ballgame as Gartner's Desai points out: " Volumes are most likely to come from B and C circles where Hutch has a limited presence," she says. "It is unlikely to garner the volumes of a Reliance or a Bharti." Ghosh himself will only say that "the management of individual circles and their financials is crucial", but chances are, he will be as happy with 12 million high-end subscribers as with five million high-end ones and 15 million low-end ones. Hutch, after all, is widely seen as the leader in value-added services and apart from contributing to the company's revenues, according to Ghosh, "it is also the reason we attract high-end subscribers".

Fact is, Hutch is also making a bit of volume play, largely through acquisitions. However, its acquisition of Aircel, the cellular service provider in Chennai and Tamil Nadu, is stuck in limbo, although it was announced way back in June 2004. Will the lack of volumes hurt, or will investors recognise the company's value-play? We will have to wait for 2005 to answer that.