Ringing out? Hutchison's Li

Acting tough: Essar's Shashi Ruia

After countless rounds of sparring with the Ruias of Essar, his partner in a cellular telephony joint venture in India, Hong Kong billionaire Li Ka-Shing, Chairman of Hutchison Whampoa, decides enough is enough. Despite holding almost 67 per cent in his Indian JV Hutchison Essar Ltd (hel, 47.45 per cent of it directly), which contributes all of 42 per cent to his global telecom operations, he realises that he cannot see eye to eye with the Ruias. The head of the HK conglomerate has few options to fall back on. The best choice: Cut his losses (just figuratively; HEL boasts one of the highest gross margins amongst Indian cellular companies), and exit the Indian JV when the going isn't that bad (it's steadily getting worse). The Ruias, who were distinctly minority partners with 33 per cent before Li's exit move, are cock-a-hoop as they are now finally in the driving seat of India's fourth-largest mobile telephony play.

It's an unlikely scenario, but the way the relationship between Essar and Hutchison, the two partners of the cellular JV, has been steadily deteriorating, you can't but help get the feeling that this is one end game one of the sides is angling for. After all, there have been instances of global telecom giants like Telstra, AT&T, Telekom Malaysia and Vodafone packing up one fine day and leaving (Vodafone and Telekom Malaysia came back, but that's another story). The circumstances of the Essar-Hutch acrimony are of course unique, but they might well have their origins in the tremendous growth opportunities on offer for the telecom sector, and the resultant astronomical valuations such plays are commanding. For instance, Idea Cellular, the JV between the Tatas and the Birlas, witnessed considerable mud-slinging too, and the matter was eventually sorted out with one partner buying out the other (the Tatas exited Idea).

Is the Hutch-Essar partnership headed down the same road? To be sure, over the past several months, the path has been getting rockier by the day, and last fortnight, the JV hit rock bottom when the partners went to court to decide the fate of one circle, the lucrative Mumbai one, which was to be merged into HEL. However, the Ruias, via their telecom holding company Essar Teleholdings Ltd (ETHL), fired off a termination notice to Hutch, calling off the transaction, because the HK ally wasn't able to get the necessary approval from the Department of Telecommunications (dot) by July 31, the set deadline.

It's difficult to give the Hutchison Essar combine a big chance of working together in harmony again. The first time the two partners got together was around 1999 when they joined hands in the Delhi circle. Other circles like Kolkata and Gujarat followed swiftly. Essar, too, had its own operations in circles such as Haryana and Rajasthan and the grand plan was to merge all the circles at some point in time to form a large telecom entity. Following several rounds of reworking shareholding structures, by early 2006, the combine was down to three partners-Hutchison Telecommunications International Ltd (HTIL), the HK telecom arm of Li, ETHL and the Hindujas (who had a stake by virtue of their presence in the Gujarat circle where Hutchison Essar was operating).

However, last fortnight's courtroom drama wasn't the first sign of discord between the two partners. The Ruias, it would seem, have their telecom game plan clearly charted out, which may or may not have to synergise seamlessly with the JV with Hutchison. For instance, in 2004, group company Essar Teleholdings acquired just under 10 per cent in BPL Mobile Communications, which ran the Mumbai circle, and which was then being operated by Rajeev Chandrasekhar. This was at a time when Essar was a partner with a 26.99 per cent shareholding in HEL. (Chandrasekhar later agreed to sell his operations in Mumbai, Maharashtra, Tamil Nadu and Kerala to ETHL, which in turn sold these operations to HEL, the JV with Hutch. Maharashtra, Tamil Nadu and Kerala were run by a company called BPL Mobile Cellular, whose merger with HEL has been completed. It's the BPL Mobile Communications' deal, for the Mumbai circle, which is still hanging fire.) Similarly, a few months later, Essar Spacetel, another group company, applied for licences in seven new circles (which were eventually sold to HEL).

You could argue that such transactions were driven by sheer commerce and hence the Ruias were perfectly justified in doing them. But that the two partners were clearly not in sync came out in the open early this year when Essar wrote to dot, seeking clarity on Hutch's indirect holdings in the JV. This came after Orascom acquired a 19.3 per cent stake in HTIL. Since Orascom also had operations in Pakistan and Bangladesh, the bogey of a security threat was duly raised. The issue got murkier when it came under government scrutiny, which was the result of the National Security Advisor writing to the government stating that Orascom's indirect presence was a threat to national security. It is gathered that Hutch was not aware of the letter sent to dot, which only added to the intrigue. If there was an issue between the promoters, why did they not settle it between themselves instead of going to dot? According to a senior telecom industry official, a development like this can only send the wrong signals. "An issue going directly to the regulator or dot is not really the right way for two partners to settle their differences," he states. And finally, a couple of months ago, when the Hindujas felt the time was right to sell their 5.11 per cent holding in HEL, there was a scramble between the two partners to grab that stake. Hutch came up trumps, with a $450-million (Rs 2,115-crore) offer, and the buyout helped it bolster its position as the single-largest shareholder in HEL.

Did that leave a bitter taste in the mouth of the Ruias, who then waited till the July 31 deadline to get back at Hutch (the Ruias were unavailable for comment)? Interestingly, the petitioner in the court last fortnight was the JV itself, and the respondent BPL Communications, but the battle clearly is between Essar (the current owner) and Hutch (the would-be majority owner). Hutch says it has paid Essar Rs 1,617 crore for the deal, and hence the transaction should be culminated, but the Ruias insist on an approval from dot for this intra-circle acquisition. The Hutch counter is that it has applied for the approval, and the termination notice may, in fact, delay the go-ahead. Essar doesn't think too much of the fact that the JV has paid its telecom holding company Rs 1,617 crore, and is willing to refund the money. But Hutch obviously doesn't want to take the money back, as it has already paid 97.5 per cent of the total money due, and is keen that the transaction goes through.

Now, with the BPL Mobile Communications case in court, it is anybody's guess how the relationship between the two partners will pan out. Regardless of the outcome, the question is whether the two partners can work together again. Sources familiar with the development point out that it is crucial for Hutchison Essar to put an end to the dispute at the earliest. "If they are keen on deriving value from the BPL Mobile brand and enhance the value of the Hutch brand in Mumbai, that seems like the only way to go about it. In the legal context, it is really a question of not just getting the approvals from the dot, but more about when it will come through," they add.

WHO COULD BUY BPL MOBILE?

Waiting in the wings: Ambani (left) and Birla If the deal between Essar and hutch for the sale of BPL Mobile Communications does not go through, Essar will have to end up looking for a buyer. For starters, Mumbai is an extremely lucrative circle with a healthy average revenue per user (ARPU). BPL Mobile, at the end of June 2006, had over 1.29 million users. The question is who would be the interested parties? Some obvious names come to mind immediately. There is Sunil Mittal's Bharti Airtel, which already has a presence in Mumbai. One option for Mittal could be to acquire BPL Mobile and then merge it with Bharti, which is exactly what Hutchison Essar intended to do. The other candidate is the Aditya Birla-owned Idea Cellular, which, post the buyout of the Tatas' stake, controls over 98 per cent of Idea Cellular. Idea does not have a presence in Mumbai and has put an application to provide services in the circle in addition to 11 other circles. Besides, the group is very keen on telecom as a business. Anil Ambani's Reliance Communications appears to be a logical candidate since the company has already filed an application to provide GSM services in Mumbai and Delhi. Ambani already operates CDMA services and the BPL Mobile operation could complement his existing operation. Another name doing the rounds is that of Malaysian operator, Maxis, which some time ago acquired a 74 per cent stake in the C. Sivasankaran-promoted Aircel that gave it a presence in Chennai and Tamil Nadu. Maxis is looking to expand its footprint and Mumbai will be a useful operation to have. Though there is no confirmation, it is learnt that Russian operator Sistema and Luxembourg-based Millicom could be the other suitors. These names are not surprising since they have always been keen on India as a market.

From Li's and Hutch's Indian operations head Asim Ghosh's point of view, there would be no ambiguity on how important the Indian operation is. The numbers tell the story: Of HTIL's total turnover of HK$ 24 billion (Rs 13,440 crore then) for 2005, India accounted for hk$10 billion (Rs 5,600 crore then). For the same period, EBITDA (earnings before interest, taxes, depreciation and amortisation) margins for HEL were at a very healthy 47.1 per cent. Apart from India, HTIL provides cellular services in Indonesia, Vietnam, HK, Israel and Thailand. At the end of June 2006, HEL has a total subscriber base of 17.54 million. Given that the subscriber base is on the growth path and given HEL's massive presence in 16 out of a possible 23 circles, India provides a huge opportunity for HTIL. Besides, with most of the regulatory overhang out of the way, HTIL can increase its stake to 74 per cent from the current level of 62 per cent-it will be 67 per cent once the deal with the Hindujas is concluded.

For the Essar Group, telecom looks like a convincing story and the group, after its initial teething problems with the sector, is sitting pretty with a 33 per cent holding in HEL. If the partners resolve the current stalemate amicably and if BPL Mobile Communications can merge itself with HEL-this will be the first intra-circle merger if it goes through-the value of HEL will only go northwards. Based on the Hinduja deal of $450 million for 5.11 per cent, HEL would be worth a cool $8.8 billion (Rs 41,360 crore). However, it may be interesting to arrive at a valuation for bpl Mobile's Mumbai circle. Would it be today more than the Rs 1,600 crore-odd Hutchison has deposited with ETHL? If so, Essar may see a great opportunity to sell the Mumbai circle to another operator. And there will be no dearth of interest (see Who Could Buy BPL Mobile?). The big question, though, is that if matters do at all come to such a pass, would it be possible for the two partners to work together ever again?