Inexplicable pricing

At the outset, Sunil Mittal needs to be congratulated on getting Vodafone to pick up a 10 per cent stake in his Bharti Tele-Ventures Ltd (BTVL) as this has put the mobile telephone business well into the stratosphere.

And of course, getting two telecom giants (Vodafone and SingTel) into one company is another major coup—most people have trouble enough managing one partner, Mittal’s had five, starting with Vivendi, British Telecom, Telecom Italia, SingTel and now, Vodafone.

Till the deal took place, valuations were a lot lower. In July this year, Hutch-Essar bought out BPL Mobile at a price of $570 per subscriber, which means the entire Hutch-Essar combine with 12 million customers is valued at around $6.8 billion or Rs 31,000 crore (minus BPL’s 2 million or so customers, the company would be worth $5.7 billion or Rs 26,000 crore).

A fortnight ago, Essar bought Max Telecom’s remaining 3.16 per cent stake in Hutch-Essar for Rs 657 crore, implying that the value of Hutch-Essar (minus BPL) is around Rs 21,000 crore, a valuation in the same range as the earlier deal.

Vodafone’s purchase price, however, values each of Bharti’s subscribers at 75 per cent more, or around $1,000, and so Bharti is currently worth $15 billion or Rs 67,000 crore.

Given that Airtel’s EBITDA in the mobile business is around a fourth more than that of the entire Hutch-Essar combine (Hutch-Essar’s earnings are around $45 million a month as compared to Bharti’s $55 million), the price of BTVL’s mobile business should be around $8.5-9 billion if the Hutch EBITDA-multiples are used. Of course, you now need to factor in Bharti’s long-distance and other revenues such as those from the landline and broadband business—based on Bharti’s latest EBITDA results, these are around Rs 1,000 crore for a full year.

None of this, however, takes you anywhere near the Vodafone-based valuation of $15 billion. More so, since at the end of the day, the long-distance telecom business will lose a lot of its profitability once the regulator finally moves on the obvious cartelisation in the segment.

In any case, at Rs 25 crore for a licence, the entry barriers in this segment are not too high. While the telecom minister has openly alleged cartelisation and wants to break this up, the regulator is moving very slowly on issues like the carrier access code, essential if genuine competition is to happen (see “Fixing the cartel”, Business Standard, October 7).

What is even more surprising is that Vodafone should pay such a high price to get into a market that is in a bind right now for several reasons. While the cellular industry growth has been at a phenomenal rate over the past few years, there is a question mark over whether this can be sustained.

A study by the Gurgaon-based Management Development Institute (MDI), for instance (published on the opposite page today), is of the view that the number of mobile subscribers will saturate at around 100 million.

While many in the industry dispute the S-growth theory the MDI uses (Arun Sarin of Vodafone, by the way, talked of S-growth on national TV after the deal), there is no doubt that the metros are already saturated.

By way of an example, in the National Capital Region, which includes Delhi and has around 22 million people (assuming that young children and very old persons may not be given a mobile phone ever), the addressable population is probably around 11 million (we’re assuming, incorrectly, that all of them can afford such phones).

Well, there are already around 6.4 million mobile subscribers in the NCR. The situation in Mumbai is quite similar. The solution is then to move to smaller cities (this is where the real growth is coming from today) and perhaps rural areas.

But moving to smaller towns and rural areas means lower average revenues per user—for new subscribers, monthly industry-ARPUs have fallen from Rs 300 last year to around Rs 200 now, and the telecom regulator is talking of ARPUs of Rs 180 for rural areas.

The other constraint, of course, is the lack of spectrum air waves on which mobile phone companies transmit and receive signal from users.

Without adequate spectrum, the growth of mobile phone companies is seriously compromised—how serious this is can be seen from the fact that this is among the priority agenda points for President Bush’s visit in February.

It doesn’t help that, so far at least, the US administration has been seen to be weighing in favour of the CDMA-group headed by Qualcomm—so, if the Indian government actually bends, the GSM-group, which includes Bharti, will be adversely affected.

Given all this, why has Vodafone paid such a high price—around 75 per cent more than that paid in a major acquisition less than three months ago? Part of the reason could be that the 10 per cent stake is a lot more than what it seems, since Vodafone will have two directors on Bharti’s board, as compared to SingTel, which has only three directors despite owning a 31 per cent stake.

The market is already speculating on SingTel exiting the business—in any case, three phone operators in one company is clearly unsustainable.