[VODAFONE HUTCH MERGER] January 24, 2013

Submission of report to demonstrate learnings on the M&A Framework and Activity as a tool of Corporate Finance towards implementing Business Strategies

Vodafone Hutch Merger

EPGDIB 2013, GROUP 5 Aman Kaushal-Roll No.6 Anuj Jain Roll No.17 Arun Samal Roll No.18 Santosh Kumar Roll No.62

[VODAFONE HUTCH MERGER] January 24, 2013

ABSTRACT
1. Mergers and Acquisitions(M&A) play a major role in the globalisation process. In an endeavour to geographically expand the utilisation of their competitive advantages, merger and acquisitions allow the firms to do so in a fast, effective and perhaps in-expensive manner. 2. Cross-border M&A are usually more complex and rife with surprises and other pitfalls, more so when the number of geographies involved in the transaction increases. The sheer range of concerns has expanded as the speed and volume of international deals have increased. 3. Any merger and acquisitions activity is intricate in its dimensions and would be affected by a plethora of laws and regulations depending upon the stakeholders involved. Any M&A scenario is largely governed by the need to conduct extensive groundwork in three major areas :(a) Strategic Invariably the initiating function for any M&A activity since the latter is corporate finance tool predominantly used for Business Strategy. (b) Legal In addition to aspects of statutory implications pertaining to creation of monopolistic/restrictive market positions, deal structuring from the tax perspective is another critical factor for the re-structuring, such that the transaction is tax neutral or results in minimising the tax implications. (c) Financial Is the most visible part of the M&A activity that generates immediate interest and implications for all stakeholders. The ultimate objective of any chosen Business Strategy is the creation/enhancement of greater value across the organisation. 4. The existing report attempts to provide insights into each of above dimensions by drawing examples from the real-life case of Vodafones acquisition of Hutchinson Essar in 2007. The case has been in the limelight due to the tax litigation surrounding the deal and, therefore, while the present report would include all the above dimensions, the references to the Legal Due Dilligence element might seem comparatively more.

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Contents
1. INTRODUCTION................................................................................................................................................................. 3 2. STRATEGIC DUE DILLIGENCE ............................................................................................................................................. 4 Introduction To Business Model ................................................................................................................................... 4 Rationale For M&A......................................................................................................................................................... 4 External Environmental Factors ............................................................................................................................... 4 Internal Environmental Factors ................................................................................................................................ 4 Benefits - Improvements in Value Chain ................................................................................................................. 5 Risk Factors ................................................................................................................................................................ 5 3. FINANCIAL DUE DILLIGENCE ............................................................................................................................................. 6 Announced Value ........................................................................................................................................................... 6 Fundamental Value ........................................................................................................................................................ 6 Acquisition Premium ...................................................................................................................................................... 6 4. LEGAL DUE DILLIGENCE..................................................................................................................................................... 8 Applicability of Laws ...................................................................................................................................................... 8 Deal Structure ................................................................................................................................................................. 8 Entities Involved ............................................................................................................................................................. 8 5. CONCLUSION .................................................................................................................................................................... 9 Strategic Fit Gaps Vs Overlaps................................................................................................................................. 9 Premium Justification .................................................................................................................................................... 9 6. TABLES, EXHIBITS & BIBLIOGRAPHY ................................................................................................................................ 10 Company Snapshot ..................................................................................................................................................... 10 Financial Results .......................................................................................................................................................... 11 Bibliography .................................................................................................................................................................. 11

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[VODAFONE HUTCH MERGER] January 24, 2013

1. INTRODUCTION
1.1 On February 11, 2007, Vodafone agreed to acquire the controlling interest of 67% in Hutch-Essar for US $11.1 billion, pipping Reliance Communications and the Hinduja Group. The acquisition of Hutchison Essar by Vodafone at an enterprise value of $19.3 billion which comes to around $770 per share was one of the biggest cross border deals in the booming Indian telecom market at that time. 1.2 Essentially the Vodafone Hutch deal involved transfer of shares of a non-resident Cayman Islands based entity between two nonresidents(Hutch and Vodafone). 1.3 Hutchison Telecommunications International(HTIL), a parent company based in Hong Kong sold its stake in the foreign investment company CGP Investments Holdings Ltd., registered in the Cayman Islands (which, in turn, held shares of Hutchison-Essar Indian operating company, through another Mauritius entity) to Vodafone. Vodafone Profile 1.4 Vodafone Group plc is a global telecommunications company headquartered in Newbury, United Kingdom. It is the world's second-largest mobile telecommunications company measured by both subscribers and 2011 revenues (in each case behind China Mobile), and had 439 million subscribers as of December 2011. 1.5 It operates networks in over 30 countries and has partner networks in over 40 additional countries. Its primary listing is on the London
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Stock Exchange and it is a constituent of the FTSE 100 Index. It has a secondary listing on NASDAQ. It had a market capitalization of approximately $ 118 billion as of 6 July 2012 (2012 -07-06), the third-largest of any company listed on the London Stock Exchange. It has a secondary listing on NASDAQ. Essar Profile 1.6 The Essar Group is a multinational conglomerate corporation in the sectors of Steel, Energy, Power, Communications, Shipping Ports & Logistics as well as Construction headquartered at Mumbai, India. Essar began as a construction company in 1969.. Hutch Profile 1.7 HTIL was a subsidiary of Hutchison Whampoa Limited(HWL) of Hong Kong, which is a Fortune 500 company.HWL is an international corporation with a diverse array of holdings which includes the world's biggest port and telecommunication operations in 14 countries and run under the 3 brand. Its business also includes retail, property development and infrastructure. Background 1.8 The two main reasons cited as responsible for HTIL to leave India were, First a growing distrust between the partners, to ensure obtaining controlling stake in an emerging industry, and Second - Need for HTIL to exit Indian investment to finance other emerging market operations, and partially offset the global 3G loses witnessed by them.

[VODAFONE HUTCH MERGER] January 24, 2013

2. STRATEGIC DUE DILLIGENCE

Introduction To Business Model
The name Vodafone comes from voice data fone, chosen by the company to "reflect the provision of voice and data services over mobile phones".
2.1

Revenue Per User (ARPU) than its competitors. By adopting this focused growth plan, it was able to establish leading positions in India's largest markets providing the resources to expand its footprint nationwide.

Vodafone had first entered the Indian Market by picking up 10% stake in Bharti Airtel in 2005 for $ 984 Million. Expansion through this interest was Vodafones original India strategy. However, Bharti was not keen on the idea and consequent to the Hutch Deal, the Bharti stake was also divested.
2.2

Rationale For M&A

External Environmental Factors India represented a market of 143 million subscribers growing at a mind-boggling rate of 5 per cent on a month-on-month basis, making it the fastest-growing cellular market in the world.
2.5

On the other hand, In 1992, Hutchison Whampoa and its Indian business partner Max Group, established a company that in 1994 was awarded a licence to provide mobile telecommunications services in Mumbai and launched commercial services as Hutchison Max in November 1995. In Delhi, Uttar Pradesh (East), Rajasthan and Haryana, Essar Group was the major partner. But later Hutch took the majority stake.
2.3

Penetration levels were still low at 12 per cent (less than 2 per cent in rural India having 67% of the population), and as developed telecom markets slide into saturation, India is clearly the geography where most of the longterm potential is concentrated.
2.6

Internal Environmental Factors Traditional European markets becoming saturated for Vodafone, while Asia seen as the next big telecom story. Hence, India is key to Vodafone strengthening its presence in Asia.
2.7

Initially, the company grew its business in the largest wireless markets in India in cities like Mumbai, Delhi and Kolkata. In these densely populated urban areas it was able to establish a robust network, well-known brand and large distribution network all vital to longterm success in India. Then it also targeted business users and high-end post-paid customers which helped Hutchison Essar to consistently generate a higher Average
2.4

3G is set to take off in India, allowing data and video to ride on cellular networks. Vodafone already offers 3G elsewhere in the world.
2.8

[VODAFONE HUTCH MERGER] January 24, 2013 Benefits - Improvements in Value Chain Vodafone gets access to the fastest growing mobile phone market in the world that is expected to touch 500 million subscribers by 2010.
2.9

Risk Factors The cellular telephony is extremely competitive, and India has one of the lowest ARPUs in the world. Besides, ARPU growth was observed to be slowing.
2.13

Hutch-Essar was 04th largest mobile operator in India with 24.41 million subscribers, i.e 16.41% of the Indian mobile market. It was present in 16 of 23 circles. Has license for six others barring Madhya Pradesh.
2.10

It has an uneasy equation with Essar, which would have remained as the one-third partner in Hutch-Essar. That could be a source of problem.
2.14

Hutchison-Essar is not just the #4 player, but also one of the better-run companies with higher average revenue per subscribers.ARPUs at Rs 374 ($8.31) against national average of Rs 335.46 ($7.45). Hutch Mumbai ARPU at Rs 609.36 ($13.54), the highest in India.
2.11

The Vodafone brand was relatively unknown in the Indian market and, hence, brand building would cost money and take time.
2.15

Revenues of $908 million (Rs 4,086 crore) in H1 2006 against $1.29 billion (Rs 5,800 crore) in 2005. Operating profits of Rs 1,017 crore, EBITDA margins at 32.7 per cent in H1 2006.
2.12

Global telecom valuations were at a high and this could mean it is years before Vodafone recovers its multi-billion dollar investment.
2.16

Its big competitors are home-grown majors, who presumably were better placed to manage the environment better.
2.17

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3. FINANCIAL DUE DILLIGENCE

Announced Value
Vodafone seems to have pegged its valuation based on Indias mobile growth story. After all, there is no other country that is adding over 6 million subscribers every month.
3.1

The enterprise value per subscriber that Vodafone paid at $770 is much lower than the $1,066 it valued each Bharti subscriber in 2005. Most importantly, the ARPU of Rs 374 for a Hutch is higher than Bhartis Rs 349. For 24.41 million subscribers, that works out to annual revenues of $2.4 billion (Rs 10,955 crore).
3.6

The increasing subscriber base has also meant that while average revenues per user (ARPU) are falling, revenues are on the rise. While during 2005 (January-December), Hutch Essar had revenues of Rs 5,800 crore, it notched Rs 4,086 crore in the first half of 2006.
3.2

This is despite a 19.3 per cent fall in its ARPU since September 2005. But the key advantage was that during 2006, Hutch added 10.67 million subscribers
3.3

Also, mobile penetration at 13% is well below Chinas 41 per cent and Brazils 54 per cent. It is expected to touch 40 per cent by 2011-12. By then Vodafone expects to control 20-25 per cent of the market against 16 per cent now. That means having a shade over 100 million subscribers. Obviously, revenues will be higher.
3.4

Finally, valuation must be judged from the perspective of the buyer (sellers would prefer the highest bidder, everything else being equal). So, comparatively, Vodafone may be willing to pay more for a significant presence in the country compared to, say, Reliance, which is already present. Unless, of course, its market share will give it disproportionate pricing power and it will be able to drive other cost synergies with its existing businesses. So, when the $54.8 billion Vodafone bagged Hutchison Essar, it valued the company at $18.8 billion or $770 per subscriber.
3.7

Acquisition Premium

Fundamental Value

In 1999, when the first telecom deal happened in India, Bharti paid 300 crore for a 63% stake in JT mobile. That worked out to an acquisition cost of $117 per subscriber.
3.8

While there are different things that go into valuing telecom companies, one of the key figures is Average Revenues per User (ARPU).
3.5

In June 2006, Hutchison paid $450 million to buy the Hindujas 5.11% stake in Hutch Essar. That worked out to be a valuation of $8.8 billiion, or $505 per subscriber.
3.9

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[VODAFONE HUTCH MERGER] January 24, 2013 It was much lower than the $1066 per subscriber that Vodafone paid to buy a 10% stake in Bharti in October 2005.
3.10

Essar paid $370 per subscriber to acquire BPL Communications in August 2005.
3.11

Since Hutch-Essar was an unlisted entity, there were no equity research reports available to calculate the FV of the firm. However, the following exhibit indicates the valuations recommended by the various investment managers tracking the deal.
3.14

Globally telecom valuations have been on the high side. In 2000, Vodafone paid $202 billion for Germanys Mannesmann.
3.12

Interestingly, the value per subscriber paid for Germanys Mannesmann was approximately $ 7725 and in 2006 there was a write of the losses pertaining to this acquisition leading to an overall loss of approximately $ 40 Bn.
3.13

In an ideal scenario, Hutchison Essar value should be pegged at around $18-19 bn, with a $12.1-12.7 bn price for the 67% stake. This is based on multiple valuation methodologies and after including a premium to be paid for the prized asset.
3.15

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[VODAFONE HUTCH MERGER] January 24, 2013

4. LEGAL DUE DILLIGENCE

Applicability of Laws
4.1. The deal involved the exit of a shareholder from an Indian telecommunications company at a time when the FDI limits threw up their own challenges. The specific focus issue was the 15% stake of Hutch-Essars MD, Asim Ghosh and the Max Group Chairman, Analjit Singh. 4.4. Analysts estimate that Vodafone was probably the least leveraged of all the bidders, including the $1.62 billion cash from its 5.6 per cent stake sale in Bharti Airtel itself, and this helped them bid aggressively.

Entities Involved

Deal Structure

4.2. As part of the deal, between the third and fourth year, Essar group got the option to sell its stake in Vodafone Essar for $ 5 Bn. This option was finally exercised by the Essar Group in 2011 and it received $ 5.4 Billion for its 33% Stake. This left Vodafone with owning 74% of the Indian business. 4.3. The other element was the complex multi-layered financing transactions that were possibly circumventing the 74% sectoral cap of FDI in telecom sector. Another reason for the FIPB to take a while in evaluating the accord of approval for the deal.

4.5. In case Essar decides to leave, Vodafone has to maintain the 74 per cent FDI limit. Hutchison held 52 per cent, Analjit Singh and Asim Ghosh together hold 15 per cent, while Essar holds 33 per cent. In Essars stake, 22 per cent is held abroad (Mauritius) as a foreign investor, and the balance 11 per cent as a domestic investor.

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[VODAFONE HUTCH MERGER] January 24, 2013

5. CONCLUSION
Strategic Fit Gaps Vs Overlaps
5.1. The acquisition of Hutch-Essar by Vodafone has proven to be in sync with its strategic vision as indicated by the following figures: 80% growth in customer base within 11 months of acquisition. By 2009 customer base of 71.5 million Declared 2nd largest mobile service provider by 2009 5.2. Despite a healthy EBITDA margin of around 30%, Vodafone is yet to generate any profit since 2007. This could primarily be due to the depreciation and Interest Payouts have remained high and contributed majorly to the lack of profitability. 5.3. However, regulatory issues affecting lack of clarity in policy and the impending repeal of the tax case by the IT Department may extend the break-even point for Vodafone even further. by around 30% to 45%. In comparison to a fair value of about Rs.25000($ 600) per subscriber value for Airtels Mobile services, Vodafone agreed to pay Rs.35000($ 770) per subscriber for Hutch-Essar. 5.5. One reason why Hutch Essars value appeared so high was that it had the highest ARPUs Rs 374, against the national average of Rs. 335 and Bhartis Rs 348.50. 5.6. On January 20, 2012, the Supreme Court ruled in favour of Vodafone. Consequently, the demand of nearly Rs.12,000 crores by way of capital gains tax, would amount to imposing capital punishment for capital investment since it lacks authority of law and, therefore, stands quashed. 5.7. However, Indian tax laws are complex and also getting more complicated by the day in terms of regular annual amendments with retrospective effect. The latter continuously revise the judicial interpretations in the light of changing business environment and creates the kind of pitfalls that Vodafone finds itself in.

Premium Justification
5.4. Some M&A analysts believe that Vodafone may have overpaid for Hutch-Essar

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[VODAFONE HUTCH MERGER] January 24, 2013

6. TABLES, EXHIBITS & BIBLIOGRAPHY

Company Snapshot

The Vodafone "speech mark" logo in use since 1997 Type Traded as Industry Predecessor(s) Founded Headquarters Public limited company LSE: VOD NASDAQ: VOD Telecommunications Racal Telecom (1983 to 1991) 1991 London, United Kingdom (Head office) Newbury, Berkshire, United Kingdom (Registered office) Worldwide Gerard Kleisterlee (Chairman) Vittorio Colao (CEO) Fixed line and mobile telephony, Internet services, digital television 46.417 billion (2012) 11.187 billion (2012) 6.957 billion (2012) 139.57 billion (2012) 76.935 billion (2012) 86,373 (2012) Vodafone Global Enterprise www.vodafone.com

Area served Key people

Products

Revenue Operating income Profit Total assets Total equity Employees Divisions Website

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[VODAFONE HUTCH MERGER] January 24, 2013

Financial Results
Vodafone reports its results in accordance with International Financial Reporting Standards (IFRS). Vodafone has some large minority stakes, which are not included in its consolidated turnover. In order to provide additional information on the overall scale and growth trends of its business, it publishes "proportionate turnover" figures, and these are included in the tables below. For example, if a business in which it owns a 45% stake has turnover of 10 billion, that equals 4.5 billion of proportionate turnover for Vodafone. Proportionate turnover is not an official accounting measure, and Vodafone's proportionate turnover should not be compared with other companies' statutory turnover. Vodafone also produces proportionate customer number figures on a similar basis, e.g. if an operator in which it has a 30% stake has 10 million customers that equals 3 million proportionate Vodafone customers. Year ended 31 March 2011 2010 2009 2008 2007 2006* 2005 2004 Turnover m 45,884 44,472 41,017 35,478 31,104 29,350 34,073 36,492 Profit before tax m 9,498 8,674 4,189 9,001 (2,383) (14,835) 7,951 9,013 Profit for the year m 7,870 8,618 3,080 6,756 (5,297) (21,821) 6,518 6,112 Basic eps (pence) 15.20 16.44 5.81 12.56 (8.94) (35.01) 9.68 8.70 Proportionate customers (m) 347.7 341.1 302.6 260 206.4 170.6 154.8 133.4

*Losses for year to 31 March 2006 reflect write downs of assets, principally in relation to the Mannesmann acquisition. Proportionate turnover includes 7,100 million from discontinued operations

Bibliography
1. Taxation of Cross-Borders Mergers and Acquisitions : Vodafone Hutch Deal, Dr.Monica Singhania & Venugopal Dastaru, Faculty of Management Studies. 2. Orange International The Creation of a 21st Century Patent, Dan Izbicki, Institutue of Practitioners in Advertising. 3. http://www.asialaw.com/Article/1971024/Search/Results/Behind-the-Deal-Vodafone-TakesOver-Hutchinson-Whampoas.html?Keywords=Hutch+Essar 4. http://finance.mapsofworld.com/merger-acquisition/company/vodafone.html 5. http://amarnaik.wordpress.com/2009/09/27/vodafone-hutch-deal-i/ 6. http://www.expressindia.com/news/fullstory.php?newsid=81217 7. http://www.slideshare.net/ashutoshmantry/ma-vodafone-hutchdeal
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