Vodafone’s $11.1 billion passage to India

Vodafone historically has been one of the worst telecom operators when it comes to mergers and acquisitions – bad deals, ill-timed exits and overpaying are part of company’s legacy. By putting a valuation of close to $19 billion for Hutch Essar, the third largest mobile company in India, with about 24 million mobile subscribers, the British giant has ensured that legacy remains unchanged.

Vodafone will pay $11.1 billion for the 67% stake in the company that is currently owned by Hutchinson Whampoa of Hong Kong, thus bringing an end to the circus around Hutch Essar. Vodafone beat out local rival Reliance and some wannabes like the Hinduja Group

toifrontpage.gifIt is fascinating to see the deal drama first hand – television networks in India are giving it top billing, while the newspapers have put out headlines that are normally reserved for a news event with national or international impact.

Most, if not all are enamored by the big price Vodafone is willing to pay in order to enter what is now one of the fastest growing mobile markets – in subscriber numbers if not revenues. Arun Sarin, the CEO of Vodafone has been under pressure to do something about “emerging markets” and that includes over paying.

The deal puts the valuation of a subscriber at about $835, even though the average revenue per user is $9.4 a month, roughly $112 a year. It also has a pretty high churn rate compared to a typical US carrier. For a typical US mobile carrier, ARPU is $50 a month, and the churn rate hovers around 1.5% per month or 18% annually.

Wharton marketing professor Raghuram Iyengar has crunched the numbers and feels that if Hutch has a margin of 45% and a churn of 1.5%, then the price per subscriber should be around $790 per subscriber. Another metric to arrive at a valuation of Hutch would be to measure the EBITDA per subscriber minus the capex over the life time period of that subscriber. (I have contacted a few analysts for their estimates on Hutch Essar, and will update the report later.)

The problem is that Hutch’s ARPU is in decline, and it is going to be tough going in this hyper competitive market that is very price sensitive. Most GSM carriers are facing a spectrum crunch, and will need to spend to upgrade their infrastructure to support a growing number of subscribers.

Vodafone is likely to face those bills, and also might have to deal with 3G upgrades in the near future as well – a strategy that may help boost the ARPU eventually. Nevertheless, on this deal we would go with the wisdom of the seller – Li Ka-Shing. He buys low, finds a sucker, and sells it really high, before the market tips over!

(Meanwhile, Bharti Airtel will buy back 5.6% of Vodafone’s stake in that company for $1.6 billion, a deal that has made money for Vodafone, mostly because its Hutch bid has inflated the telecom valuations in India. Vodafone had bought 10% of AirTel for $1.5 billion in 2005.)