Case Study on Piramal healthcare acquiring 5.

5% stake in Vodafone

By Priyanka Thaker Anup Pawaskar Akshay Bhalerao

(Prin. L.N. Welingkar Institute of Management Development and Research, Mumbai)

Why was it important for Vodafone to sell its stake to Piramal? Prima facie, the Piramal-Vodafone deal seems to have manifested due to Vodafones previous deal with Ruias of Essar ending on a bitter note. Before April 2011, British telecom giant Vodafone held a majority of about 42.4 per cent stake in Vodafone Essar Ltd. followed by the Ruias of Essar- 33 per cent. (Out of this 10.97 per cent was through a company named ETHL Communication Holdings Ltd. and remaining 22.04 was Essars) The remaining balance of 24.6 per cent was held between IDFC and Analjit Singh of Max Group.

Vodafone 24.6 33.00 Analjit Singh +IDFC 42.4 Essar

Fig.1 Vodafone Essar Plc. Holdings prior to April 2011

The marriage between Vodafone and Essar was never a happy one. In January 2011, Vodafone objected to Essars plans to place part of its 33% stake in India Securities, a small public company. Vodafone feared the move would give an inflated market value to Vodafone Essar. After a public spat, Vodafone had approached the market regulator SEBI and also filed a petition in the Madras High Court. The court ruled in favour of Essar. Subsequently, the four yearlong marriage ended in a divorce on April 1, 2011, the Ruias made an exit, though after making a whopping profit of 22,000 crore ($5 billion). The breakup deal is expected to be completed by November, 2011 After Essars exit, Vodafones stake would have risen to about 75.4 per cent .The Indian telecom sector allows for 74% Foreign Direct Investment. To comply with the FDI laws, Vodafone had to look for an Indian stakeholder.

24.6 75.4

Vodafone Analjit Singh+IDFC

Fig 2.Projected Vodafone Plc Holdings after Essar completed exit.in November 2011

IDFC Issue The IDFCs (The Infrastructure Development Finance Company) holding too, is under suspicion. More than 50 per cent in IDFC is held by foreign investors. Omega, a company 61.6% owned by IDFC, has held a 5.11% stake in Vodafone Essar since 2007. According to the FDI guidelines, if the investing company is owned or controlled by non-resident entities', the entire investment by the investing company in a Indian company will be considered as foreign investment. So, the equity held by IDFC could be considered as foreign. Vodafone is now selling half the 10.97 per cent stake it bought from one of the Essar group companies, ETHL Communications Holdings, to Piramal Healthcare. Vodafone had agreed to buy the 10.97 per cent stake at $1.26 billion, thereby valuing 5.5 per cent stake at $640 million. On account of this new Piramal deal, following will be the new stake holding pie of Vodafone plc. Vodafone will own 69.9 per cent of the stake, Piramal-healthcare stake will be 5.5% and the balance 24.6 per cent will be as per the earlier stake holding pattern (Held between IDFC and Analjit Singh of Max Group)

24.6 Vodafone 5.5 69.9 Piramal Healthcare Analjit singh+IDFC

Fig 3. Vodafone Plc. Holdings after Piramal deal.

Thus compliance with Indian Telecom FDI norms seems to be the main factor behind Vodafones strategy to sell 5.5% of its stake to Piramal Healthcare.

What factors were considered by both Piramal and Vodafone before finalizing the deal?

Factors considered by Piramal: Vodafone is the second largest mobile phone operator in terms of revenue ($6.16 billion for the fiscal year ended 31st March 2011) behind Bharti Airtel, and third largest in terms of customers. Vodafone has about 14,15,19,840, i.e. 23.63% of total 59,87,79,674 Indian mobile phone subscribers as of June 2011 the

Also, in 2011, Vodafone made a profit for the first time in the four years while majority of Indian telecom companies are facing losses under pressure of low tariffs. The industrys outlook towards Indian telecom sector is a positive one, with millions of subscribers being added every month and space for growth. For the Piramals, the advantage of the deal was that the money invested could generate profit of $128 billion close to 20 % According to Ajay Piramal, the guiding principle for this move is that Piramal Healthcare would look at a minority equity status, not be involved with the management and look for high returns with minimal risk to the shareholders.

Factors Considered by Vodafone: After the split of Vodafone and Essar, Vodafone was looking for a stake holder in India so that they can comply with the FDI rules. This was a burning issue for Vodafone. Also Vodafone obviously doesnt want to go in to another tussle with the authorities after the 11000 Crores tax evasion case. Also Vodafone is expected to launch an IPO in 2012 and hence it was essential for them to have an Indian stake holder. So that the launch is smooth and free from hassles. Also Primal Health care as no say in the board of Vodafone. Hence it satisfies the need of abiding with the local law and gives them the liberty to operate as a company without any interference from Piramal.

What are the possible risks associated with the transactions going forward?
Global Economic Scenario The telecom industry is considered to be somewhat immune to the economic conditions to a large extent. However, given the financial crises in Europe and the U.S., telecom companies might be a little cautious while rolling out any new megaplans. The Indian telecom sector has seen a significant downward re-rating since 2007.For example, Bharti Airtel, was valued at $33 billion when Vodafone bought a 67% stake in the then Hutchison Essar in February 2007, but is now valued at around $30 billion, despite adding some 180 million customers since then. An interesting thing to note is that when Vodafone got the Ruias out, the payment essentially valued the company at $16 billion. But when they invited Piramal in, at $640 million for 5.5 per cent, they are essentially valuing the company at $11.6 billion. Also when Vodafone bought Hutch Vodafone Indias previous avatar when it was owned by Hutchison Whampoa it had valued the company at $19.3 billion.

Cut throat competition and falling ARPU in India The competitive intensity in the telecom industry in India is one of the highest in the world and has led to sustained fall in realisation for the service providers. Intense competitive pressure and cut throat pricing has resulted in declining ARPUs. With increasing number of new entrants in the telecom space the competitive intensity is likely to continue, putting further downward pressures on the telecom tariffs. Thus, the telecom companies like Vodafone might have to grapple with further decline in ARPUs, going forward. Further, with the telecom companies moving their focus to the rural areas for driving the future subscriber growth they might not witness a commensurate increase in revenues. In fact, the risk of steep decline in ARPUs will increase going forward as the telecom companies penetrate rural markets that are characterised by higher concentration of low income, low-usage customers. A higher-than-expected decline in ARPU poses a risk of reduction in margins of service providers. Alternatively, telecom operators are turning their focus to steadily increasing the minutes of usage (MoU) to counter the sustained fall in ARPUs. Likewise, the growth of the VAS is also crucial for some improvement in the ARPUs of operators. Excessive Competition Another major concern that has come to the forefront in the recent past has been heightened competitive intensity in the industry that has correspondingly fuelled the price war between industry players. The Indian wireless market is one of the worlds most competitive markets, with 12 operators across 23 wireless circles and 6 to 8 competing operators in each circle. The auction of new 3G licences and the introduction of mobile number portability (MNP) are likely to heat up competition in the industry, going forward.

Limited Spectrum Availability Spectrum is the most important resource that is required for providing mobile services. Given that spectrum is a finite resource, the availability of the same would be inversely proportional to the number of operators. Thus, larger the number of service providers smaller will be the amount of spectrum available to each of them. Scarcity of spectrum leads to higher capex on deployment of mobile networks for the operators as they need more cell sites to improve service quality. Further the growing usage of spectrum and the resultant scarcity may lead to re-use of spectrum and increase chances of congestion in networks leading to constraints on service quality. Evidently, the competition in the industry is expected to intensify further with the entry of new players, both domestic as well as foreign players. With the competitive intensity of the industry already at such high levels new operators might find it difficult to gather significant share in Indian telecom market. While the new players may benefit from a faster network rollout through tower sharing, they will face challenges in terms of high subscriber acquisition costs and lower ARPU customers . Price War putting Pressure on Margins The ever-increasing competitive intensity in the sector, with licenses and spectrum in several circles allotted to newer operators, is also a concern and could lead to unrealistic pricing levels to grab subscribers. The pricing strategy of per second billing already has taken the price war between telecom operators to the next level. The intensifying price war could put significant downward pressure on the industry revenue growth. Further, the on-going price war and the concomitant decline in telecom traffic could raise the entry barrier for new companies. Regulatory Charges The regulatory charges in the telecom sector have a complicated structure because multiple levies impede the smooth implementation of telecom projects in India. Given the continuously-declining ARPUs, and the extremely-low tariffs, sustaining the current growth rates of the industry requires urgent attention towards rationalising the convoluted tax structure in the sector.

TRAI has recommended to the DoT committee to phase out the multiple levies in this sector with a single levy in a phased manner. Further with regard to license fees, which currently stand at 6%-10% of total revenue, TRAI has suggested that it be reduced at a uniform rate of 6% across all licences.

Vodafone Profits: Are they Sustainable? Even though Vodafone managed to earn profits for the first time in 4 years, the biggest question here is that will it be able to continue earning it in the long run? The biggest pressure a telecom company in India faces is low tariffs. With almost every company offering plans of 1 paisa per second, call-rates are no longer the name of the game. Value Added Services (VAS), robust connectivity, voice clarity etc. are the factors that will pull customers in the long run.

What is the reason for Piramal to invest $640 million in a non related company? Lots of Cash
In spite of the volatility in the markets, Piramal Groups turnover was U.S $ 1 billion in FY 2011. It had cash and receivables of about Rs 10,000 crore, after distributing Rs. 2,700 crore to the shareholders. Also,Piramal Healthcare sold its domestic drug formulations to Abott for a $3.8 Billion(around 17,000 crores) in May 2010.Sitting on a pile of cash, Piramal healthcare seemed to be looking for a place to invest this bounty wisely and profitably. Why a Telecom company? By Piramal's own statement, PHL is no longer going to be a pure pharmaceutical company but a diversified conglomerate. The Piramal Group has interests in a myriad of industries that encompass healthcare, drug discovery & research, diagnostics, glass, real estate and financial services. Ajay Piramal seems to be following a strategy of Smart Diversified Investing, a strategy followed by companies like General Electric. Such diversified holdings across different sectors reduce risk and volatility.

Flexible Options Also Piramal healthcare has the option to either exit at a huge premium in two years when Vodafone makes an equity offer in the Indian markets, or to get $900 million back in cash (a cool 40 per cent return) from Vodafone if the equity offer does not happen- A head I win, tail you lose situation.

Attractive Returns According to Ajay Piramal, Piramal Healthcare expects to get returns between 17 and 20 per cent, amounting to almost $128 billion which would be higher than keeping the funds in a fixed deposit.

Is there any regulatory and legal issues Piramal and Vodafone need to take care of for this transaction?

FIPB clearance? The Foreign Investment Promotion Board (FIPB) is a government body that offers a single window clearance for proposals on Foreign Direct Investment (FDI) in India that are not allowed access through the automatic route. Essar 's 22.04% stake sale to Vodafone may run into an Foreign Investment Promotion Board (FIPB) roadblock, The department of telecommunication (DoT) on September 2,2011 said that even though it is a stake sale between two non-resident entitiesVodafone and Essar's off shore entitythe deal should get FIPB approval. Vodafone had given a presentation to the committee, where they said they did not require approval for the stake sale of 22% held by Essar's foreign entities or for the 5.5% stake sale to Piramal Healthcare. A subcommittee set up by FIPB was expected to oversee the matter and submit its report soon.

Vodafone Tax Dispute Vodafone is currently fighting a tax dispute case in Supreme Court of India over its 2007 purchase of Hutchison Whampoa Ltd. It had appealed to the Supreme Court challenging a lower court order that Indian tax authorities had jurisdiction over tax bills in cross-border deals. This case is being keenly watched by foreign investors The tax authorities have said Vodafone's deal was liable to be taxed because most of the assets were based in India and under the law; buyers have to withhold capital gains tax liabilities and pay them to the government. Vodafone has earlier said the law did not require it to deduct tax and that capital gains tax is usually paid by the seller. Vodafone hopes its Rs.11, 000 crore ($2.5 billion) tax disputes would be cleared by the end of the year or early next year. However a verdict gone against Vodafone could have serious consequences .It could affect Vodafones image at the same time lead to roadblocks in their IPO plans.

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