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A battle is set to break out for Hutchison's up-for-sale Indian telecom business with blue chips-be it service providers or equity firms scrambling to finance a $22 bn bid for the business. At present Reliance Communications and Vodafone appear to be leaning toward a buyout offer from Hutch, with Vodafone targeting to buy Hutch's stake in an all cash deal while Reliance has lined-up banking firms to finance a rival offer. Essar, which is the second largest holder in the Hutch JV, has also thrown its hat in the ring with $11 bn for the remaining stake. The other strong bidder in the fray is the Hinduja group, which had a long association with the Hutchison Essar initiatives in India.

But with the bid reaching $22 bn, isn't it a simple case of money chasing for this asset?

Valuation Thrill
Hutchison Essar was pegged at $9-9.5 bn in June 2005 and at that time if Hutch had made its intentions clear, of selling its stake, it would have been the most sought after buying target. But since then it has come a long way and is now valued at $22 bn, which is undoubtedly on the higher side. Though buying Hutchison Essar would provide a much-needed fillip to Reliance Communications and Vodafone's businesses, as the former is keen to ramp-up its GSM operations while the latter would get a smooth entry in the Indian telecom market-but the unrealistic bid-up is likely to result in low value, even over the long run.

The market capitalization of HTIL is around $11 bn, whereas Hutchison Essar is estimated around $5 bn.

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.

"We would peg the Hutchison Essar value at close to $17 bn, with a $11-12 bn price for the 67% stake," said Sameer Walia, MD, The Smart Cube.

Equity analysts suggest for a lower valuation as compared with the current level of $22 bn. Lehman Brothers, in its January 11, 2007 equity research report, said that Hutchison Essar acquisition by Reliance Communications makes sense as it provides a ready GSM platform for Reliance rather than waiting for the consistently delayed new GSM spectrum to roll-out its own network. However, Lehman Brothers think the indicated valuations of $20 bn for Hutchison Essar is expensive. In case any other entity buys into Hutchison Essar, Lehman Brothers believe that both Bharti and Reliance Communications stand to gain significantly from the post-buyout transition at Hutchison Essar.

A bid of $13.5-14 bn could value Hutchison Essar at a 24% premium to Bharti, which has a market capitalization of $25.7 bn, according to CLSA.

At $14 bn, analysts estimate Hutchison Essar's enterprise value/EBITDA at 20.6 times year-to-March 2007 earnings, well above Bharti's 16.2 times.

For Essar, buying or selling in Hutch is more of a compulsion rather than any value addition. In the present scenario, it will definitely be valued at a higher price, somewhere near $7 bn for its 33% stake in Hutchison Essar. In an ideal situation, it won't be able to fetch $5.9-6.3 bn and in case it buys the remaining 67%, it will have to cough-up $13 bn. Also, if it decides to sell-off the entire stake at a later stage, it might not be able to make much profit in this venture, as it is very unlikely that the bid would be raised further from the current level of $22 bn. At this level, shelling out $15 bn to sell at $22 bn is not a good business proposition for any operator, especially when it can easily get $5-7 bn for its 33% stake.

Man Financial's equity analysis dated December 20, 2006 says that HTIL's stock (which holds 67% economic interest in Hutchison Essar and is listed in Hong Kong) has posted a 41% gain over the past three months, though it has underperformed its peers-Bharti and Reliance Communications. "We estimate that 85% of the value in HTIL comes from its holding in Hutchison Essar. Based on this, the equity value of Hutchison Essar, as reflected by the current HTIL stock price, is estimated at $14.4 bn. We believe that the deal is likely to value Hutchison Essar's equity at $14-15 bn," according to Man Financial.

At present Reliance's market capitalization is around $20 bn with subscriber base of 28 million (GSM + CDMA) while Bharti, India's largest private cellular operator has a market capitalization of $29 bn with subscriber base of 30 million. Analysts have valued Hutch at $18 bn, which currently has an ARPU of Rs 374 and a base of 22 mn subscribers. Bharti has an ARPU of Rs 349 while Reliance ARPU is Rs 320.

Analysts are skeptical about the current valuations. Goldman Sachs, in its analysis dated December 21, 2006 said: "Using our local analysts' SOTP valuation of $15.5 bn for Hutchison Essar's enterprise value and deducting $1.1 bn of net debt for end 2007 leaves an equity value for the theoretical maximum 74% of $10.8 bn."