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The deal, at last, is done. After weeks of uncertainty, Britain's Vodafone announced on February 11 that it had decided to pay $11.1 billion in cash and assume $2 billion in debt to buy a 67% stake in Hutchison Essar, one of India's largest mobile operators with more than 22 million subscribers. Vodafone's purchase of the controlling interest in Hutchison Essar -or Hutch, as it is commonly called -- from Hong Kong-based shipping and real estate baron Li Ka-Shing values the company at nearly $19 billion, which is twice as much as the first round of bidders in January thought it was worth. Four days later, the Aditya Birla group's Idea Cellular -- another large mobile phone services provider with 12.4 million subscribers -- found more than $27 billion in investor money bidding for its stock during the company's initial public offering, which had intended to raise some $480 million. The IPO was oversubscribed by 57 times, according to media reports. As both transactions show, India's mobile phone market is red hot -- which begs the question whether it is too hot. Are these enormous valuations justified by the market's growth potential? India Knowledge@Wharton spoke to faculty members from Wharton, the Indian School of Business, and other experts to find out. Their view is that while it might appear that these transactions are overvalued, the market has lots of growth potential. As such, a shakeout -- if it occurs -- is unlikely in the near future. What the Numbers Reveal The growth numbers explain most of the market's fervor. India's cell phone user population doubled during the past year to 150 million at the end of 2006. More than 6 million new subscribers are signing up for mobile services each month, making India the world's fastest growing mobile market. Cell phones are not just a way to keep in touch with loved ones in a country that loves to talk, but in a booming economy they also become workstations for millions in India's unorganized sectors. Vodafone's India-born CEO Arun Sarin said in a speech in Barcelona recently that he expects the 150 million subscriber base -- which represents a penetration rate of just 13% -- to grow to 500 million in a few years. Much of this growth is expected to come from more than 600,000 villages where millions of Indians live. "We are really excited to move into the rural areas," Sarin said in his speech. "Whenever we get into these rural areas, we find people love to talk. They light up our base stations immediately." Wharton marketing professor Jagmohan Raju says enterprise valuations at the level of Vodafone's payment for Hutchison Essar might not appear to be justified using conventional analysis tools, but he agrees with Sarin that most of the growth in the future will come from the lower end of the market in rural India. "The way to justify these valuations is not to base them on how many subscribers [the acquiring company plans] to have," Raju says. "The numbers are justified based on a prediction of higher value-added services, and also some sense of how mobile phones can be used for marketing. Will the mobile handset be a device that will be used to send ads -- perhaps video ads -- to subscribers? Can you add more services and more value at the lower end, with somebody else subsidizing the cost of
" Gupta notes. "It is a good strategic fit all around.S. and that adds to the cost. This deal is also a "huge windfall for the Hutch guys. "They will get a better global franchise and access to technology and features as India becomes the tech battleground. Designed for the rural consumer. to share the costs of infrastructure development in rural areas. "This is a deal priced to perfection." He believes that Vodafone will now go about trying to increase its market share from 15% at present to at least 25% in the next few years. so they [the service providers] know your location. Ravi Bapna. but [in India] the power supply to your base station battery is uncertain. Vivek Gupta. it will send you the information. Price wars are likely as the battle heats up. "These are highly correlated. "They could not have wished for anything more. It also has voice prompts in three Indian languages. "In the developed world. Bharti Airtel. Low-cost phones like Motorola's MotoFone F3 will allow for "mcommerce" capabilities to emerge in the industry. Vodafone is looking for growth in Asia because markets like the U. "Google will tie in these things. and further validate the growth story for mobile phone services in India. -which has an 80% penetration rate for cell phones -. ZTE officials met Sarin and Indian communications minister Dayanidhi Maran in Barcelona to discuss plans for a handset manufacturing hub in India to supply Vodafone in India. "Those are mind-boggling numbers." says Bapna. notes that Google's co-founder and president Larry Page has said he wants cell phones to be free. Its MotoFone F3 handset was launched in India last December at a price of Rs. professor of information systems at the Indian School of Business in Hyderabad. "The fact that Vodafone and Bharti Airtel are going to share base stations in rural areas is a good sign. Motorola CEO Edward Zander two years ago declared India as the company's "headquarter country" for its "High Growth Markets" initiative. an extended battery life and two antennae." Significantly. 1.offer little growth potential.the phones?" He says these value-added services could go beyond ring tones and text messaging to bringing television and advertising to handsets." He sees the same underlying fundamentals driving the record subscriptions for Idea Cellular's IPO. and these will ultimately benefit Indian consumers.655. Chinese cell phone maker ZTE is also headed for this market." Market Wedge Phone maker Motorola is also pulling out all the stops to secure its bet that the future growth for its handsets will be at the lower end of the price spectrum.T. managing director of consulting firm A. Brazil and Russia. ." he says. because it has a multiplier effect. you have guaranteed power supply." Gupta says that this transaction secures Vodafone's position as a major player in the global telecom industry and gives the company a strategic presence in Asia. Like other global telecom firms. believes that Vodafone's Hutch deal is good for shareholders of both companies as well as consumers." he says. including banking. if you type in an SMS saying you are looking for a restaurant in Brigade Road (in Bangalore's main shopping district)." he says. Vodafone will face strong competition from Indian mobile firms such as Reliance Communications." he says. insurance and other financial services. Vodafone has signed a deal with India's biggest mobile operator. the lowest priced in the market. the phone has features such as an "e-ink display" so that the letters on the screen are wide and large and are visible in bright sunlight. or about $37. and maybe also give you a restaurant coupon. "What I see on the horizon is more localized search with phones that connect to GPS (satellite-based global positioning systems). In the process. Kearney's Indian operation.
" Market estimates put prepaid mobile phone users in India at about 80% of the total. "Any player capable of doing that in the current Indian scenario will have to attract and retain a fickle and under-trained workforce. ARPUs for Indian mobile phone service providers range from $10 to $20 a month. and if that doesn't pan out. high-volume and low-margin Indian market is significantly different from the rest of Vodafone's acquisitions.not now. In fact. Sarin has expressed a desire to also acquire the 33% stake held by Mumbai's Essar group." He describes Indian customer service levels as "abysmal" and notes that Vodafone could use its strengths in that department to increase ARPUs from higher-end customers and reduce customer churn. value lies in the eyes of the acquirer. Bhattacharya believes that is why it is important for Vodafone to start preparing for those questions. communications and technology) investments factor in the intangibles. and Vodafone has that capability. "This is where the rubber meets the road. but three years from now -. Customer Service Clearly. he says. "Postpaid services are easier to manage. companies have to pay huge margins to retailers in India who sell these prepaid cards." he says. . could be that its service levels will be "hard to replicate" for Indian mobile service providers as "it may not be part of their DNA." he says." Raju points to another challenge. and have fewer intermediaries." he says. "Right now. Vodafone will do well to emulate the lean model of [Bharti] Airtel. and that will come with more post-paid subscribers than prepaid. he is keen on forging a successful partnership with the Ruia family that runs the group. "At the end of the day -. and Hutchison Essar currently occupies the top slot." Bapna says a major hurdle Vodafone will face with its acquisition is ensuring synergies and integration across the two companies. "One of the key issues in valuations is the reliability of revenue recognition. "like beauty. Raju says that the gains are manifold for providers that are able to win over more post-paid users. The premium is typically based on two things: One is the synergies you can extract and the second is the option value or the strategic value you place on the business." says Bapna. So where does its competitive edge lie? Bapna says that in Britain. rapid change and disruptive innovation are a way of life in the mobile industry." he says. "The U. Vodafone sets itself apart from the competition with "above-average customer service. market has more post-paid subscribers than prepaid ones. "Investors are placing a premium on being there." he says. this strategy can lead to significant rents. it is almost certain that companies such as Vodafone are making big ICT (information. He says "the real option value" for Vodafone to gain a presence "in the world's hottest market" cannot be underestimated.S. "ICT investments tend to pay off in new and unexpected ways over time for those who make the initial investments and have the ability to respond in an agile fashion." He adds that it is inconceivable for a global player to be locked out of the Indian market. "It's about training your work force as you manage growth. Vodafone will face me-too competitors as it attempts to increase revenue and profitability with value-added services in the face of the lower ARPUs (average revenue per user) that industry analysts predict. The highgrowth." Arindam Bhattacharya. "That is why it is often difficult to say that there is a premium paid on the discounted cash flows of the acquired entity. "Given that technological uncertainty. If it is executed well. vice president and director at Boston Consulting Group in New Delhi says that in the M&A world.analysts will ask Arun [Sarin]: What is your story for India." Vodafone's edge here.Hardly anyone questions Vodafone's optimism about the growth potential of mobile telephony in rural India." and the valuation arithmetic plays out differently for each bidder.
Once that market is saturated." Until then.is likely." Gupta predicts that eventually India's penetration rates could rise as high as those in the U. It is perhaps the one device that has broken the caste/economic barrier with ease. We have seen that happen in the business process outsourcing industry (such as Citigroup. "One option is to wait and get attacked. "The market is still in its early stages. Or they [foreign companies] will look at defending themselves by launching their own attack." he says. Bhattacharya adds." As competition for India's mobile market heats up. "Penetration is still low.but it also has the opportunity to segment the consumer base and exercise price and service quality differentiation. "a shakeout is natural. Kearney's Gupta believes this will not happen anytime soon. but A.S. but that will happen a few years out.and possibly mergers -." Who moves first in these strategic wars before the other guy blinks will be decisive." Bigger Deals The Vodafone deal is a precursor of more big-ticket transnational deals in the Indian marketplace. a shakeout -. and we will see it happening in IT too. . IBM and GE expanding their Indian presence). the leaders in those markets will also try to make big moves.. though it is hard to predict how long that might take. though. there should be enough room for India's mobile services operators to grow without stepping on one another's toes." he says. "With Indian firms becoming aggressive and attacking the incumbents in their home markets. "The market will grow and rural penetration will continue for the next three or four years. and the cell phone has become accessible technology for everyone. says Bhattacharya.T.