Sometime in the next month or so, the battle for control of India’s fourth largest mobile phone operator (third largest privately-owned), Hutchison-Essar, will truly begin – with the opening bids coming in. At this stage, the details are a bit murky to say the least. What we do know is that the company will be valued around $18 billion (double of what it was in June 2006 when the Hindujas sold their 5% stake). We also know that the battle will involve a fascinating cast of characters competing against and co-opting each other. They include:
- Li Ka-shing: a Hong Kong tycoon who owns 67% of the company – he has indicated that he wants to sell his stake
- Anil Ambani: owner of Reliance Communications, India’s second largest mobile operator – a successful bid would allow him to topple Sunil Mittal as the market leader
- Arun Sarin: CEO of Vodafone, the world’s largest mobile operator (by revenues) – he needs Hutch to satisfy shareholders who want to see a strategy for growth
- The Ruia family: owners of the steel and oil-refining Essar Group and the remaining 33% of Hutch – they have not decided whether to exit along with Li, hold, or try to buy out Li’s stake. They (claim they) have the right to refuse another investor from buying Li’s Hutch-Essar stake.
- Orascom: Egyptian telecom company which owns ~20% of Li’s Hutch Telecom (not Hutch-Essar). If Reliance, Vodafone, and/or the PE firms encounter resistance from the Ruia’s and decide to buy in to the parent company, Orascom (claims it) has right of refusal.
- The Hinduja family: definitely the long-shot here – they may try to make a play for Li’s stake
- Palaniappan Chidambaram: If Essar decides to sell its stake along with Li, then any foreign player will need a local partner – foreign ownership in telecoms is capped at 74%
Increasingly, it looks like this will turn into a battle with Vodafone on one side, and Reliance on the other. Orascom, the Ruia’s, and possibly the Hindujas will try to play the spoilers. Vodafone’s Sarin was in India this past week for a round of meetings with the finance minister and the various executives involved in the deal. Not to be outdone, Ambani made his own trip to North Block, no doubt urging Chidambaram to (wink, wink) help keep the company primarily in Indian hands. Of course, neither Reliance nor Essar have the financial muscle to make a bid that large on their own – so they, in turn, are wooing cash-rich and deal-hungry private equity players including Blackstone, KKR, The Carlyle Group, and others to come on board as partners. Whether or not one or more of these players are eventually involved, this deal will represent a significant turning point in Indian finance – for the private equity industry; and more importantly, in the market for corporate control.
Unlike retail and institutional investors; hedge funds and mutual funds; and other asset managers – private equity firms are known primarily for being active investors. In most cases, these firms buy a large enough chunk of a company to be able to influence management and long-term strategy decisions – usually through directorships. In some cases, the firms seek outright majority control in order to give them the power to replace the management team altogether. Due to the large size of the deals, the investment decisions are usually predicated on an agreed-upon strategy for aggressive growth. Historically, large and established private equity firms have been able to consistently beat market returns – often by large margins – primarily because of this activist investment philosophy (as well as their ability to mobilize large amounts of cheap debt financing).
Private equity firms first came on the Indian radar screen in the mid 1990s. In the ensuing years, some got carried away in tech mania, others made bets on the promise of regulatory change, and some others simply tried to get their footing. With some notable exceptions, the deals were relatively small and foreign interest was minimal. That was, of course, until a US investor sold their $300 million stake in Sunil Mittal’s Bharti-Airtel for an amazing $1.9 billion. Though the returns were certainly a magnificent advertisement for investment in India, another more subtle fact aroused the fancy of the other foreign private equity majors. A majority of the sale was done through three large half-billion dollar block trades – which were almost perfectly absorbed by the capital markets. Finally, they had an ‘exit-strategy’!
A host of big spenders like Blackstone, Carlyle, TPG, and others committed to India in no uncertain terms – poaching away talent, and opening their own big, shiny offices at Nariman Point, Mumbai. The next stage, still ongoing, is the vigorous hunt for good investments. In looking for deals which can satisfy their hunger for returns, western private equity players have found their traditional investment model challenged by three central facts about the current Indian corporate world:
- A hunger for financing so that they can take advantage of the massive growth in opportunities – both in India and abroad.
- An equal revulsion toward ceding any corporate control to the investor – either because the company is family owned, or simply because the owner is worried about the prospect of challenges to his power
- A comparative lack of debt financing in most Indian companies. (This should be a plus because it means that the large companies can absorb a good deal of debt – thus bolstering the investor’s returns.)
In the countries where the industry is most vibrant, private equity
serves a critical economic function: it acts as a powerful force that aligns management’s interests with those of shareholders. It challenges the notion of the almighty CEO or chairman by acting as a check on their power, and benchmarking their performance. Ideally, corporate governance improves, profits grow faster, and operations are more efficient [see comment 1]. This is contingent on the ability of these firms to buy a large enough stake to gain control and be able to influence management in the first place.
Foreign PE firms in India have not quite gotten to this stage yet. Till date, with few exceptions, private equity deals have been financed mostly with equity; and rarely is the investor given anything close to majority control [see comment 2]. Indian CEOs want these firms as ‘partners’ – though not the type that can tell them how best to run their business. However, as the industry matures, and the honchos of the Indian business world move on to these PE firms, this reality is slowly changing and the market for control of India’s most-promising businesses is rapidly expanding. This is most clearly represented by the potential Hutch deal – where a 67% stake is up for grabs.
An expanding market for control is in the best interests of the shareholders of these Indian companies. More importantly, it is in the best interests of the broader economy. As private equity (both domestic and foreign) expands, there will be an increasing premium attached to good management. Growth will be generously rewarded by the market; and disappointing performance will be punished.
Despite this seemingly cold calculus towards management, private equity and venture capital firms are a lot more patient than most other classes of investors. This is because when big-ticket asset managers (like pension funds, oil sheikhs, and university endowments) plow their money into private equity funds, they essentially lock-it in at the sole discretion of the fund’s managers. This gives the manager the flexibility to negotiate long-term strategy with the management teams on potential investee companies, and it gives management the confidence that the investor will not pull out at the hint of trouble; or simply to create liquidity.
Over the coming months, it will be interesting to see what happens with the Hutch-Essar deal. It will represent a significant turning point in the evolution of private equity in India which began about a decade ago.
Will the Ruia’s – who have plainly admitted that their existing business (steel and oil refining) has no overlap with Hutch’s – relent in the face of Reliance Communications and Vodafone (and possibly Orascom), who both have more domain knowledge, financial muscle, and are hungrier (my guess) for market share in the world’s fastest growing mobile market?
What will the entrance of cash-rich private equity firms mean: will they use their international connections to out-maneuver, or will they pay a hefty price to buyout the assorted ‘Rights of First Refusal’?
Or, will babudom prevail – neatly condemning the fate of the deal to the courts?