Growth of Indian Telecom

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Project Report

GROWTH OFINDIAN TELECOM INDUSTRY

(MERGERS & ACQUISITIONS)

Submitted in fulfilment of PGDM

2007-2010

UNDER THE SUPERVISION OF

Prof. Akshey Kumar

SUBMITTED BY

Rajesh KumarR.No. 11/11

Apeejay School of Management, Dwarka, New Delhi.

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CERTIFICATE

This is to certify that the project work done on Growth of Indian Telecom Industry,

(Mergers and Acquisitions) submitted to Apeejay School of Management, Dwarka, by

RAJESH KUMAR in fulfillment of the requirement for the award of PG Diploma in

Management, is a bonafide work carried out by him under my supervision and guidance.

This work has not been submitted anywhere else for any other degree/diploma.

Date: 18/05/10 Name of the guide:

Prof.Akshey Kumar

ACKNOWLEDGEMENT

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I am thankful to my mentor Prof. Akshay Kumar, Apeejay School of Management, Dwarka, New

Delhi, for giving me the opportunity to work on this project and provide me with valuable inputs

throughout the period of completion of this project. I, therefore, express my sincere gratitude for

his constant guidance and motivation without which this project could not have taken its formand shape.

I also thank Apeejay School of Management for providing deep insights in the field of

Management and for constantly guiding me throughout the project.

My project was a great learning experience and for that I shall always be indebted to Apeejay

School of Management.

RAJESH KUMAR

TABLE OF CONTENT

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S.NO. DESCRIPTION PAGE NO.

1. EXECUTIVE SUMMARY 5

2. INTRODUCTION 6

3. LITERATURE (Market Study) 9

Regulatory Environment 10

Key Players 19 Market Share 22

4. RESEARCH 25

Contours of M&A 26 Allure of M&A 27

5. ANALYSIS 32

Major M&A Deals 33 Idea Cellular takeover of Spice 35 Reliance MTN merger failure 43

6. FINDINGS 47

M&A Success or Failure 48

Recent Trends 54

Future Opportunities 55

7 CONCLUSION 57

8. ANNEXURE/ REFERENCES 60

Executive Summary

Indian Telecom industry is the second fastest growing telecom market in the world after China.

The overall tele-density India has reached 48.04% at the end of April 2010. The growth has been

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fueled by progressive policies of TRAI and deregulation. The telecom industry is changing at a

rapid pace with constantly changing policies, new players, alliances and partnerships being

announced on a daily basis.

In this study, I have looked at various M&A transactions that have taken place in the recent

past. After doing a broad review, I have focused on two specific events, namely, Idea Cellular

takeover of Spice Telecom and Reliance MTN merger failure. I have identified the following

trends and drives in the industry:

Global ambitions of Indian Telecom giants will see acquisitions and joint ventures in

growing African and South East Asian markets.

Telecom players are also looking to tap into global funds to finance their aggressive growth

plans. This will result in partnerships joint ventures and equity sellout to foreign players.

New license holders will continue to look to sell their stake at a premium. New policies will

seek to curb this license arbitrage.

Smaller players with operations in only a few circles will find in difficult to compete with

the nationwide players. The industry may see consolidation with these smaller operators

being acquired by the larger ones.

Unbundling of the corporation will continue as companies will seek for economies of

scale and lower startup cost by infrastructure sharing.

3g and WiMax license auctions presently under way will spur M&A and partnership activity

for the over all growth of the market.

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INTRODUCTION

Mergers an d Acqu isition s(M&A) are strategic tools in the ha nd so f m an ag em ent to achieve greater

efficiency by exploitingsynergies and growth opportunities. Mergers are m otivated by d esire to grow

inorgan ically at a fast p ace, quickly grab market share and ach ieve economies ofscale.

The objective of my project is to study the Telecom industry in India and understand how

the recent trends of Mergers, Acquisitions and Partnerships are making it truly an

international business. I will focus on the following two deals in the industry to gain deeper

understanding of the M&A nuances in this industry.

India hasbecome a hot bed of telecom mergers and acquisitions in the last decade. Foreign

investors and telecom majors look at India as one of the fastest growing telecom markets in

the world. Sweeping reforms introduced by successive Governments over the last decade have

dramatically changed the face of the telecommunication industry. The mobile sector has

achieved a teledensity of 44% by the e n d o f A p r il 2 0 1 0which has been aided by a bouquet of

factors like aggressive foreign investment, regulatory support, lower tariffs and falling

network cost and handset prices.

M&A have also been driven by the development of new telecommunication

technologies. The deregulation of the industry tempts telecom firms(telcos) to provide bundled

products and services, especially with the ongoing convergence of the telecom and cable

industries.Theacquisition ofadditional products and services has thus becomea profitable move

fortelecom providers.

Idea Cellular takeover of Spice Telecom: I have selected this as it is one of the biggest

deals that happened in Indian Telecom. It is a deal that will throw light on the consolidation

trends in the Indian Telecom industry.

Reliance MTN merger failure: Studying the drivers in this deal will help me understand

the global expansion trends in the Indian Telecom industry.

The above two deals will provide me with deeper understanding of both consolidation andglobal expansion trends in this industry.

Sector Overview

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Regulatory Environment

Key Players

Recent Trends

Regulatory environment

Telecommunications is one of the few sectors in India, which has witnessed the most

fundamental structural and institutional reforms since 1991. Considering the great potential

for the growth of telephone demand with the accelerated growth of economic activities, the

Government of India announced the National Telecom Policy in 1994 and the New Telecom

Policy in 1999. The National Telecom Policy provides for private sector participation to

supplement the efforts of DOT in basic telephone services. The opening up of the basis

services provided a big opportunity for private & foreign investors. More policy initiatives

include Addendum to NTP-1999, Broadband Policy 2004, Amendment to Broadband Policy

2004 etc.

The opening of the sector has not only led to rapid growth but also helped a great deal

towards maximization of consumer benefits. The tariffs have been falling continuously

across the board as result of healthy and unrestricted completion.

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REGULATORY ENVIRONMENT

M&A in telecom Industry are subject to various statutory guidelines and Industry

specific provisions e.g.

Companies Act, 1956;

Income Tax Act, 1961;

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Competition Act, 2002;

MRTP Act;

Indian Telegraph Act;

FEMA Act; FEMA regulations;

SEBI Takeover regulation; etc.

We will cover some of these regulations hereunder which are unique to the telecom industry.

TRAI Recommendations

Telecom Regulatory Authority of India (TRAI) is of the view that while on one hand

mergers encourage efficiencies of scope and scale and hence are desirable, care has to be

taken that monopolies do not emerge as a consequence.

TRAI had issued its recommendation to DoT in January 2004 regarding intra circle

Mergers & Acquisitions which were accepted by DoT and are stated below.

Regulatory Authority of India Act, 1997 (as amended in January 2000). Under the TRAI Act,

TRAI carries out various functions. It is empowered to make recommendations, either suo-moto

or on a request from the Licensor on a wide range of matters. These include:

the need and time for introduction of a new service provider;

terms and conditions of a telecommunications license;

revocation of licences;

measures to facilitate competition and promote efficiency in the operation of telecommunication

services;

technological improvements in services;

specifications as to the type of equipment to be used by the service providers

measures for the development of telecommunication technology and any other matter[s]

relatable to [the] telecommunication industry in general;

efficient management of spectrum.

ensuring compliance with terms and conditions of telecom licenses;

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fixing terms and conditions for inter-connectivity between service providers;

ensuring technical compatibility and effective inter-connection among different service

providers;

regulating arrangements among service providers for sharing revenues;

laying-down standards for quality of services;

prescribing and regulating periods within which local and long distance telecommunication

circuits are to be provided by service providers;

maintaining a register of inter-connect agreements;

ensuring effective compliance with universal service obligations

fixation of tariffs

DOT Guidelines

Department of Telecommunications (DoT) can be credited with issuing a series of liberalising

initiatives in telecom sector which has led to phenomenal growth of the Industry. Based on

recommendations of TRAI, DoT issued guidelines on merger of licences in February 2004. The

important provisions are state below:

Prior approval of the Department of Telecommunications will be necessary for merger of

the licence.

The findings of the Department of Telecommunications would normally be given in a periodof about four weeks from the date of submission of application.

Merger of licenses shall be restricted to the same service area.

There should be minimum 3 operators in a service area for that ser vice, consequent upon

such merger.

Any merger, acquisition or restructuring, leading to a monopoly market situation in the

given service area, shall not be permitted. Monopoly market situation is defined as market

share of 67% or above of total subscriber base within a given service area, as on the last

day of previous month. For this purpose, the market will be classified as fixed and mobile

separately. The category of fixed subscribers shall include wire-line subscribers and fixed

wireless subscribers.

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Consequent upon the merger of licenses, the merged entity shall be entitled to the total

amount of spectrum held by the merging entities, subject to the condition that after merger,

the amount of spectrum shall not exceed 15 MHz per operator per service area for Metros

and category A service areas, and 12.4 MHz per operator per service area in category B

and category C service areas. In case the merged entity becomes a Significant Market

Power (SMP) post merger, then the extant rules & regulations applicable to SMPs would also

apply to the merged entity. TRAI has already classified SMP as an operator having market

share greater or equal to 30% of the relevant market.

In addition to M&A guidelines, DoT has also issued guidelines on foreign equity participations

and management control of telecom companies.

The National Telecom Policy, 1994 (NTP 94) provided guidelines on foreign equity

participation and as revised by NTP 99 permitted maximum 49% cap on foreign investment.

Recently by its order no. - 842-585/2005-VAS/9 dated 1s t February, 2006 DoT has

enhanced the FDI limit in telecom sector to 74%. The key provisions of these guidelines are as

follows:

The total composite foreign holding including but not limited to investments by Foreign

Institutional Investors (FIIs), Non-resident Indians (NRIs), Foreign Currency Convertible

Bonds (FCCBs), American Depository Receipts (ADRs), Global Depository Receipts

(GDRs), convertible preference shares, proportionate foreign investment in Indian

promoters/investment companies including their holding companies, etc., referred as FDI,

should not exceed 74%. The 74% investment can be made directly or indirectly in the

operating company or through a holding company and the remaining 26 per cent will be

owned by resident Indian citizens or an Indian Company (i.e. foreign direct investment

does not exceed 49 percent and the management is with the Indian owners). It is also clarified

that proportionate foreign component of such an Indian Company will also be counted towards

the ceiling of 74%.

However, foreign component in the total holding of Indian public sector banks and Indian

public sector financial institutions will be treated as Indian holding.

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The licensee will be required to disclose the status of such foreign holding and certify that

the foreign investment is within the ceiling of 74% on a half yearly basis.

The majority Directors on the Board including Chairman, Managing Director and Chief

Executive Officer (CEO) shall be resident Indian citizens. The appointment to these positions

from among resident Indian citizens shall be made in consultation with serious Indian investors.

The merger of Indian companies may be permitted as long as competition is not

compromised as defined below:

No single company/legal person, directly or through its associates, shall have

substantial equity holding in more than one licensee Company in the same service area

for the Access Services namely; Basic, Cellular and Unified Access Service. Substantial

equity herein will mean equity of 10% or more

A promoter company/Legal person cannot have stakes in more than one LICENCEE

Company for the same service area Some exceptions have been

provided to this guideline.

The Licensee shall also ensure that any change in shareholding shall be subject to all

necessary statutory requirements.

As per recent news reports, the Government wants to arm itself with power to block FDI

in case the investment from companies or countries deemed undesirable, even if it is within

the approved limit. This is a positive step due to increasing security concern India is facing

but has led to apprehension that the new law will be used to block investment from certain

parts of the world.

FEMA Guidelines

The foreign exchange laws relating to issuance and allotment of shares to foreign entities are

contained in The Foreign Exchange Management (Transfer or Issue of Security by a person

residing out of India) Regulation, 2000 issued by RBI vide GSR no. 406(E) dated 3rd

May, 2000. These regulations provide general guidelines on issuance of shares or securities

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by an Indian entity to a person residing outside India or recording in its books any transfer of

security from or to such person.

RBI has issued detailed guidelines on foreign investment in India vide Foreign Direct

Investment Scheme contained in Schedule 1 of said regulation. As per the FDI scheme,

investment in telecom sector by foreign investors is permitted under the automatic route within

the overall sectoral cap of 74% without RBI approval.

The salient features of FDI scheme as applicable to telecom sector is as follows:

Industries which do not fall within the ambit of Annexure A can issue shares under

automatic route to foreign companies (Para 2). Since telecom sector is not listed in Annexure

A hence foreign investment can be made in telecom sector upto 74% cap without prior

approval of RBI.

In case, investment by foreign investor(s) in an Indian telco is likely to exceed sectoral cap

of 74%, then they should seek approval of (FIPB) Foreign Investment Proposal Board. (Para 3)

FDI scheme permits automatic approval of transfer of shares from one foreign shareholder

to another, so long as the transfer is in compliance of FDI scheme and the regulation.

(Regulation 9)

However, if the shares are being transferred by a person residing outside India to a person

resident in India, it shall be subject to adherence to pricing guidelines, documentation and

reporting requirements of RBI. Application seeking RBI approval is to be made in Form TS

1. (Regulation 10 B)

The issue price of share should be worked out as per SEBI guidelines in case of listed

companies. In case of unlisted companies, fair valuation method as prescribed by erstwhile

Controller of Capital Issues should be adopted and should be certified by a Chartered

Accountant. (Para 5)

FDI scheme also stipulates the norms on dividend balancing, whereby the cumulative

amount of outflow on account of dividend for a period of 7 years from commencement of

production or services should not exceed cumulative amount of export earning during those

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years. The dividend balancing guidelines are applicable to companies included in Annexure

E of FDI scheme and telecom industry is not included in said annexure. (Para 6)

In case preference shares are issued to a foreign investor, the rate of dividend shall not

exceed 300 basis points over the Prime lending rate of SBI, prevailing on the date of Board

meeting where such issuance is recommended. (Para 7)

The reporting requirement are contained in regulation 9 viz. a) The Indian company should

report the details of receipt of consideration to RBI within 30 days of receipt and b) The

Indian company should submit report of issuance and allotment of shares in Form FCGPR along

with necessary certificates from the Company Secretary and the Statutory Auditor of the

Company.

An Indian Company may also issue shares on Rights basis or issue bonus shares

(Regulation 6A); subject to compliance of conditions of FDI scheme and sectoral cap.

FDI scheme prohibits investments by citizen or entities of Pakistan and Bangladesh

(regulation 5) primarily on security concerns. In the recent past, DoT has also delayed its

approval to an Egyptian companys investment in Hutch India on similar grounds.

SEBI Takeover Guidelines

SEBI takeover guidelines called Securities and Exchange Board of India (Substantial

acquisition of shares and takeover) Regulations, 1997 are applicable to listed Public

companies and hence would be applicable in case of M&A in listed telecom companies like

Bharti, Reliance Communication, Shyam Telecom, VSNL, Tata Teleservices (Maharashtra)

Limited, etc. These guidelines have been amended by SEBI and notified vide SO No. 807(E)

dated 26.05.2006.

The highlights of the amendment are as follows:

No acquirer who together with persons acting in concert with him, who holds 55% or more

but less than 75% of the shares or voting rights of the target company shall acquire by

himself or through persons acting in concert unless he makes a public announcement as per

the regulations. Further, if a target company was unlisted, but has obtained listing of 10% of

issue size, then the limit of 75% will be increased to 90%. Regulation 11(2)

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If an acquirer who together with persons acting in concert with him, who holds 55% or more

but less than 75% of the shares or voting rights of the target company is desirous of

consolidating his holding while ensuring that Public Holding in the target company does not

fall below the permitted level of listing agreement he may do so only by making a public

announcement as per the regulations. Further, if a target company was unlisted, but has

obtained listing of 10% of issue size, then the limit of 75% will be increased to 90%. -

Regulation 11(2A)

The minimum size of public offer to be made under Regulation 11(2A) shall be lesser of

a) 20% of the voting capital of the company; or b) such other lesser percentage of voting capital

as would enable the acquirer to increase his holding to the maximum possible level, while

ensuring the requirement of minimum public shareholding as per listing agreement.

Competition Laws

Competition Commission of India (CCI), established in 2003, holds statutory responsibility for

ensuring free and fair competition in all sectors of the economy. The Competition Act, 2002 has

provided for a liberal regime for mergers, whereby combinations exceeding the threshold limits

fall within the jurisdiction of CCI. The threshold limits are quite high. Most competition laws in

the world require mandatory prior notification of every merger to the competition authority but

under Indian law it is voluntary. However CCI can also take suo motu cognisance of a merger

perceived as potentially anti competitive and it can also enquire until one year after the merger

has taken place. Once CCI has been notified, it must decide within 90 days of publication of

details of the merger or else it is deemed approved. The CCI can allow or disallow a merger or

can allow it with certain modification. Most of the operative provisions of Competition Act have

still not been notified.

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Key players.

BSNL: BSNL recorded a revenue of Rs 35,296 crore in the last fiscal, down from Rs 40,135

crore in FY 2006-07, a decline of 12.1%. The company is looking at new business streams to

increase revenue and reduce losses. BSNL is toying with the idea of entering into managed

network services and enterprise business, which will add value to mobile as well as landline.

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Pre-reform Partial

Deregulation

Further Deregulation Take-off

Pre-1994 1994-1999 1999-2002 2002 ward

s MTNL-

Mumbai and

Delhi: DTS

elsewhere

No mobileservice

NLD-DoT per/

BSNL ILD

4 private fixedserviceproviders withless than 1%market share

2 GSM mobileplayers in eachcircle

13 players start

Licenses converted torevenue sharing

Private sector shareless than 5% inrevenue terms

Competition in NLDand ILD

Licenses on Revenueshare

Calling PartyPays

CDMA launch

3-6 operators ineach circle

Intra-circlemergerguidelines

NationalTelecom Policy(NTP)1994

TRAI constituted1997

NTP 1999

BSNL formedOct.2000

Internet Telephony2002

Broadbandpolicy 2004

NationalTelecom Policy1994

New TelecomPolicy, 1999

Unified

Licensing


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Apart from this the company is also looking at adding IPTV and VoIP services in its portfolio.

BSNL would also be investing Rs 15,000 crore for the next three years in a bid to return to its

profitable position. Like other service providers, BSNL is also planning to focus on the rural

segment in the coming years. BSNL leads the broadband segment, as far as subscribers are

concerned. Currently, the company has 2 mn out of the 3.9 mn subscribers in the country

Bharti: Bhari Airtel as it crossed the magical figure of 100 mn subscribers in the country. The

customer addition has taken its revenue to Rs 32,624 crore (Approx.) in FY 2009-10, clocking

47.8% increase. The company has also formed an alliance with four global IT majors: Alcatel

Lucent owned Mobilitec, Germany-based CoreMedia, US-based Adamind and UK's Apertio for

its service delivery platform. Continuing with its strategy of focusing on its core business and

outsourcing the rest, Bharti signed a $35 mn three-year outsourcing deal with BPO service

provider, Firstsource Solutions. Bharti has launched operations in Sri Lanka and has invested

$200 mn for the same. The company also launched its DTH services. Bharti is focusing on the

rural and enterprise segments as its growth areas.

Reliance: Reliance Communications recorded an increase of 71% in its net profit. And an

increase of 28.8% in its revenue, which is Rs 23,638 crore in fy 2009-10. It received start-up

GSM spectrum. It has huge expansion plans in rural India. It also expanded globally with

acquisition of UK-based Vanco and Uganda-based Anupam Global Soft. In a landmark deal,

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Reliance partnered with Microsoft to deliver IPTV in India on the latter's mediaroom platform.

Reliance Communications will have the exclusive deployment rights for the platform in India.

Vodafone: Vodafone Essar achieved 46.5% rise in telecom revenue in India with its income

from operations touching Rs 22,477 crore in FY 2009-10. Vodafone entered India through its

acquisition of Hutchison Essar stake.

Tata Communications: The Tata-run VSNL created a significant landmark when it announced

financial results for the last fiscal-an astounding growth of 85%, to touch Rs 18,857 crore.

VSNL's transformation has helped it lead in segments such as wholesale voice, wholesale and

enterprise data, and retail broadband; and ensured global infrastructure and global customers

Telecom Equipment Players.

The top equipment players in the Indian telecom space are Nokia, Ericsson, Nokia Siemens

Networks, Alcatel-Lucent, Cisco, Sony Ericsson, Huawei and ZTE.

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THE CONTOURS OF M&A IN TELECOM

M&A are also referred as Corporate Marriages and Alliances. Mergers can be across same or

similar product lines. In many cases mergers are initiated to acquire a competing or

complementary product. A reverse merger is another scenario in taxation parlance where a

profit making company merges with a loss incurring company to take advantage of tax

shelter.

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A horizontal merger (mergers across same product profile) adds to size but the chances

for attainment of profit efficiency are not very high. On the other hand a vertical merger

(entities with different product profiles) may help in optimal achievement of profit efficiency.

Say a mobile operator acquires a national long distance company and thus saves IUC

charges. In telecom Industry, most of the acquisitions were horizontal which helped the acquirers

to expand the area of their operation and customer base quickly. These provided economies

of scale with phenomenal benefit to the acquirers in terms of higher profitability, and better

valuations.

Takeovers generally have three typical patterns:

a) In the first model, the investor acquires a controlling stake in the acquired company and

retains it as a separate entity. This is the simplest model with the intent to avoid the legal

hurdle for merging the company into the parent company. This route also gives the

acquirer a flexibility to sell off the operation on a stand alone basis later on, in case the merger is

not successful. This mode has been followed by Hutchison, which has retained most of the

acquired companies (Usha Martin- Kolkata, Fascel- Gujarat, Aircel Digilink Haryana,

Rajasthan and UP East, Sterling Cellular- Delhi, Escotel - Punjab) as separate legal entities.

b) In the second model, the acquirer merges the acquired company with the parent after

acquiring controlling stake. This model requires completion of merger formalities with dueapproval of High courts and also from DoT. It has the advantage of avoiding statutory

compliance for several entities and integrate all operations seamlessly into a single legal

entity. This model has been followed by Bharti, which has merged most of the acquired

entities with the parent in due course of time.

c) The third model entails purchase of assets of the target company on stand alone basis

without purchasing the company as a whole. In some cases, where the licences were

cancelled by DoT due to default, such companies sold the telecom assets and customerdatabase to the acquirer, who could easily integrate the same into his existing licence and

strengthened his network and customer base at a nominal cost. The seller company which

was stripped of licence as well as telecom network was ultimately wound off.

THE ALLURE OF M&A IN TELECOM

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Indias telecom liberalisation was noticed by Global investors in 1995 when the

Government permitted entry of foreign telecom operators through Joint venture route.

Some of these global giants included Vodaphone, AT&T, Hutchison Whampoa, Telekom

Malaysia, and Telestra Australia. We now need to understand some of the predominant

objective of takeovers in telecom sector, which can be summarised as follows:

Acquisition of licences or geographical territory;

Acquisition of spectrum;

Acquisition of telecom infrastructure and network;

Acquisition of customer base to achieve an economic base;

Acquisition of brand value;

Higher operating profit (EBITDA) margin;

A combination of above.

Market access: There has been almost saturation of demand in the home market of

majority of foreign investors where teledensity ranges from 40% to 100%. On the other

hand, the teledensity in Indian market though currently hovering at 48% is like a low

hanging fruit. The rural teledensity is almost negligible at about 8%. Indias young and

middle class market offers tremendous scope for market expansion and new business. For

example, even after 15 years of economic reforms, sale of most consumer durable goods

has not exceeded Rs. 60 million, whereas telephone penetration has already crossed the Rs.

120 million mark and is all set to cross Rs. 250 million mark by 2010. This huge expansion is

possible only with higher focus on rural telephony, bridging the digital divide and higher

allocation of network and funds to rural areas which are not so rewarding in terms of ARPU.

Spectrum: Spectrum is turning out to be thebiggest bottleneck for Indian mobile operators as

they face network problems, poor voice quality and call dropping. GSM operators initially get

4.4 MHz of spectrum while CDMA operators get 2.5 MHz spectrum. In case of GSM operators

with 10 lakh or more subscribers, they are eligible for 10 MHz spectrum, while CDMA operators

get 5 MHz for 10 lakh subscribers. Since CDMA technology carries the voice in small

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packets, it can carry about five times more traffic and hence has a lower spectrum

allocation.

However, as the number of mobile users is growing at an amazing rate of 4 million per

month), spectrum is falling short of requirements. Thus the foreign investors prefer to acquire

an existing operation to ensure ready availability of spectrum, instead of applying for a new

licence where spectrum allocation from DoT is really a challenging task. The Government is

also taking effective steps to get approx 40 MHz spectrum vacated from Indian defense services

which will give a fresh lease of life to spectrum starved market. This will be a key driver for

all future M&A in India.

Network roll out: Network roll out is a nightmare for telecom operators. It is more complex

for a foreign operator who may not be conversant with local conditions. Network roll out

involves Right of way (ROW) approvals, coordination with local government departments,

acquiring BTS and BSC sites on rentals, acquiring municipal and local approvals to set up tower

and antenna, obtaining electrical connection for the sites, import of equipment, installation of

tower, equipment and shelter, SACFA and TEC approvals, integration of various sites and

final launch of services in a geographical area etc. Generally the time to roll out a network in

a circle takes minimum 6 months to 1-year time. The industry is also resorting to site and

infrastructure sharing with other operators to reduce its capital expenses and operating expenses

cost and optimise profitability.

Human Resource:

The dovetailing of human resources of the acquired company into the culture of parent

company has significant importance in any M&A deal and can even spoil a deal if not

properly managed. It is now an established principle that local leaders decide the successor failure of a cross boarder deal. The savvy acquirer retains competent local leaders and

dangles incentives and awards to align their personal interest with that of the merged

entity. Premium is placed for target companies which have strong management team in

place, lower manpower base and higher employee productivity. Some benchmarks used in

this regard are Number of customers per employee, Revenue per employee per month etc.

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Majority of the telecom companies resort to outsourcing of routine and non core activities

and reduce number of on roll employee to attract better valuations. Hence, it is essential

to make an assessment of the off roll and outsourced staff involved in a telecom operation

to ascertain the true operational efficiency and real manpower cost.

Brand value:

In most cases, where the role in valuation acquisition is for majority control, the foreign

investor is likely to introduce its own brand in India instead of local brand. Hence,

generally no value is placed on brand related expenditure amortised or any goodwill. However,

where the investor takes minority stake and the brand stabilised by the controlling local

partners has become popular, brand value plays an important Better margin possibility: Across

Asia-Pacific, be it China, Indonesia, Philippines, Thailand or Australia, operating margins

(EBITDA) average 40% - 60%, which are considerably higher than the mid-30% for Indian

telecom operators. The EBITDA margin of Bharti Airtel at 37% is the highest among all

telecom operators whereas for other operators it ranges from 11% to 25%. Thus, the scope

for enhancing margins is fairly significant in Indian market since Government levies,

licence fees, etc. are likely to come down to give further fillip to teledensity. The Government is

also providing Universal Service Obligation (USO) support to operators to expand their

network in rural areas. The foreign investors continue to look at India to spread their market.

In the initial years, the number of operators in each circle were limited to four which was

a major entry barrier. Further the entry fee for acquiring a licence was also high. But over the

years, the DoT has been consistently liberalising entry norms and making market access easier

for foreign investors with the ultimate objective of benefiting consumers.

THE VALUATION OF A TELECOM LICENCE

George Bernard Shaw had once said, Economists know the price of everything, but the

value of nothing. This saying is aptly reflected in case of telecom valuation also. The

acquirer pays hefty valuation to acquire an entity and the Business value placed is much

higher than Accounting value.

The local promoters strive hard to enhance the enterprise value of their project by adopting a

multi pronged strategy. This involves a careful incubation of network across the entire

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circle, hiring a strong management team, installing robust billing system, well oiled channel

partner network and above all, an aggressive selling strategy to build a critical mass of

customer base. In their aggression to inflate enterprise value, some operators end up creating

phantom subscribers to attract better valuation. Phantom subscribers refer to low value

prepaid cards, which are sold by channel partners to unwilling end users. These cards are not

likely to yield much revenue to the operator, but just retained as customers to show an inflated

subscriber base and fetch higher valuations.

The Investment banker has to decide what is being valued a) Whether its a valuation

of companys equity or its assets; b) Whether the company is being valued as a going

concern with all its assets and liabilities or is under liquidation; or c) Is it a valuation of

minority interest or a Controlling stake; d) Whether the valuation of entity on per sub base

is appropriate; e) Whether the EV/EBITDA ratio is in line with Industry trend. The list of these

factors is endless. Enterprise value (EV) refers to the market capitalisation of a company plus

debts. When an investor acquires a company, it takes over not only the assets of the

company, but also assumes the liability to pay the existing debts and liabilities of the company.

Thus, Enterprise value is the sum total of all fair value of assets and the liabilities of the acquired

entity. The key performance metrics to evaluate the EV are:

a) EV / EBITDA ratio: This ratio reflects number

of years the unit has to yield operating profit (EBITDA) to return the basic investment made

by the Investor. This ratio is in the nature of PE ratio from the viewpoint of a retail

investor and varies from Industry to industry. In telecom Industry, most of the deals struck

in the past couple of years have been at EV/EDITDA ratio of 6-10 times.

b) EV/Revenue Ratio: This ratio indicates

number of years required to generate revenue to return the investment price paid by the

acquirer. In one way it can be likened to pay-back period. EV/Revenue ratio is on an average

five or less.

c) Per subscriber EV (EV/number of acquired

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subscribers): This ratio represents value placed by the acquirer on subscribers acquired

along with complete network and infrastructure. Smart acquirers on the lookout prefer to

pay a premium for taking over an existing operation say US$ 450 per subscriber as against

network rollout which costs even less than 1/3rd cost @ US$ 100. As we would see later, the

per subscriber rate varies from US$ 400 to US$ 1000. A company earning higher Average

Revenue Per User (ARPU) is likely to command better per subscriber rate. A better rate is

also dependent on other factors like Churn ratio, VAS revenue, type of circle, average life

cycle of customer, subscriber acquisition cost, quality of customers etc. An indicative

Enterprise value can also be computed by multiplying the subscriber base of the company

with the per subscriber rate. For example, if the subscriber base of a telecom operator is

1,00,000 customers and the applicable per subscriber rate for this categor y of operator is

US$ 400, then the indicative enterprise value will be US$ 40,000,000 (US$ Forty million).

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Major M&A deals in Indian telecom sector

RECENT PARTNERSHIPS, MERGERS & ACQUISITIONS

NTT DoCoMo takes stake in Tata Teleservices $10 bn.

New GSM license holders

In January 2008 the Department of Telecommunications allocated 2G GSM spectrum for 120

circles to nine applicantsUnitech, Datacom (Videocon), Loop (BPL), Shyam, Idea, STel,

Spice, Swan and Tata Teleservices.

This allocation based on a first-come first-serve basis and the subsequent second-hand deals

where some global major acquired stake in the new allotee companies valuing them much higherthan the license fee sparked major controversy. Currently there is a proposal under discussion to

ban dilution of promoters equity in a company for 3-5 years.

Telecom Infrastructure (Tower) consolidation Mobile subscriber base is expected to touch 500

million by 2010 for which at least 3.8 lakh more towers are required. In a bid to tap this

opportunity, telecom players have demerged their infrastructure into separate tower business to

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unlock the value by selling minority stake. Reliance Telecom Infrastructure (RTIL) and Swan

Telecom are in advanced talks for a multi-year infrastructure sharing deal. RTIL, which has

about 47,000 towers is the third largest telecoms infrastructure company after Indus towers

(85,000 towers) and Bharti Infratel

The first M&A deal in India was the sale of Mumbai licence by Max group to

Hutchison Whampoa group of Hong Kong. The deal fetched over half a billion dollars for Max

group and was touted as a major success for Indian entrepreneur in telecom venture. This

followed a series of M&A in subsequent years as stated hereunder. Some of the other high

profile deals were Vodaphones acquisition of 10% equity in Bharti in 2006 for US$ 1

billion, Maxis acquisition of Aircel at enterprise value of US$ 1 Billion, Birla Groups

acquisition of Tatas stake in Idea Cellular. Interestingly some of the high profile investors who

had sold their stake around year 2000 are now reentering India like Telekom Malaysia

(exited India in 2000 from Kolkata licence and recently acquired 49% stake in Spice

Telecom) and Vodafone (exited India in 2003 from RPG Cellular Chennai and recently

acquired stake in Bharti). In April 1998, Max group had sold its stake in Mumbai licence to

Hutchison Telecom for US$ 560 million. Somewhere along the way Max group again picked up

a small stake of 3.16% in Hutch and resold it to Essar Group in October 2005 for US$ 147

million. Max India has staged another comeback in Hutch by acquiring an 8.33% from Kotak

Mahindra Bank for Rs. 1,019 crore in 2006. This second return to the telecom business reflects

the buoyant conditions in tele-com sector. The valuation of state owned Bharat Sanchar Nigam

Limited (BSNL) is estimated to be US$ 30 Billion one of the highest in India. On a global

scale, China Mobile has emerged as the worlds most highly valued telco with enterprise

value of US$ 131.46 billion, followed by Vodaphone at US$ 123.11 billion as on July 2006.

From the table, readers can find that average valuation per subscriber ranges from US$ 400 to

US$ 550 which in turn is based on a variety of factors including Average ARPU, type of

circle, competition in the circle, Category of operatorwhether only a Mobile service

provider or an integrated telecom player (like Bharti and Reliance) etc. Valuation is

generally lower in case the acquirer takes a minority stake as against controlling stake.

Similarly, valuation also suffers if the target company is not listed and hence has lower liquidity

(as in case of Idea, Hutch etc). As a thumb rule, suggested by one economist, the differential for

non liquidity of non listed entity could be as high as 20% -25%. While most of the GSM

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operators resorted to M&A in order to achieve growth, Reliance Infocomm did not go for

inorganic route and instead rolled out a green field project. This was also due to the fact that

Reliance had adopted CDMA technology and was able to roll out the network at much lower

costs.

In 2008, Tata communication expanded its global VPN service to china through an

NNI(Network to Network Interface) agreement with Chine Enterprise Netcom Corporation, a

value added telecommunication services and integrated IT solution provider and subsidiary of

CITIC (Chine International Trust and Investment Corporation), allowing them to serve their

many global and India MNC customers who require a single scalable and reliable global VPN

with deep reach into both India and Chine and broad reach around the world.

Idea Cellular takeover of Spice Telecom

On 25th June 2008 the countrys fifth-largest mobile operator in terms of subscribes, Idea Cellular

announced the acquisition of B K Modi-owned Spice groups 40.8 per cent stake in Spice

Communications for Rs. 2,716 crore. Idea acquired the stake at Rs. 77.30 a share. The Birla

group company, Idea Cellular said it would merge Spice with itself through a share swap where

Spice shareholders would get 49 Idea shares for every 100 spice shares held. It will also pay an

additional Rs.544 crore as non compete fee.

Idea Cellular Ltd No. of shares % of totalshares

Dec 2008Locked in-sharesAditya Birla Nuvo Ltd 49,85,97,140 16.08

Tmi Mauritius Ltd 46,47,34,670 14.99Birla Tmt Holdings Pvt Ltd 2,84,74,968 0.92PromotersAditya Birla Nuvo Ltd 83,75,26,221 27.02Birla Tmt Holdings Pvt.Ltd 28,35,65,373 9.15Hindalco Industries Ltd 22,83,40,226 7.37

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Grasim Industries Ltd 17,10,13,894 5.52Igh Holding Pvt Ltd. 24,91,498 0.08Public Shareholding

Tmi Mauritius Ltd. 46,47,34,670 14.99P5 Asia investments Maurities Ltd 33,00,00,000 10.64Monet Ltd 8,95,00,000 2.89Hsbc Global Investment Funds A/C HsbcGlobal Investment Funds Mauritius

8,42,50,000 2.72

Wagner Ltd 6,15,00,000 1.98Lic of India Money Plus 3,93,60,382 1.27Lic of India- Market Plus 3,56,45,682 1,15.

Idea Cellular Overview

Idea Cellular, the leading GSM mobile services operator has licenses to operate in all 22 service

areas of India with Commercial operations in 11 service areas. With a customer base of over 26

millions, it runs operations in Delhi, Himachal Pradesh, Rajasthan, Haryana, Uttar Pradesh

(East), Uttar Pradesh (West) and Uttaranchal, Madhya Pradesh and Chhattisgarh, Gujarat,

Maharashtra and Goa, Andhra Pradesh, and Kerala, hold spectrum for Mumbai, Bihar, Orissa,

Tamil Nadu (including Chennai) and Karnataka and licenses for the remaining six service areas.

With the planned launch of services in Mumbai, Bihar, and Jharkhand in Q3 2008, and Orissa

and Tamilnadu (including Chennai) towards the end of the calendar year, ideas footprint will

soon cover approximately 90% of Indias telephony potential. Idea is listed on the National

Stock Exchange (NSE) and the Bombay stock Exchange (BSE) in India.Idea Cellular is a part of the US $ 28 billion Aditya Birla Group. The group has a market cap in

excess of US $ 31.5 billion, operates in 20 countries, and is anchored by 100,000 employees

belonging to 25 nationalities. Refer to Exhibit 8.4 for financial results summary of Idea Cellular.

Spice Telecom Overview

Spice Telecom is the brand name of Spice Communications Limited, a mobile phone service

provider in India. Spice Telecom was operating in the states of Punjab (India) and Karnataka i.e.

in 2 circles of 23 Telecom Circles of India. Spice Communications Limited was promoted by

Dilip Modi of Modi Wellvest Private Limited, which owned 40.80% of the Company. Telekom

Malaysia Berhad owns 39.20% through TMI India Limited, Mauritius. TMI India Limited is a

wholly owned subsidiary of TMs International investment holding company TM International.

Spice was incorporated as Modicom Network Private Limited on 28 March 1995 as a private

Limited company. Spice subsequently became a deemed public company under Section 43(1A)

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of the Companies Act, 1956 of India with effect from 1 April 1999 and its name was changed to

Modicom Network Limited. Spice assumed its present name via a fresh Certificate of

Incorporation dated 3 December 1999. With the addition of the word Private in Spices name

under Section 43 (2A) of the Companies Amendment Act, 2000 of India, Spices name was

changed to Spice Communications Private Limited with effect from 28 October 2003. On 28

December 2006, Spice was converted into a public limited company and assumed its present

name.

Spice currently offers mobile telecommunication services in the Punjab and Karnataka states of

India. As of 30 April 2008, Spice had 4.4. million subscribers representing a 1.7% market share

in India, and was the second and fifth largest mobile telecommunication service provider within

the Punjab and Karnataka circles respectively.

Spice was listed on the Bombay Stock Exchange Limited on 19 July 2007, and on the National

Stock Exchange of India Limited on 16 June 2008. Refer to Exhibit 8.2 for financial results

summary of idea Cellular.

TM International Overview

TM International (TMI) is an emerging leader in Asian telecommunications with significant

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Spice Communication Ltd. Type / Name of holder No. of shares % of total

sharesDec 2008Locked in shares

Idea cellular ltd. 13,79,85,000 20

Promoters

Tmi India Ltd. 33,80,63,250 49

Idea Cellular Ltd. 28,34,89,350 41.09

Green Acre Agro Service Pvt. Ltd. 6,07,68,043 8.8


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presence in Malaysia, Indonesia, Sri Lanka, Bangladesh and Cambodia. In addition, the

Malaysian-grown holding company has strategic mobile and non-mobile telecommunications

operations and investments in India, Singapore, Iran, Pakistan and Thailand.

The Groups mobile subsidiaries and associates operate under the brand name Celcom in

Malaysia, XL in Indonesia, Dialog in Sri Lanka, AKTEL in Bangladesh, HELLO in

Cambodia, Spice in India, M1 in Singapore, and MTCE in Iran (Esfahan).

Listed on Bursa Malaysia, TMI is among the top ten biggest public listed companies in Malaysia

by market capitalization, and the first listed pan-Asian pure cellular service provider in the

region.

The Group, including subsidiaries and associates, has over 44 million mobile subscribes in Asia,

putting it among the largest mobile telecommunication providers in the region by turnover. The

Group has approximately 13,000 people under employment in ten countries.

Synergies Anticipated

This deal gave Idea Cellular another 44-Lakh subscribers of Spice Communications in Punjab

and Karnataka circles in addition to own 2.6 crore subscribers in 11 circles. The acquisition of

Spice gives idea the much needed headway in Punjab and Karnataka states that account for

more than 10 per cent of Indias wireless subscribers. It will give us incumbent advantage in

both these circles, said Mr.Kumar Mangalam Birla, Chairman, Aditya Birla Group. We are

now in the big league of telecom players in the country. Added Mr Birla. Idea Cellular would

get hold of crucial spectrum of licences recently got by Spice for operations in four more circles

including Delhi, Tamil Nadu & Andhra Pradesh.

The primary benefits of this transaction are:

Idea gains entry in the contiguous wireless markets of Punjab and Karnataka, which account of

11% of Indias total wireless subscribers.

Spice, a pioneering operator, delivers a strong running start in Punjab and Karnataka.

4.4 million subscribers as at 30 April 2008,equivalent to a 15.1% market share in the two service

areas.

# 2 wireless operator in Punjab with a 22.3% market share.

Idea to consolidate its position with its all-India subscriber market share increasing from 9.5% to

11.1%. Importantly, Idea would be No.1 in 3 service areas, in the top 3 in 5 more service areas,

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and with a rapidly improving share in all its other operating service areas.

Ideas operations in the 900 MHz GSM spectrum band will increase from the current 7 services

areas to 9 service areas, driving scale economies and operational synergies resulting in lower

operating and capital expenditure.

TMI, an emerging leader in Asian telecommunications with over 44mn subscribers and a

presence in 10 countries, will grow its presence in the Indian telecom sector and become

substantial shareholder in Idea. The primary benefits of TMIs investment into Idea are:

Idea is currently rolling out operations in Mumbai, Bihar, Orissa, and Tamil Nadu (incl. Chennai)

services areas, and will also roll out in the remaining service areas of Kolkata, West Bengal,

Assam, North East and J&K, after receipt of spectrum. This investment will support ideas

aggressive growth plans.

Idea and TMI will develop areas for business co-operation to leverage TMIs strong presence in

10 principal Asian Market, including neighboring countries like Sri Lanka & Bangladesh where

TMI is a market-leader. TMIs experience of operating 3G in similar markets will be of value to

Idea, as also the convergent interests of the 2 companies in areas extending from international

traffic to roaming, to mobile value added services etc. Idea and TMI would sign a Business

Cooperation Agreement to this effect.

Mr. Kumar Mangalam Birla, Chairman, Idea Cellular Limited said: This announcement marks

a major step in the Aditya Birla Groups telecom business. Idea has performed strongly, but I

believe its best lies ahead. Idea will benefit operationally by leveraging synergies with TMI

which will be a significant shareholder in our Company. Further, I look forward to welcoming

colleagues from Spice into the Idea family, and indeed the over 100,000 strong Aditya Birla

Group. Together we aim to grow a top class organization in the service of our subscribers.

Mr. Sanjeev Aga, Managing Director, Idea Cellular Limited said: The strategic import of this

move travels beyond Punjab and Karnataka. By the end of the year the idea yellow will

increasingly colour the Indian landscape.

In addition, the resulting infusion of funds from TMI will (Rs. 7300 crore) will support the

capital requirement for

Expansion from 11 service areas to PAN India by CY 09.

Capex plan of ~ Rs. 65bn for FY 08-09 and ~ Rs.60 bn for FY 09-10 for existing service areas

and new launches (excluding 3G)

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Current Status

Idea has launched its brand in Punjab on Dec 19,2008 and in Karnataka on Dec 29,2008. It has

also announced plan to invest 300 cr. In Karnataka to expand its reach and services.

Deal Structure

The takeover deal was a complex one. Idea will be acquire the Modis 40.8% stake in Spice (for

Rs.2,720 crore) at Rs. 77.30 per share. According to the complex agreement, TM International

(TMI), the Malaysian telecommunication giant holding 39.2 per cent stake in spice, will swap its

stake for Idea shares and will be offered 469 million shares by way of preferential allotment of

shares in Idea at a price of Rs. 156.96 a share. This will take TMI stake in idea to 14.99 per cent.

The TMI will invest Rs.7,500 crore for buying this stake in Idea Cellular and a part of these

funds will be used to buy Modis stake. The balance Rs. 4,500 crore will be used to retire the

bebts in Ideas books, Birla said, TMI will get one seat on Ideas board.

Spice holding structure before the acquisition was:

40.8% Modi Group (Promoter)

39.2% TMI

20% Other public shareholding.

Spice holding structure as to today is (Refer to Exhibit 8.1 for details):

49.9% Promoter Group including Idea Cellular

49.0 TMI

1.1% Other (public )

Current idea holding is as follows (Refer to Exhibit 8.3. for details):

49.13% Promoter and Promoter Group

14.99% TMI

35.88% Other public shareholding including institutions

Planned Merger

Idea Cellular has said it would merge Spice with itself through a share swap where Spice

shareholders would get 49 Idea shares for every 100 Spice shares held. However at the current

(Feb 12,2009) price levels:

Spice Communication Stock Price = Rs.77.0

Idea Cellular Stock Price = Rs. 49.15

At current prices, Spice communications shareholders will lose when the share swap happens.

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One reason for the high price for Spice could be that only 1.1% of its shares are currently

floating and news reports suggest a lot of speculative buying and selling is happening.

20% open offer

The SEBI Takeover Regulations at the very rudimentary level is all about giving the public

shareholders an opportunity to get the same price which a shareholder usually a promoter

gets on a negotiated deal. The regulation ordain an acquirer 20 per cent of the stake from the

Public after having acquired 15 per cent or more of the same from the promoters. As per the

SEBI SAST (Substantial Acquisition of shares and Takeovers) Regulations, in a listed

companys acquisition if promoters sell out to a new company, public shareholders are also

entitled to the same per share amount.

As per the Idea Spice deal, Idea launched the mandatory 20% open offer for the spice

shareholders, jointly with Telekom Malaysia International (TMI) at Rs.77.30. The open offer

commenced on 17th Septemeber 2008 and closed on 6 th October 2008. Following the successful

completion, the above 40.8% stake which was hitherto held in an escrow account pending open

offer formalities stands transferred to Idea as of date.

Non Compete fee

Sometimes, these deals involve a non-compete fee xvi, a sum payable to the promoter for not re-

entering the same field for a certain period. That the fee is discretionary is evident from not all

deals having a non compete component. The logic for the non-compete is that the promoter has

certain unique skills and possesses industry knowledge, and if he were to start the same business

again, he could become a formidable competitor. That entitles them to a payment which is not

given to minority shareholders, because obviously they do not possess these skills. What this

means is that in the above cases, the public shareholders got a lesser amount than the promoter.

Regulations 20 (8) of the SEBI SAST says: (8) Any payment made to the persons other than

the target company in respect of non-compete agreement in excess of 25% of the offer price

arrived at under sub-regulations (4) or (5) or (6) shall be added to the offer price.

Idea will pay approximately Rs.544 crore as non-compete fee to the Spice Group. This is an

addition to the Rs.77.30 per share that the Idea will pay for acquiring 40.8% stake (Rs. 2,720

crore) . Hence the total payment to Spice Group is Rs.3,264 crore (Rs. 2,720 crore+ Rs. 544

crore). In the absence of non compete fee the Idea group would have to offier a higher per share

price to Spice Group and as a result to other shareholders (for 20% open offer).

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Valuation

A back- of -the envelope estimate of valuation of Spice can be arrived at based on the (Enterprise

Value) / (Number of subscribers) multiple.

Idea has paid Rs. 2716 Crore for 40.8% stake in spice. Hence the total enterprise value (100%) of

Spice will be Rs. 6657 Crore approximately. With a subscriber base of 44 lakh subscribers, the

Enterprise value per subscriber comes out to be approximately Rs. 15,129 or approximately $

300 (Assuming USD 1 = Rs. 50) as per this transaction. This is on the lower side as generally EV

per subscriber ranges between $ 400 to $ 550. One of the reasons for this low valuation could be

that Spice is present on only 2 circles. Spice has also underperformed as compared to other

players . It has a lower EV/EBITDA multiple, ROCE and EV/Subscriber. A comparison of these

metrics (in January 2008) across players is shown belowxvii..

Summary

The drivers for this deal are as follows:

TMI

Grow presence in growing Indian Telecom Sector via ownership in a large Indian telecom

operator.

Idea Cellular.

Inorganic expansion in Karnataka and Punjab circles.

Infusion of funds from TMI to support Ideas aggressive growth plans.

Technical expertise from TMI including 3G operations

Leverage TMIs strong presence in 10 principal Asian markets, including neighboring countries

like Sri Lanka & Bangladesh where TMI is a market-leader.

Spice Communications

Being a small player in a highly competitive market requiring huge investments and economies

of scale is not sustainable.

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Reliance MTN merger failure

MTN Group

MTN was launched in 1994. It has a market value of about $ 38 billion and more than 68 million

customers across 21 countries in Africa and the Middle East. MTN is operating services in

Africa, Iran, Afghanistan and Syria. These are high potential markets. Some analysts have

estimated that MTN has potential to accumulate up to 240 million subscribers in these markets

by 2012.

Reliance Communications

Reliance Communications Limited founded by the late Shri Dhirubhai H Ambani (1932-2002) is

the flagship company of the Reliance Anil Dhirubhai Ambani Group. The Reliance Anil

Dhirubhai Ambani Group currently has net worth in excess of Rs. 55,000 crore (US $ 14 billion),

cash flows of Rs.11,000 crore (US$ 2.8 billion), net profit of Rs. 7,700 crore( US$ 1.9 billion)

and zero net debt. Rated among Asias Top 5 Most Valuable Telecom Companies, Reliance

Communications is an integrated telecommunications service provider. The company, with a

customer base of over 48 million including over 1.5 million individual overseas retail customers,

ranks among the Top 10 Asian Telecom companies by number of customers. Reliance

Communications corporate clientele includes 1,850 Indian and multinational corporations, and

over 250 global carriers.

Reliance Communications has established a pan-India, next generation, integrated (wireless and

wireline), convergent (voice, data and video) digital network that is capable of supporting best

of-class services spanning the entire infocomm value chain, covering over 15,000 towns and

400,000 villages. Reliance Communications owns and operates the worlds largest next

generation IP enabled connectivity infrastructure, comprising over 165,000 kilometers of fibre

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optic cable system in India, USA, Europe, Middle East and the Asia Pacific region.

Relieance Communications (previously Reliance Infocomm) was formed in 2005 when Anil

Ambani and Mukesh Ambani carved up the Reliance empire, which included telecom, oil, and

financial services, after a rivairy developed between them when their father died in 2002 and left

no will. When lacking a will, the sibs developed some ill will toward each other. An agreement

was hashed out by their mother,under which Anil Ambani took the telecom, energy, and

financial services assets while Mukesh Ambani took the oil and petrochemical business to form

Reliance Industries.

Reliance has rapidly become a global wireline and wireless powerhouse, having acquired

companies such as U.S. based Yipes Enterprise Services in recent years

Reliance in talks with MTN: Exclusive negotiationsxxi

As soon as Bharti backed out of MTN, on May 26th Reliance Communications Ltd. (RCom)

stepped in, and the two have now entered exclusive negotiations for a period of upto 45 days

with respect to a potential combination of their businesses. Shri Anil Dhirubhai Ambani,

Chairman of Reliance Communications, said We are delighted to be engaged in exclusive

negotiations with MTN Group to achieve a partnership , which would provide investors,

customers and the people of both companies a unique and global platform for exponential

growth, creating substantial long term shareholder value .

The discussion were around a broad framework, where MTN would take up to 74 percent in

Reliance Communications and Reliance Chairman Anil Ambani could swap between 43 and 63

percent of his holding, depending on the success of an open offer, to become the biggest

shareholder in MTN.

Morgan Stanley had estimated an open offer for Reliance Communications shareholders could be

at 613 rupees per share, a 7 percent premium to the stocks closing price on May 23, the last day

they traded before the firms said they were in talks.

The Reliance-MTN deal was complicated by restrictions on foreign ownership in India and

South Africa and political sensitivities in each country about which company would be dominant.

Under South African rules, buying 35 per cent of a company obliges the purchaser to make an

open offer for the rest. India limits foreign ownership in the telecoms sector to 74 per cent and a

purchase of 15 per cent of a company triggers a mandatory open offer for another 20 per cent.

Mr.Ambani owns 66 per cent of Reliance Communications, valued at about $ 520 billion, and

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intends to exchange this under a mechanism, yet to be agreed, for a 34.9 percent stake in MTN.

The deal would represent the biggest foreign direct investment in India to date and Mr.Ambani

would become the single largest shareholder in the South African company. The deal could

involve cash as well as equity to avoid breaching the restrictions - especially on Reliance, which

is already 11 per cent foreign-owned. Mr. Ambani is reported to be offering to buy MTNs shares

at a significant premium in exchange for management control.

Economic Times reported that the two sides were negotiating the ratio for a share swap.

Mr.Ambani was pushing for 66 MTN shares for 100 Reliance ones, while MTN wanted 51 MTN

shares for 100 Reliance shares, it said.

Some proposed details of the deal were;

Deal expected to be a part-cash and part-equity deal with a west Aisa-based sovereign wealth.

It might commit close to $ 10 billion to ADAG.

A special purpose vehicle will be created for this deal with ADAG, which will have the

controlling stake.

Deal needs approval of black empowerment group as a non-South African company will have

majority stake.

Sources said the other equity holders of the SPV are expected to chip in around $ 4 billion. Given

MTNs current valuation of nearly $ 28 billion, a deal is expected to be done at a valuation of

around $ 35 billion, assuming a 20% premium. This means, the SPV may need to pay around $

11-12 billion for a 35% stake .

Given the other equity holders contribution of $4 billion, RCOM will have to chip in around $7

billion to $8 billion. This is likely to be funded by a mixture of internal accruals and debt. The

exact amount of debt depends on the amount of equity which RCOM is willing to put in. The

acquisition cost will go up if RCOM is allowed to hike its stake further to 40%. Both the parties

are yet to arrive at the exact deal size which would depend on the premium, sources said xxiii .

Lombard Odier Darier Hentsch & Cie, promoted by Lebanons former prime minister Najib

Mikati, holds 9.82 per cent, Newshelf 664 (Proprietary) Ltd holds 13.06 per cent and directors

and subsidiaries hold 0.03 per cent. The public and financial institutions hold the rest.

The Failure: Sibling Rivalry

On June 12th 2008, in a male fide effort to disrupt the talks, Reliance Industries Ltd (RIL), part

of the Mukesh Ambani group, sent a communication to MTN Group, making a claim of an

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alleged right of first refusal to buy the controlling stake in Reliance Communications Ltd.

(RCOM). The letter further said that RIL will take legal action against RCOM and also make

exemplary damages against MTN. Reliance communications spokesperson refuted the claim

saying RILs claim is legally and factually untenable baseless, and misconceived.

RIL based its claim on an agreement of January 12, 2006, which was unilaterally signed only by

RILs officials, when RCOM was under RILs control, under a procedure which the Honble

Bombay High Court, vide its judgement dated 15th October 2006, has held to be unfair and

unjust.

In July 2008, Reliance Communications Ltd. (RCom) and African operator Mobile Telephone

Networks (MTN) have walked away from M&A talks owing to certain legal and regulatory

issues, namely an ongoing feud between Reliance chairman Anil Ambani and his brother

Mukesh Ambani, chairman of Reliance industries.

On July 9th 2008, RCOM and MTN agreed to continue their negotiations in relation to such

potential business combination, and have extended the period of exclusivity until 21 st July 2008.

However, on July 18th 2008, the two companies mutually decided to allow the Exclusivity

Agreement to lapse citing certain legal and regulatory issues.

Summary

The Reliance-MTN deal would have created a $66 billion emerging- markets telecoms group

with operations in about two dozen countries and about 120-million subscribers. This episode

highlighted the following issues:

Such cross border deals need to be sensitive to the issue of national pride and control

of the Companies.

Who controls which entity and ultimately who is taking over whom is an important

consideration in this kind of merger of equals.

Many Indian businesses are owned and controlled by promoter families. The issue of loss of

control and the difference of opinion among family members is an important consideration for

such deals. This came to fore in the Reliance MTN deal.

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M&A IN INDIAN TELECOM

SUCCESS or FAILURE

A merger to be successful should create new capabilities, offer better value proposition to the

combined entitys customers and above all enhance shareholders value. Empirical studies

prove that M&A brings with it the advantage of synergies to the operators and in majority

of cases results in immense increase of shareholders value. M&A in Indian telecom industry

has also benefited other stakeholders i.e. customers, Indian economy and society at large.

M&A have acted as catalyst to stupendous growth in teledensity to 14% in 10 years

(1995 -2006), as against 2% in 48 years (1947-1994) of independence. According to a study

conducted by the reputed international agency, OVUM on The economic benefits of

mobile services in India on behalf of Cellular Operators Association of India, it was found

that mobile sector has generated 3.6 million jobs directly or indirectly and the same will

rise by at least 30%. Similarly the Mobile industry contributes over Rs. 145 billion per

annum by licence fees, spectrum fees, import duties, taxes, etc. Taking the OVUM findings

on the base of 48 million subscribers in January 2005, COAI has estimated that at a

mobile subscribers base of 200 million in 2007, the industry would contribute over 10

million jobs and over Rs. 500 billion annual revenue to the Government.

From foreign investors perspective, they have immensely gained from investing in India. As

per recent news, out of Hutchisons total global revenue of Rs. 13440 crores, over 45%

comes from India which is no mean achievement. Indian promoters who commenced their

telecom operation on a small scale in few circles, gained immensely on sale of their stake to

foreign investors. In fact, some of the worlds largest telecom companies, who have left

India with a bitter experience a few years ago like British Telecom, Vodaphone, France

Telecom, Telekom Malaysia, Telestra Australia are all set to return even as minority

shareholders on witnessing telecom success story.

ACCOUNTING ISSUES

The accounting issues arising in any M&A include merger accounting by the acquirer,

treatment of goodwill and reserves of the acquired company, treatment of Goodwill/capital

reserve arising on M&A, choice of the method of accounting pooling of interest or

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purchase method, accounting for share of profits/losses and dividends for investments made in

Indian operating company.

Accounting Standard 14 classifies amalgamations (also referred as business combination)

into two categories for the purpose of accounting

a) amalgamation in the nature of merger and

b) amalgamation in the nature of purchase. AS 14 provides that in case of amalgamation

in the nature of merger, pooling of interest method is to be applied, whereas for other cases

purchase method is to be applied. This standard is appli-cable only if two or more entities are

merged to form a new entity. In case of takeover of majority interest which does not yield to

formation of a new merged entity, AS 14 is not applicable. In order to apply pooling of interest

method (in case of merger scenario) five conditions have to be fulfilled i.e. a) transfer

of all assets and liabilities to transferee company b) 90% of shareholders of transferor

company should become shareholder of transferee company c) Consideration for purchase

should be paid by issue of equity share of transferee company d) Continuation of business

of the acquired company and e) No adjustment to be made for assets and liability taken over.

Since in most of the telecom acquisitions, conditions No. (B) and (C) are generally not

applicable, the purchase method is applied for takeovers.

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IFRS 3 prohibits pooling of interest method and permits only purchase method of accounting

by the acquirer

in M&A. With issuance of IFRS 3, IAS 22 stands withdrawn. The significant changes

introduced by IFRS 3 are as follows:

In June, 2001, the US Financial Accounting Standards Board (FASB) adopted two new

accounting standards: FAS 141 Business Combinations and FAS 142 Goodwill and Other

Intangibles which was applicable for business combinations from 1 July 2001. These

introduced major changes in US accounting as follows: a ban on pooling (i.e. merger

accounting); all business combinations are to be treated as purchases (i.e. acquisitions); no

amortisation of goodwill and in most cases, annual testing for goodwill impairment testingrather than amortisation, for acquired intangible assets with indefinite lives. Takeovers in Indian

telecom industry have seen following common accounting and financial issues:

In telecom acquisitions, goodwill is stated at cost/book value less accumulated

amortisation and is amortised on straight-line basis over the remaining period of service

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licence of the acquired company from the date of acquisition. For example, say A Limited

acquired B Limited at a purchase consideration of US$ 1.5 billion, as against the book value

of US$ 1 billion on 1s t August 2006. The licence of B Ltd is expiring on 30th July 2016. In this

case, US$ 500 million is the goodwill in the books of A Limited and will be amortised over

next 10 years being the balance period of licence of B, on SLM basis,

In case of change of brand and launch of ten off fully. For example, when Hutchison

finally decided to introduce Hutch Brand on consolidation of its operations across India, it had

to write off all the local brands like Orange, Fascel, Command etc which were am-ortised earlier.

Major write off of debts is also seen. For example, upon demerger of Reliance Infocomm

from Reliance Industries Limited, over US$ 1 billion were written off from the Balance Sheet

which included; inter alia, bad debts, receivable etc.

Change in key accounting policies of acquired unit in line with the acquirers accounting

policies, like revenue recognition, treatment of licence fee payment, debtors provisioning,

treatment of activation revenue.

In many cases, the new operators also junk the existing billing system leading to major write

off.

Intelligent network (IN) system is the heart for credit monitoring and management of

prepaid services. In some cases, IN system of a preferred vendor is installed leading to

junking of existing IN system and its resultant write off.

TAXATION

Following are the major taxation issues in any M&A deals including telecom sector:

1) Carry forward of losses of the acquired company.

2) Capital gains on sale of shares by Indian shareholders.

3) Capital gains on sale of shares by foreign shareholders.

Carry forward of losses:

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The Income Tax law relating to carry forward of losses are contained in Section 72, 72A

and Section 79 of the Income Tax Act, 1961. While Section 72 provides timeline for

carry forward of losses, Section 79 stipulated conditions for carrying forward of losses.

Capital gains

The capital gains arising from transfer of shares is liable to taxation under the Income Tax

Act depending upon the nature of gain, whether it is long term or short term. Section 112

provides for taxation of long-term capital gains (LTCG). However, Section 10 (38) in-troduced

in 2004 provides for full exemption from Income Tax for long term capital gains (LTCG)

provided a) The capital gain arises on transfer of shares of listed public companies; b) At the

time of transfer, the transaction is chargeable to securities transaction tax (STT ). In case of short

term capital gains on listed securities (arising in less than 12 months), on fulfilling same

conditions, Indian investor has to pay tax on STCG @ 10% u/s 111A. Twelve months

holding period is appli-cable only for listed securities, in case of unlisted securities, the minimum

holding period has to be 36 months, before it qualifies as long term.

Section 10(23G)

This section was introduced in 1995 with an objective of promoting investment in telecom

sector by Indian and foreign investors. Telecom operators, whether listed or not were

required to get the approval of Ministry of Finance u/s 10(23G) on submission of

requisite details. In case a telecom entity was approved under this section, the investors in

such entity were entitled, objective of promoting investment in telecom sector by Indian and

foreign investors. Telecom operators, whether listed or not were required to get the

approval of Ministry of Finance u/s 10(23G) on submission of requisite details. In case a

telecom entity was approved under this section, the investors in such entity were entitled, inter

alia, tax exemption on long term capital, interest on long term finance and dividend. The

approval was given by Ministry of Finance (MOF) on year-to-year basis or for a block of years

based on satisfying eligibility criteria

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The Mauritius connection

The scenic Mauritius has emerged as the favourite landing point for foreign investors for

FDI in Indian telecom companies. Mauritius accounts for more than a third of the aggregate

FDI inflows. Indias tax treaty with Mauritius provides exemption from capital gain

arising out of Investment in India made by a Mauritius resident company. A common strategy

adopted by foreign investors is to hold the shares of Indian operating company through

Mauritius based special purpose vehicle (SPV). In case of exit, these SPVs are sold to

foreign investors who land in Mauritius. Board level changes are made in such SPV and new

investors take control of the SPV and nominate their representative on the Indian telecom

company. In such a case, in accordance with DTAA with Mauritius, no capital gains tax is

levied on the foreign nvestor. No transfer is needed to be recorded in the register of transfer

of Indian telecom company as the same Mauritius SPV continues as a shareholder.

Mauritius accounts for more than a third of the aggregate FDI inflows. Indias tax treaty with

Mauritius provides exemption from capital gain arising out of Investment in India made by a

Mauritius resident company. A common strategy adopted by foreign investors is to hold the

shares of Indian operating company through Mauritius based special purpose vehicle (SPV). will

take necessary steps to ensure compliance of the proposed guidelines by a) offloading the

minimum stake required for listing on Mauritius based stock exchanges and listing of their

SPV b) Maintaining office infrastructure and incur operational expenditure as per proposed

guidelines.

Licence fee on sale proceeds of licence:

As per current licensing guidelines, telecom operators have to pay licence fee on

Adjusted Gross Revenue (AGR) which includes non operating revenue like revenue from

handset sale, Interest revenue etc. There is no clarity whether the sale proceeds of a

telecom licence will be included within the levy of AGR and attract licence fee.

In this regard, lets review the case of Shyam Telecom Ltd (a DoT licencee itself ),

Holding company of Hexacom (Rajasthan Licence) who sold its Hexacom operation. The

following extract from the Annual report of Public listed company Shyam Telecom (Year

2006, page 53) is self explanatory: The company sold its holding in HIL to Bharti Televenture

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Limited for a consideration of Rs 1751.87 Million. With respect to Income arising on

transaction referred above, the company based on a legal opinion believes that it is not

covered under the definition of Adjusted Gross Revenue, as inter alia, such revenue do not

accrue out of operation licenced or require to be licenced by DoT The issue is covered under

generic petition filed by Association of Basic Telecom operators (ABTO) with TDSAT

contesting the inclusion of non telecom related service revenue in the AGR which is pending

resolution. In view of the legal opinion obtained by the company and the above petition filed

by ABTO with the TDAST, the company is of the opinion that no revenue share is payable from

sale of above investments and has accordingly made no provisions in its books of accounts.

As the telecom operators consolidate their op-eration, they are likely to utsource more and more

operational and financial activities. Chartered Ac-countant firms which have attained economies

of scale and have knowledge base, operational skills, IT savvy team, cost effective manpower

support are likely to see a vista of opportunity ahead of them in Indias telecom Industry.

Recent trends

The world in the last decade has seen a boom in the number of mobile subscribers. Fixed line

subscribers on the other hand have remained more or less flat or down with some increase in the

developing markets. Figure below shows that the trends of fixed telephone lines in the period

1997-2007. Sector Mobile subscribers on the other hand have increased exponentially reaching a

penetration of 49 per 100 inhabitants worldover. Mobile penetration in India is currently around

35%. Internet has caught on in the developed world with penetration reaching 62 per 100

inhabitants in 2007. However, in the developing world internet penetration is still abysmal. In

2007, only 17 per 100 inhabitants had used internet on an average. had used internet on an

average.

The following figure shows the growth in wireless subscribers in India. The number of

subscribers was very small prior to 1998. The sector has exploded since then due to a favorable

regulatory environment and intense competition.

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India has one of the lowest average revenue per subscriber (ARPU) rates. The ARPU was Rs.

239 in June 2008x. As more subscribers are added from the rural areas, which represent a

majority of the unpenetrated market, ARPU is expected to go down further. This trend is seen in

the figure below. The number of internet subscribers in India is on a steady rise. Many of the

wireless service providers are also providing internet subscribers in India is on a steady rise.

Many of the wireless service providers are also provid

Growth of Indian Telecom

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