Why Vodafone paid $18.8 billion

Charles Assisi / TNN / Feb 13, 2007, 01:23 IST

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Much like people need to eat, they need to communicate. And because they eat and talk, they appreciate food and telephones.

MUMBAI: Much like people need to eat, they need to communicate. And because they eat and talk, they appreciate food and telephones. Theoretically, therefore, companies that offer food and communication services ought to be hugely profitable. The premise is a simple one. But strangely enough, people aren't. Which is why, both the food business and telecom business are horribly complex ones.
For the moment though, because Vodafone just paid an obscene amount of money to get a foothold into India, we'll stay clear of food and simply ask a fundamental question.Why would anybody pay $18.8 billion to get a foothold in India?
If the numbers are anything to go by, Indians are among the stingiest folks on the planet when it comes to using their cellular phones. Apparently, the average revenue per user (ARPU) is just $8 (approximately Rs 360). As against this, the equally miserly Chinese pay a little more and generate an ARPU of $9.43 (Rs 423).
Now consider this. At $18.8 billion for Hutch Essar, to acquire each of these Indians who spend barely $8 each month ($96 annually), Vodafone paid $794. If each of these users continues to use their phones as they do now, it will take Vodafone at least eight years to recover their investment.

Ask an analyst though and he'll tell you Vodafone got itself a pretty damn good deal. As Harit Shah of Angel Broking points out, "If we compare this to the valuations enjoyed by Bharti Airtel at around $1,040 per subscriber, it comes at a reasonable discount".
So what's going on really?
Across the world, if there is one consistent trend, it is this. Even as the numbers of phones people carry grow, they are talking less. In mighty Japan for instance, where people live on their phones, ARPU declined $8 from 2004 levels. Add to this significant ARPU drops in countries like Switzerland, Finland and the US and it becomes fairly obvious why telecom operators are getting desperate.

To get around this paradox, phone companies, are increasingly pushing value added services. For instance, you're told what fun it is to send a text message. For that matter, you can pleasure yourself by accessing the internet on your phone or flirting with some cool chick using instant messaging services. Thanks to these data initiativesas opposed to the more conventional voice services — ARPU from data is on the rise.
Coming back to Japan, 17% of the overall ARPU is now generated by data services. In varying percentages, these numbers of true of countries like South Korea, Italy, Australia, UK and US. But these gains are not enough to offset the losses they are raking in on account of a decline in ARPU generated by voice.
Therefore, if telecom operators have to survive in the long run, they need to look at markets where the upside potential is huge — the biggest of which are India and China. While both of these countries deliver very low ARPUs, they make up in terms of volume. In China for instance, data ARPU is just $2 — but the sheer volumes of users delivered $5 billion to telecom operators. It is much the same thing in India — data ARPU accounts for only $1.2.
But the point is this: China Mobile has overtaken Vodafone as the world's largest telecom operator. And there are more Indians signing up for mobile services than anywhere else in the world.
Add to this another variablethe operating expenditure per subscriber (Opex). In India, it is just $5.49 while in China it is even lower $4.73. The Opex keeps going down as the numbers of subscribers go up. In more developed markets, the room to rope in more people has for all practical purposes has begun to taper off.
Thanks to all of these, the EBITDA margins (a measure of a company's cash flows before certain deductions) of Indian and Chinese operators are in excess of 40%. It compares favorably with that of Western operators who are struggling to keep their margins at these levels.
Is it any wonder then that telecom operators are willing to pay through their nose to get in?

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