BREAKINGVIEWS - Vodafone set for long and dirty war with Essar

A woman talks on a mobile telephone as she passes a Vodafone store in central London November 8, 2008.

-- The author is a Reuters Breakingviews columnist. The opinions expressed are her own --

By Una Galani

LONDON (Reuters Breakingviews) - Vodafone appears to have a nasty $5 billion misunderstanding with its Indian partner. A week ago the UK-based telecom operator assumed Essar had agreed on clean exit from the India's third largest operator. But now its increasingly fractious associate is disputing the valuation of its 33 percent stake -- and the very mechanism of this complicated deal.

The pair supposedly had agreed terms over sale of the 33 percent stake as part of Vodafone's entrance into the Indian market back in 2007. Essar holds its stake in the joint venture in two parts. When Essar last week exercised its put option over a 22 percent stake, Vodafone believed the move triggered its entitlement to exercise a call option over a remaining 11 percent stake. Vodafone said it expected the deal to close in November.

The details are hazy but Essar, which didn't comment at the time, reckons it is owed up to $700 million more, according to a person familiar with the situation. The Indian group does not dispute the exercise of its put option of 22 percent -- and is happy to book two-thirds of $5 billion. But Essar believes it is entitled to seek the remaining 11 percent stake, held through an onshore entity, to be valued differently under Indian rules.

The claim is odd given the entire 33 percent stake is probably only worth $3 billion based on multiples of peers. It is unclear whether Essar hopes arbitration -- which is most likely to decide the outcome of the messy dispute -- will somehow end in its favour or whether it hopes that Vodafone will be persuaded to settle. The UK listed telecoms operator needs all the time it can get to concentrate on other problems in India - such as the intense competition and a $2.5 billion dispute over tax relating to the 2007 acquisition.

Either way, it makes both sides look bad. Even supposing the claims by Essar are not supported by the terms of original deal over the 33 percent stake, Vodafone should have been aware of the disagreement before it presented it as a fait accompli. Vodafone has won much praise for clearing up its portfolio around the world, but the Indian problem threatens to taint a winning streak.

CONTEXT NEWS

-- Essar is seeking $600 million to $700 million more from UK-based Vodafone for the 33 percent holding it owns in their Indian joint venture, according to a person familiar with the situation. Vodafone said last month it would buy out its partner Essar in a deal worth $5 billion.

-- In March the UK operator said that Essar had exercised a put option over a 22 percent stake in the joint venture and that, following the move, Vodafone had exercised a call option over an 11 percent stake held by Essar.

-- When Vodafone acquired a 67 percent stake in Vodafone Essar for $11.1 billion in 2007, it gave Essar two put options over the 33 percent stake. The first allowed Essar to sell the entire stake to Vodafone for $5 billion. The second allowed Essar to sell between $1 billion and $5 billion worth of Vodafone Essar shares at a "fair market value".

-- Earlier this year, Essar pushed a plan to inject an 11 percent stake in the joint venture into Indian Securities (ISL), a listed company it controls. It argued that this would reveal its true value. Essar did not make any official comment when Vodafone announced it had exercised the option.

(Editing by Robert Cole and David Evans)