-- The author is a Reuters Breakingviews columnist. The opinions expressed are his own --
By Hugo Dixon
LONDON (Reuters Breakingviews) - Vodafone has won the first round in its war with Essar. The UK group's partner in its Indian mobile venture is downplaying a plan to inject its stake into an illiquid shell - a move which could have artificially inflated the stake's value. Although the saga could have more twists, the most likely conclusion is that Vodafone will pay $5 billion to buy out Essar completely.
Vodafone can feel pleased that it has thrown a spanner into Essar's plan to pop part of its 33 percent stake in Vodafone Essar into Indian Securities, the listed shell. If
that had led to an artificially inflated value, Essar could have tried to use it as the basis for squeezing more money out of the UK group when its put options over the stake fall due in May.
Although Essar says it is still pursuing the plan, management accepts that Vodafone's tactics mean it will no longer be able to complete the move before the May deadline. It will either have to take the fair value as determined by investment banks - or sell the entire stake for $5 billion, a price fixed four years ago when the Indian mobile market was less cut-throat.
Exiting for $5 billion wouldn't be a bad outcome given that the stake is now worth perhaps only $3 billion. But Essar understandably wants to see if it can do even better. Given that its shell-injection ploy has failed, it might be thought it would just be simpler to grab the $5 billion. But the Ruias, who own Essar, haven't become one of India's richest families by doing the obvious.
It's hard to know what new ploy they could use. But if they choose the fair value route, they don't have to sell out completely. They could then keep their special shareholder rights, including their veto over key decisions, and threaten to be such a nuisance that Vodafone eventually agrees to pay them off.
Such "greenmail", though, would probably only make sense if Essar can persuade the valuers that the stake is worth reasonably close to $5 billion. Given that this now seems unlikely, the best guess is that the Ruias will eventually exit completely and redeploy their cash in their other rapidly-growing capital-hungry businesses: oil, steel, ports and power.
-- Essar is downplaying plans to inject part of its 33 percent stake in the Vodafone Essar venture into a listed shell company after objections by its partner Vodafone, according to two people familiar with the situation. Instead, the partners have agreed to appoint two investment banks to value the stake in the Indian mobile operator as a precursor to Essar deciding whether to sell it to Vodafone. Essar has until May to decide whether to exercise options to sell the stake.
-- Vodafone has appointed Goldman Sachs, while Essar has appointed Standard Chartered, people familiar with the situation told Reuters.
-- Essar was previously pushing a plan to inject an 11 percent stake into Indian Securities (ISL), a listed company it controls. It argued that this would reveal its true value.
-- Essar said: "There is no change in our plans to merge Essar Telecommunications Holdings Pvt. Ltd. with India Securities. As we have stated before, the investment banks are free to choose whether or not to consider the listed value of ISL in their fair value determination." Management, however, now accepts that Vodafone's tactics mean that it will no longer be able to complete the merger before the May deadline.
-- Vodafone saw Essar's plan to inject the stake into ISL as an attempt to artificially inflate the stake's value as a precursor to selling it, arguing that ISL was a highly illiquid vehicle.
-- When Vodafone acquired a 67 percent stake in Vodafone Essar for $11.1 billion in 2007, it gave Essar two put options over its 33 percent stake. The first allows Essar to sell the entire stake to Vodafone for $5 billion. The second allows Essar to sell between $1 billion and $5 billion worth of Vodafone Essar shares at a "fair market value".
-- Under the second option, fair market value is supposed to be determined by two investment banks, one appointed by each partner. If the two banks don't agree, a third investment bank would be appointed to adjudicate. The value paid by Vodafone,
under this option, would be its fair market value plus around $700 million to take account of the fact that Vodafone Essar is carrying extra debt as a result of its push into 3G mobile technology.
-- It is this valuation process that the partners have now inaugurated.
-- After Essar said it planned to inject its stake into ISL, Vodafone complained to the Indian court that the merger documents for the deal were not clear. It also complained to the Bombay Stock Exchange that there were oddities in ISL's valuation.
Editing by Robert Cole and Martin Langfield