Vodafone is obliged to pay $5 billion for a one-third stake that Essar Group owns in Vodafone Essar Ltd (VEL), the mobile telephony company they jointly own in the country.

That is built into the agreement the two entered into, nearly four years ago. But the question is whether the acquisition could become more expensive than that. The question has assumed greater relevance ever since Vodafone Plc went public with its opposition to a proposed merger between two Essar Group companies.

Higher pay-out likely for Vodafone

Obviously, the UK-based firm is not concerned about shareholders of India Securities Ltd (ISL), nor does it have a locus standi in objecting to a merger between two entities in which it has no equity stake.

According to market watchers, the only reason why Vodafone is objecting to the merger of the two entities is because it could result in a higher pay-out for the British telco if Essar exercises before the due date the ‘put option' (the right to sell) for a quantity that is even marginally less than the full one-third stake that it currently owns. For then, an alternative method of valuation could come into play should the latter decide to do so.

According to the shareholders' agreement signed by Vodafone and Essar in 2007, Essar has the option of selling its 33 per cent stake in Vodafone Essar before May 8, 2011. Essar has the option to either sell out entirely to Vodafone for a pre-determined amount of $5 billion or Essar can sell part of its shares to Vodafone in which case the valuation will be based on the fair market price.

For arriving at this ‘fair market price', the Ruias could well claim that the share price of India Securities, post merger, should be taken as the benchmark as it embeds within it the value of the mobile telephony business. The Ruias are proposing to put through a ‘reverse merger' (a larger entity being subsumed in the identity of a smaller company) Essar Telecom Holdings Ltd (ETHL) with ISL, which is an Essar Group company listed on the Bombay Stock Exchange. Of the total 33 per cent held by the Ruias, ETHL holds 11 per cent stake in Vodafone Essar.

Vodafone in its letter to the Securities Exchange Board of India has noted that the share price of ISL has risen sharply ever since the proposed merger was announced by the Essar Group. On January 14, 2010, the share price of ISL was Rs 6.25. However, on January 17, 2011, it had increased more than eleven times to Rs 69.05. According to analysts, Vodafone may be worried that Essar may manipulate valuation in this manner to sell part of the shares in VEL. Given that Essar is assured of $5 billion, the share price of ISL has to be greater than Rs 360 for the Ruias to claim a higher valuation. The problem for Vodafone will arise then as the value of ISL could well be construed as an indicator of a fair market value of Vodafone Essar. Therefore, the British telco is not taking chances and has asked SEBI to investigate the sudden increase in the share price of ISL.

Objections ‘motivated, incorrect'

But Essar has dismissed these concerns as factually incorrect. “Vodafone's objections to the merger are motivated and factually incorrect. If the market value being discovered by the merger were to be manipulated and artificial, as Vodafone claims, the investment banks would naturally ignore that value when making their determination. The investment banks are under no obligation to use the listed value alone, “said an Essar spokesperson.

Meanwhile, sources say that the top team from Essar is in London to resolve the issue with Vodafone. But given that the two sides have had an uneasy relationship over the past two years ever since the Ruias picked up stake in BPL's Mumbai operations (now Loop Mobile), the latest spat seems to be headed towards an all out war.

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