Why a Hutch; when no rabbits inside!

I was interested in anarticle that discussed about an acquisition in the Sri Lankan Telco Industry. The story was interesting to me in several ways. Firstly, I have a small holding of Sri Lanka Telecom PLC (SLTL.N000) shares and hence this is of importance to me as a shareholder. Secondly, the story talks about an acquisition and some valuation numbers for the target company (Hutchison TelecommunicationsLanka (Private) Limited) and thirdly there is underlying politics to all this.

Rotten story

In fact, this acquisition story is not a new thing to the market. It has been floating around for quite some time. This story suggests that Hutch was on the lookout for a sale in Sri Lanka. This article gives more color to the industry’s rumors to the possible consolidations. As per this article it looked like the acquisition of Hutch by SLT was imminent. Likewise, I can give many examples of this nature and the fact is none of these contemplated acquisitions have taken place as of my writing.

Presidential attention

Interestingly, this is not the first time that country’s presidential attention, albeit in different presage, was driven to this story as per the above article. In 2014, the then president also interfered in this matter as this article suggests. Further, this latter story from 2014 points out to the fact that there were disagreements on the value of the acquisition target. At the time, SLT has offered to buy Hutch USD132 million (c. LKR17.1 billion at LKR/USD of 130) whereas Dialog had offered USD78 million (c. LKR10.14 billion) as per the article.

The Telco Industry in Sri Lanka

Well, let’s quickly look at the Sri Lankan Telco Industry. Telco industry in Sri Lanka is regulated by the Telecommunications Regulatory Commission of Sri Lanka (TRC) and there are currently 6 operators offering Landline, Mobile, Data, Enterprise, TV, etc services. See the below table for a brief analysis:

Clearly, these things suggest that the Lankan Telco Industry is now in a saturated situation and I attribute to it an Oligopolistic market structure (well, except that fact that they can’t set prices and earn abnormal profits as a result of regulation). The 3 firm concentration ratio as per my calculations (based on subscriber base) is about 82%. To give it a different flavor I looked at the Herfindahl-Hirschman Index – HHI value for the Lankan Telco Industry and based on my calculations I arrived at an index value of 2,588 which suggests that it is a highly concentrated industry.

Refer below chart from Central Bank of Sri Lanka annual report.

Value vs Price

With that brief discussion I move on to value the target. No, I can’t do it. Why? I don’t have any revenue or cash flow figure to do a valuation model. Hutch is not a listed entity in Sri Lanka and hence no information is publicly available except what I gathered so far. I can only make some approximations by looking at the other players and their performance.

Also based on the available information, I think I should be able to do some sort of pricing of the target. That should be better than nothing, I suppose!

The new deal value is mentioned in that above article as being USD130 – 135 million (c. LKR19.17 billion using LKR/USD 142). Which is equivalent to a Price to Subscriber ratio of c.LKR9,585. More than Dialog’s Price to Subscriber ratio and a 33.75% discount to that of SLT itself.

As with my approximations please look at the above table. Accordingly, based on mobile revenue and mobile subscriber base, I arrive at LKR6,020.49 and LKR6,120.00 of Revenue per Subscriber for Dialog and SLTL respectively. Quite contrast to that, the same figure for Airtel is LKR4,939.09. I think this is explained by Dialog’s and SLTL’s market leading positions, product offerings, etc. If I try to approximate the revenue figure for Airtel using an average of Dialog and SLTL Revenue per Subscriber figure, I arrive at a LKR10.926 billion whereas it’s actual is LKR8.89 billion. Hence, I reject leaders’ ratio as an approximation figure for Hutch and Etisalat. (May be for Etisalat it may be ok to use and average of all three: Dialog, SLTL and Airtel. However, Etisalat is not the focus in this post, hence I don’t bother too much about it). I, therefore, utilize Airtel’s ratio to approximate the sales figure for Hutch and arrive at a LKR9.878 billion as their topline. (I’m sure Hutch must also be operating at a loss like Airtel and Lanka Bell). The proposed payment consideration is at an implied Price to Sales multiple of 1.94x which compares with the same of 1.33x for both Dialog and SLTL. (Actually a premium of 45%). Or to look at it from another angle. Hutch should be at least making LKR14.4 billion or more to justify paying that much to acquire it by SLTL.

Figures in LKR '000s except ratios which are times.

As per the blow chart, as per my approximations (I accept that my approximations may be wrong!) I derive a Price/Sales based price of LKR13.15 billion for Hutch. Similarly, applying the SLTL and Dialog Price/Subscriber ratios I derive a pricing range of LKR28.94 billion to LKR18.86 billion.

Bottomline

Given that it is a horizontal integration strategy, my doubt is why should anyone (especially one of the dominant players already) pay Hutch market leading multiples? In fact, in this case all what SLTL would be acquiring is Hutch’s subscriber base and I don’t see any other synergies to them in this deal. Specially, given that no one is competitively bidding and the only bidder came at very low level, I think they should let Hutch voluntarily exit the market (let them bleed and die and then later lure its subscriber base at a cheaper price, simply) or offer at a cheap price now that would be worthwhile. Or else numbers should speak for themselves.