Last Wednesday, Essar had decided to exercise its underwritten call option for two-thirds of its 33 per cent stake, two months ahead of the option window closing. Vodafone officials claimed the original shareholders' agreement of 2007 gave them, in such an event, embroiled in regulatory drama, as the ball has been pushed to the Reserve Bank of India's court.
Last Wednesday, Essar had decided to exercise its underwritten call option for two-thirds of its 33 per cent stake, two months ahead of the option window closing. Vodafone officials claimed the original shareholders' agreement of 2007 gave them, in such an event, the automatic right the exercise their "call" option for the residual 11 per cent as well.
In 2007, Vodafone granted options to Essar, giving it the right to sell its entire stake for $5 billion or to dispose of a part of it at a fair market value arrived at by an independent entity.
But within a week, this deal has become the latest area of confrontation between the two JV partners, with Essar planning to seek legal arbitration against Vodafone and also deciding to continue the reverse listing plans of its group entitities. This, the steel-to-power-and-telecom conglomerate says, will give it a better understanding of the fair market price of its stake in its telecom JV.
Essar said on Friday it "fully intends to honour all its rights and obligations under the various agreements with Vodafone and also expects Vodafone to do the same. This will be done in accordance with all applicable laws and regulatory approvals".
It added that Essar continued to be a shareholder in Vodafone Essar, with all its rights and obligations, until the transaction was concluded, expected by the end of November.
The bone of contention is clearly the fair market valuation of Essar's stake in the JV. Vodafone Essar is a JV since 2007, where Essar has 33 per cent and the residual 67 per cent is with Vodafone, the world's largest mobile operator by revenue.
Essar's 33 per cent is held in two entities. A foreign entity, Mauritius-based Essar Communications (Mauritius) Ltd (ECML), holds 22.03 per cent. An Indian entity, Essar Telecommunications Holdings Pvt Ltd (ETHPL), holds 10.97 per cent.
What has baffled everybody most is the share valuation in the two entities. The value of the option in the overseas entity has almost a 50 premium compared to the value of the option held by the Indian entity. The 22.03 per cent in ECML is valued at $3.8 billion and the 10.97 per cent in the Indian vehicle, ETHPL, is valued at $1.2 billion. This is where, telecom industry watchers say, the regulatory aspect will come into play.
According to the Foreign Exchange Management Act (Fema) policy of RBI, the transfer of shares between two foreign entities is not subject to its guidelines. However, the transfer from an Indian entity to a foreign one does come under its jurisdiction.
According to Clause 2.2 of Annexe 3 of the Fema guidelines on FDI in India governing the price of shares transferred by way of sale by a resident to a non-resident, where the shares of an Indian company are in an unlisted entity, "then the value of those shares shall not be less than the fair value to be determined by a Sebi-registered Category I merchant banker or a chartered accountant as per the discounted free cash flow method."
By that logic, Essar's 10.97 per cent should be valued at a fair market price, determined by an I-Bank. Both Essar and Vodafone have appointed investment bankers Standard Chartered Bank, UBS and Goldman Sachs to help them evaluate the fair market valuation of the JV.
The challenge for RBI, said people in the know, is whether it will approve a transfer of shares at a price lower than the contractual price agreed between Essar and Vodafone for the offshore shares. Or, will it consider the intrinsic value of the share under the current sectoral circumstances on a discounted cash flow basis?
Telecom stocks in the recent past have all underperformed and most analysts say under the current market realities, the value of Essar's entire 33 per cent will be around $3 billionn. Some, like the analysts in JPMorgan, came up with reports suggesting it would be even less, at around $2 billion.
But if RBI insists the price ascribed to the foreign shares is the fair market price, then Essar will get an additional $700 million on top of the $1.2 bn call option price.
Sources added Essar was keen to stand by its contractual obligations and would honour the call option for the 10.97 per cent stake in Vodafone Essar Ltd. It has already applied to RBI, seeking permission to transfer these shares for $1.2 bn in terms of the call option exercised by Vodafone. But the exercise has to comply with the applicable laws and regulatory approvals.
However, Vodafone insists that its transaction, including the valuation that was done for the entire 33 per cent stake, complies with RBI norms.