Exit Bharti, Enter Reliance in MTN Tango

Two days after merger talks with Bharti Airtel collapse, South African telco MTN Group begins negotiations with Bharti rival Reliance Communications
Anil Ambani, chairman of India's Reliance ADA Group. Indranil Mukherjee/AFP/Getty Images

A year ago, Anil Ambani, chairman of India's Reliance ADA Group, was vacationing in South Africa. While in the country, he was invited for dinner by Phutuma Freedom Nhleko, president of MTN Group, South Africa's leading telecom player. (The two had earlier met at an international forum, say Reliance insiders.)

That dinner didn't lead to any immediate relationship between the companies. However, it may have planted the seed for the surprise announcement on May 26 that Ambani's Reliance Communications had begun "exclusive negotiations" with MTN for a "potential combination of their businesses."

Making the news even more dramatic in India was the timing. Not only had the Reliance conglomerate—with $29 billion in assets, and interests in power, telecom, financial services, and entertainment—previously said it had no interest in MTN, but the South African company's talks with Indian company Bharti Airtel had only 48 hours earlier collapsed (BusinessWeek.com, 5/15/08).

Potential $63 Billion Juggernaut

What attracted Reliance, India's No. 2 telecom operator, to the MTN deal, just when it soured for rival Bharti? The chance to become a leading global telecom player. "Africa has been on the radar for both Bharti and Reliance, as it's the last of the underpenetrated telecom markets," says Madhusudan Gupta, senior research analyst in Singapore for Gartner (IT), a global IT research and advisory firm. A Reliance-MTN combination would create a $63 billion telecom juggernaut with 116 million subscribers across India, Africa, and the Middle East, larger than AT&T (T) and many European players.

That, of course, was what had attracted Bharti to MTN (BusinessWeek, 5/15/08). Only a week earlier, on May 16, Bharti—backed by bankers Standard Chartered (STAN.L)—was the favored suitor, all set to pick up a controlling stake in the South African telco. The Bharti proposal went to the MTN board on May 21. The deal floundered, analysts say, because of a regulatory hurdle. A not-so-ebullient debt market would have forced Bharti to cough up huge equity in a cash-and-shares deal that was expected to be around $20 billion. This would have increased the foreign stake in Bharti beyond the 74.5% limit set by Indian law.

MTN, it appears, was uncomfortable with that. "We knew that the MTN deal wasn't worth it for Bharti," says Hitesh Kuvelkar, associate director for research at Mumbai brokerage First Global Securities. His calculations showed that Bharti would not be able to "enjoy the same low-cost economies of scale in Africa like it does in India."

Colonial Past Complicates Matters

There were also political calculations on MTN's part. South Africa's leading telecom player wanted to soft-pedal the takeover aspect of the deal, a reflection of the sensitivity of a deal involving a company from India. (When both countries were under British colonial rule, many Indians moved to South Africa, and later the apartheid system classified Indians as a group separate from both whites and blacks.) MTN didn't want to be seen as selling out to an Indian company, say deal insiders. "It wasn't a question of who merged into whom, but who was seen to take over whom," says an investment banker close to the deal.

So the drama heightened.

On May 22, MTN spurned Bharti's offer of a buyout with a counterproposal to make the Indian telco its subsidiary. A piqued Bharti backed out, citing that the "convoluted structure" of the deal would have "compromised" its minority shareholders and would not have "captured the synergies of the combined entity." Analysts hailed Bharti's move as "clever," and its share price rose 6% in the last three days.

Investment bankers say the parting of ways was evident. There was nothing on the table that benefited Bharti, except MTN's markets, says Kuvelkar. MTN has 68 million subscribers in 21 countries in Africa and the Middle East. The great potential is in Africa, where fixed-line infrastructure is underdeveloped and telephone penetration is low. The same holds true for Iran, another country where MTN operates.

For first Bharti and now Reliance, the dalliance with MTN is part of an ambitious global expansion plan. The two Indian companies already operate in one of the largest and most dynamic emerging markets in the world, and dream about being global players with special skills in providing low-cost, high-quality mobile service to the developing world. MTN is a perfect partner. Bharti has a small presence in the Seychelles, and its telecom software subsidiary Bharti Telesoft has its electronic prepaid solutions running in Botswana, Cameroon, Egypt, Ivory Coast, Madagascar, and Senegal.

Skepticism About Reliance's Follow-Through

Reliance made its African foray in February, when it acquired Uganda-based telco Anupam Global Soft, which has licenses to start services and set up infrastructure. As the sixth telecom operator in Uganda, Reliance plans to launch GSM as well as enter fixed-line and Internet services this year. Reliance also announced plans in April to invest $500 million along with eWave World, a British telco it owns, to build and acquire WiMAX networks in emerging markets including Africa. Reliance is also building a 9,000-kilometer undersea cable from Egypt to South Africa. And on May 26, Reliance acquired Vanco (VAN.L), a British enterprise network services provider, for $77 million.

There is no doubt MTN is a big opportunity for Reliance. But not everybody is impressed. Reliance is known for making dramatic announcements. Investors, however, wonder about the company's ability to follow through. Reliance Communications' stock is down 5.63% in the last three days. Analysts are concerned about the risk of Reliance spreading itself too thin, given the group's acquisition of assets across different but difficult sectors like infrastructure, entertainment, power, and telecom (BusinessWeek.com, 4/15/08). Among Reliance's big-ticket commitments is a $6.5 billion outlay in telecom, which includes expanding GSM services to 14 Indian states, setting up direct-to-home (DTH) television operations, and laying undersea cables.

Past history may also be clouding the vision of some skeptics. In February, 2007, Reliance joined the race to bid for Hong Kong-based Hutchison Whampoa's 67.5% stake in Hutch Essar in India, but never really made a bid. Sensibly, the company "realized it couldn't improve margins by buying Indian assets," says a private equity player. Vodafone (VOD) finally bagged the deal for $20 billion. "I'm apprehensive about the seriousness of Reliance's intentions," says Anil Kumar, secretary of Telecom Watchdog, a New Delhi-based nongovernmental organization.

This time, however, Reliance could be serious, say analysts. Reliance's interest in MTN has been longstanding; many believe that Ambani must have discussed possible partnerships at Nhleko's dinner a year ago. This time around, Reliance can't be seen to propose and then not go through with the marriage.

Before it's here, it's on the Bloomberg Terminal.