Vodafone faces fresh challenge to expansion into India

Vodafone's hopes of expanding its presence in the Indian mobile phone market took a fresh knock yesterday after the billionaire Hinduja family entered the auction for the country's fourth-biggest network operator.

The move means that Vodafone now faces competition from at least three rival bidders in the $17bn-$20bn battle for control of Hutchison Essar. The auction began last month after Hutchison Whampoa, the Hong Kong-based conglomerate controlled by Li Ka-Shing, said it planned to sell its 67 per cent shareholding in the mobile network.

Aside from the Hindujas, the Indian family at the centre of the passport scandal which cost Peter Mandelson his job as Northern Ireland Secretary, two other Indian bidders have declared their interest in Hutchison Essar. These are Essar itself, which owns the remaining 33 per cent, and Reliance, which operates India's third biggest mobile network.

In addition to the four declared bidders, at least three other mobile operators and a variety of private equity firms have been touted as possible buyers, underlining the vast potential of the Indian cellular market, which is growing at a rate of 5 to 6 million subscribers a month.

But the scramble for Hutchison Essar has also led to fears among some investors that Vodafone could end up overpaying for the Indian company and being forced to beat an expensive retreat, as it did after its foray into the Japanese mobile market.

The Hinduja family's decision to throw its hat in the ring for Hutchison Essar marks a reversal in strategy. Until last June it owned a 5 per cent stake in the company but sold the shareholding to Hutchison.

Confirming the family's interest in buying out the majority shareholder, Ashok Hinduja, executive chairman of Hinduja TMT, the family's outsourcing division, said that funding was not an issue because the business was not leveraged at all.

The auction of Hutchison Essar has been clouded by a dispute between the two existing shareholders. Essar, a steel and shipping group controlled by the Ruia family, claims the shareholder agreement gives it first right of refusal in the event that Hutchison decides to sell out.

But industry sources said yesterday that this only applied if the rival bidders were Indian. Supposing that this is the case it would strengthen Vodafone's hand in the forthcoming bid battle.

There were reports yesterday that Maxis Communications of Malaysia and a consortium involving Orascom of Egypt and Qatar Telecom had dropped out of the bidding while reports that the US mobile operator Verizon would enter the fray were greeted with scepticism.

However, Vodafone still faces an uphill struggle to win the auction given the number of large and well-financed local groups pitted against it. If it loses, then relations are scarcely likely to be enhanced with its existing mobile partner in India, the market leader Bhati Airtel, in which Vodafone has a 10 per cent stake. Bhati is rumoured to have been furious at Vodafone's ambition to drop it in favour of taking control of Hutchison Essar.

An offer pitched at $18bn would value Hutchison Essar at a racey multiple of 27 times earnings. But the prize would be a major foothold in one of the world's fastest growing mobile markets. Analysts estimate that penetration could double in the next two years from its present level of 12 per cent and quadruple in four years while the Indian government has set a target of increasing subscribers from 140 million now to 180 million by the end of this year.

The biggest player in the Indian market is Bhati with 27 million subscribers to the end of September last year. It is followed by the Government-owned BSNL - which operates in low-profit underdeveloped areas and has 23 million users - Reliance on 22 million and Hutchison on 20 million.

The country has some of the lowest mobile tariffs in the world. You can get a connection for as little as £2.50 a month while cheap handsets manufactured in China cost as little as £20 to buy outright. The result is a market in which mobile phone ownership has reached far beyond the middle classes who have been the main beneficiaries of India's economic boom. It is not unusual to see the driver of a tuk-tuk autorickshaw pull over to answer his mobile phone.

In fact a recent ad campaign for one of Hutchison Essar's rivals featured a mobile phone ringing on a busy street. Several affluent types including a businessman and a model reached for their handsets, but it turned out it was a shoe-shine boy's mobile that was ringing.

But behind this lies a market that is structured very differently from those in the West. In India, you only get a mobile connection that works in your home city, and international-style roaming charges apply if you travel to another city. The result is that while mobiles are extremely cheap if you use them at home, using them on the road can be an expensive proposition.

And while mobile charges may be very low compared to those in the West, so are salaries, and many less well-off Indians make few calls, buying prepaid mobile connections and only recharge them for the minimum amount so that others can call them.

At the moment it is in the cities that you see mobile phones on every corner. But the real potential for massive growth lies out in the vast rural hinterland, in the villages where there are simply no phones at the moment.

Compared to its 143 million mobile phone users, India has only 41 million fixed telephone lines, and the disparity is set to increase. Fixed line infrastructure, and the vast majority of the market, are still controlled by inefficient state monopolies that cannot compete with the private mobile operators.

There are few lines in remote rural areas, and the cost of bringing in fixed lines is prohibitive. But many of these areas already have mobile coverage, and the coverage area is set to grow with more and more mobile towers being built across the country. Mobile phones are offering Indian villagers their first ever opportunity to have a telephone.

The poor quality of many of the existing fixed lines in many areas means businessmen often prefer mobiles as well. It's not unusual to find yourself unable to make an international call on the fixed lines because the network is jammed - but for it to be perfectly easy by mobile.

Mobiles have also got round India's notorious bureaucracy, that requires you to fill in a raft of forms and present all sorts of paperwork to get a fixed line installed.

By contrast, you can get a prepaid mobile connection by walking in off the street.