Mobile giant Vodafone's takeover of Hutchison Essar gets mired in allegations that the foreign holdings in HEL exceed the 74 per cent FDI cap.
ON April 27 the Foreign Investment Promotion Board (FIPB) finally cleared Vodafone's acquisition of Hutchison Essar Ltd (HEL) after being unable to do so over meetings in three previous sessions spread over almost two months. But the clearance has opened gaping holes in the regulatory framework for foreign direct investment (FDI). Despite the grave reservations expressed from within his Ministry, Finance Minister P. Chidambaram gave the final clearance for the takeover on May 4.
Several bidders, Indian as well as foreign, responded to the invitation for bids sought by Hutchison for its stake in HEL since late last year before Vodafone emerged the winner in February. While Vodafone is the biggest mobile operator in the world, HEL is the fourth biggest mobile operator in India. On February 11, Vodafone said its bid placed HEL's enterprise value at $18.8 billion and that it was buying the 67 per cent stake of Hutchison Telecommunications International Ltd (HTIL) in the company for $11.1 billion.
The deal, the biggest ever takeover of an Indian company by a foreign one, has been shrouded in controversy ever since the Delhi High Court asked the FIPB on March 9 to "consider and decide the issues as expeditiously as possible, preferably within two months". A public interest litigation (PIL) petition, filed by Telecom Watchdog (TW), a non-governmental organisation (NGO), alleged that foreign holdings in HEL were above the prescribed FDI cap of 74 per cent. It alleged that HTIL, based in the tax haven of the Cayman Islands, indirectly owned a 67 per cent stake in HEL. Since the Essar group, the other major partner in HEL, held 22 per cent of its 33 per cent stake in HEL through Mauritius-based companies, the PIL alleged that effective FDI in HEL amounted to 89 per cent, 15 percentage points above the legally set cap.
The more serious allegations centred around three sets of transactions, involving three blocks of shares accounting for 15 per cent of HEL shares, which apparently belonged to Indian shareholders but, according to TW, were held by Indian entities fronting for HTIL and its overseas subsidiaries. The PIL alleged that HEL was guilty of violating the FDI cap. This resulted in violations of licence conditions prescribed by the Department of Telecommunications (DoT). Moreover, it alleged that HEL had violated the provisions of the Benami Transaction (Prohibition) Act and the provisions of the Foreign Exchange Management Act (FEMA).
The Delhi High Court asked the FIPB to probe the deal within two months, a move that indicated that a prima facie case existed. The FIPB, which is composed of bureaucrats representing various Ministries involved in clearing FDI proposals, met three times since then but could not reach a conclusion. Meanwhile, it summoned fresh details from the three Indian entities alleged to have been fronting for HTIL - Asim Ghosh, managing director of HEL, Analjit Singh, chairman of the Max group, and the Infrastructure Development Finance Company (IDFC). It also sought the views of the Reserve Bank of India and the Ministry of Law and Justice (MLJ) and the DoT, besides other government agencies, departments and Ministries. It is clear that the indirect acquisitions by HTIL were made as part of a "reorganisation plan" worked out after the FDI cap in the telecom sector was raised to 74 per cent in November 2005 from 49 per cent. In March 2006, Somerley Ltd, financial adviser to independent shareholders in HTIL, explained the rationale to its constituency. It pointed out that a series of "option arrangements" would enable HTIL to increase its stake in HEL "it does not currently own".
Four Hinduja group companies (two Indian and two based in Mauritius) held a 5.11 per cent stake in HEL through IndusInd Telecom Network Ltd. (ITNL). On June 30, 2006, these four companies entered into an agreement with Hutchison Telecommunications (India) Ltd, registered in Mauritius, to sell their stake in HEL to it for a consideration of $450 million. While HTIL (Mauritius) immediately acquired 2.34 per cent of HEL's stake from the two Mauritius-based entities of the Hinduja group, it agreed to take over the remaining 2.77 per cent through a third party at a later date.
This brought into the picture the IDFC, whose main objective is to fund investments in infrastructure projects. It floated a company, SMMS Investments Pvt. Ltd, in which its subsidiary, IDFC Private Equity Fund, was an equal partner. SSKI Corporate Finance Ltd (which runs the stock trading portal sharekhan.com) held 2 per cent in SMMS. SMMS was, therefore, designed to act as the vehicle for acquiring ITNL, and through it 2.77 per cent of HEL. In fact, the share purchase agreement was designed to enable SMMS to acquire the 2.77 per cent stake in HEL while being Hutchison's "nominee" to play that role.
On August 7, 2006, the eight parties - the four companies involved in the joint venture and four belonging to the Hutchison fold - signed a "Framework Agreement". Hutchison assured the `investors' that FDI in HEL "is within the sectoral cap and not more than 68.5 per cent". Hutchison provided a guarantee in favour of DSP Merrill Lynch Capital Ltd for a loan of Rs.810 crore. It also provided another guarantee in favour of IDFC for Rs.240 crore. The remaining Rs.50 crore came from the three stakeholders in SMMS. HTIL (Mauritius) paid for all expenses associated with the formation of SMMS. "This," Telecom Watchdog observed in its letter of April 26, 2007, to the FIPB, "clearly establishes beyond doubt that IDFC was acting on behalf of HTIL (Mauritius)." HTIL (Mauritius), in fact, paid for stamp duties and registration fees to the Registrar of Companies, administrative expenses, audit formalities and maintenance expenses. HTIL (Mauritius) and its associates even paid the joint venture promoted by IDFC Rs.1 lakh for "out of pocket expenses".
IDFC and SSKI, the owners of the joint venture, were not allowed to sell their stake without permission from HTIL (Mauritius). However, Hutchison could acquire the joint venture by paying 15 per cent interest on the Rs.50 crore invested by IDFC and SSKI in SMMS. The terms of the agreement were so utterly one-sided that ITNL shares, which were acquired by SMMS at Rs.103.59 a share, would have to be handed over to Hutchison at Rs.6.23 a share, below its par value of Rs.10. Hutchison's "call" option would enable it to acquire the equity held by the joint venture company "at any time" at a predetermined price. This price, referred to as "transfer price" in the agreement, is merely the Rs.50 crore invested by IDFC plus interest at the rate of 15 per cent on that amount (Rs.66.125 crore at the end of the first year).
Anil Kumar alleges that the Rs.240 crore that IDFC invested has come from the India Development Fund, which the Finance Minister announced in his 2002-03 Budget presentation. He also says IDFC "engaged itself in benami investment" without "cross-checking" HTIL's declaration that its holdings are within the FDI cap.
The Analjit Singh and Asim Ghosh transactions were similar in nature and were concluded around the same time, February-March 2006. However, they were different from the IDFC-promoted front for Hutchison. The idea was to get companies promoted by the two corporate chieftains to invest indirectly, through subsidiaries, in Telecom Investments (India) Private Ltd (TII), which held 19.54 per cent of HEL.
Scorpio Beverages Pvt. Ltd, a company fully owned by Analjit Singh, invested in a stake of about 39 per cent in TII, implying a stake of 7.58 per cent in HEL. It did this indirectly through a chain ending at ND Callus Info Services Pvt. Ltd. Similarly, Goldspot Mercantile Company Pvt. Ltd., fully owned by Asim Ghosh, invested indirectly in a stake of 23.97 per cent in TII, implying a stake of 4.68 per cent in HEL, through two companies, one of which was Centrino Trading Company Pvt. Ltd.
The controversy centres on the following issues. Documents available with Frontline - filings by Telecom Watchdog to the FIPB, the Reserve Bank of India's comments on these transactions, as well as a document prepared and circulated to FIPB members just before the April 27 meeting - make it clear that Hutchison arranged and stood guarantee for loans to fund these transactions.
Hutchison stood guarantee for two Standby Letters of Credit (SBLC) issued by a bank in Hong Kong. While Centrino got a loan of Rs.489.86 crore, ND Callus got Rs.792.44 crore.
The loan agreements of the two chains of companies stipulated that the borrowers would pledge the shares. On March 1, 2006, Analjit Singh and Asim Ghosh, along with their chains of companies, entered into separate Framework Agreements with 3 Global Services Pvt. Ltd, a company fully owned by Hutchison and incorporated in India.
The suspicion that these two entities were acting as benami agents of Hutchison is strengthened by the nature of the agreements they entered into with Hutchsion. Although these two entities "own" the shares, they are prohibited from transferring the stake except under certain highly restrictive conditions favourable to Hutchsion. More significantly, Hutchison has the right to buy back the entire stake at any time within 10 years of the agreement at par value. In other words, Centrino and ND Callus, which bought the TII shares at Rs.3,841 a share, will have to surrender them on demand to Hutchison at a price of Rs.10 a share. Simple math will show that Asim Ghosh's incentive for the transaction amounts to 2.5 per cent of TII, or 0.23 per cent of HEL. Analjit Singh's incentive is higher, 0.3 per cent of HEL, perhaps a reward for his longer association with Hutchison.
Two days before the FIPB clearance on April 27, Union Minister for Communications and Information Technology Dayanidhi Maran gave a clean chit to the transaction saying there was nothing wrong with it going by the licensing conditions. "As far as my Ministry is concerned, we have said there is no breach of licensing conditions either by Hutchison or Vodafone," he said. However, he conceded that the FIPB was the relevant authority to explore the shareholding pattern in HEL.
However, it was the note prepared by the Law Ministry that played a critical role in getting the deal cleared on April 27. In response to the reference made to it by the FIPB, the Ministry gave a clean chit to the trio. Its language was couched in truism. It observed, for instance, that the "call" and "put" options in HTIL (Mauritius)'s agreements with the three companies/individuals are "subject to Indian law" and can only be exercised in accordance with Indian law.
On the question of exploring who had a "beneficial ownership" of the relevant shares, the Law Ministry's opinion explored the issue in terms of a narrow reading of the Companies Act, effectively equating a formal statement with actual intent. It thus accepted the notion that since Analjit Singh, Asim Ghosh and IDFC are formal owners of shares in HEL, they must be actual beneficiaries as well.
Documents available with Frontline, two of them in particular, give the impression that the Law Ministry's role was primarily aimed at finessing the Vodafone deal. The first is a note prepared by the Foreign Trade Division of the Department of Economic Affairs in the Finance Ministry. This note was prepared for members of the FIPB and circulated to them on the eve of the meeting on April 27. It is a scathing indictment of the Law Ministry's approach to the serious and substantive issues sent to it for reference.
The note, at the outset, observed that HEL representatives, in their presentation to the FIPB on March 29, "could not give satisfactory reply to the specific queries raised by the Board on the unfettered right of disposal by the resident Indian share holding". In other words, the three fronts were unable to prove that they owned the shares so clearly as to be able to sell them on their own free will, which is the true test of ownership.
More damaging was this observation: "They [HEL representatives] could not repel the suspicion raised by the board that the agreements entered into between foreign collaborators [which is also the guarantor], lending institution and the Indian companies are of such a nature which does not provide independence to the Indian shareholders the right to enjoy the complete usufructs of the assets."
The note also pointed to the contradictory media pronouncements made by HTIL before regulatory agencies in the U.S. and Hong Kong on the one hand and to Indian regulatory agencies on the other. It observed that while HTIL claimed in its overseas filings that it held 67 per cent of HEL, to Indian authorities it claimed that it held only 52 per cent.
The Law Ministry did not, apparently, find anything objectionable about the manner in which the share agreements among the three companies arrived at the value of shares when they were to be relinquished in favour of HTIL by the three entities. However, the Finance Ministry note pointed out that "fair market value" would be applicable only to a fraction of the holdings held nominally by the three Indian entities. Only a maximum of 0.125 per cent of HEL shares that Asim Ghosh held, out of his total holdings of 4.68 per cent in HEL, would have to be paid a "fair market value" if and when HTIL exercises its option to acquire the stake held by him. In Analjit Singh's case it would be only 0.23 per cent out of a total stake of 7.58 in HEL.
The Finance Ministry note also observed that although Analjit Singh and Asim Ghosh could nominate three out of five directors, including chairman and managing director, on the TII board, TII could not take any decision without the consent of HTIL. In fact, it pointed out, the presence of HTIL's representative is necessary "to constitute the required quorum even in adjourned meetings". Moreover, HTIL representatives enjoy "veto power on all major decisions of the company".
The most scathing remarks in the note are reserved for the Law Ministry's opinion that contradictory statements before Indian and foreign regulators cannot be "used to ascertain the FDI". The note drew from HTIL's filing before the Hong Kong stock exchange and pointed out: "HTIL, therefore, clearly has shown beneficial interests in HEL of the extent of 67 per cent." It pointed out that Press Note 5 of 2005, which defines what constitutes FDI in the telecom sector, clearly includes all forms of FDI - direct as well as indirect - to determine whether they are in compliance of the cap.
In conclusion it noted: "Thus if TII [the company in which Asim Ghosh and Analjit have invested in order to acquire their stakes in HEL] or Omega [the company through which IDFC is invested in HEL] is to be treated as subsidiary under the Hong Kong or Cayman law, it has to be treated as a subsidiary here also."
On March 20, the RBI, in response to FIPB's reference to it asking for its comments, confirmed that FDI limits were "breached" in July 2006. It observed that from declarations filed by HTIL to the U.S. Securities Exchange Commission on March 2, 2007, the holdings pertaining to Asim Ghosh and Analjit Singh in TII "appear to be multilayered transactions" and are funded through an SBLC issued in Hong Kong. It noted: "Since funding has been at the instance of HTIL, it would imply that these persons would be holding shares in concert with HTIL, and if this is taken into account, the foreign holding in HEL may breach the FDI cap of 74 per cent."
The RBI also raised serious doubts about whether the deal was in keeping with the provisions of the FEMA. It observed that the credit issued by a foreign entity "could be construed as a structured obligation [through credit enhancement] and this could be reckoned as a circumvention of the ECB [external commercial borrowing] guidelines issued under FEMA regarding the eligible lender as well as end use of funds."
The RBI's final message to the FIPB was: "Given the magnitude of the irregularities, we are of the view, that there is a need to have a thorough investigation to assess the complexities of the transaction and to establish the actual foreign holding in the company."
But the final decision was puzzling, not least because of the grave misgivings raised from within the Finance Ministry, which is the FIPB's parent Ministry. Maybe bigger hands were at play, but the row over the violations has made a mockery of regulations governing FDI.