Mumbai, Jan. 18: Vodafone Group Plc and its Indian partner, the Ruias-controlled Essar group, are locked in a battle once again.

Vodafone is crying foul over the Ruias’ move to transfer an 11 per cent stake that Essar Telecommunications Holding Pvt Ltd (ETHPL) — a privately-held company — holds in Vodafone Essar to a listed group entity called India Securities Ltd (ISL).

The Ruias have a 33 per cent stake in India’s fourth-largest mobile telephony player. Vodafone of the UK effectively controls the remaining 67 per cent.

Vodafone Essar is an unlisted company at present.

The Ruias’ 33 per cent stake in Vodafone Essar is held through two entities: 11 per cent is held by ETHPL, while another 22 per cent is with Mauritius-based Essar Telecom India Ltd.

Vodafone has approached the Securities and Exchange Board of India and the BSE voicing “its concerns” regarding the reverse merger of ETHPL into ISL and has demanded a probe.

The UK telecom company’s basic objection to the reverse merger is the fact that the value of the ISL stock “could be misinterpreted” to indicate “fair market value of Vodafone Essar”. Vodafone said it “does not wish a company in which it holds a majority interest to become the subject of a false market”.

On Tuesday, the ISL scrip surged 5 per cent to touch a new 52-week high of Rs 72.50. Exactly a year ago, the stock had hit its 52-week low at Rs 6.36. According to the BSE, the promoters of ISL — Essar Capital — hold a 74.22 per cent stake in the company.

Put option

The British telecom company’s objection arises from a shareholders’ agreement between itself and the Essar group in 2007 under which the Essar group holds a put option to sell its entire holding to the UK telecom group.

A put option gives the seller—the Ruias in this instance-— a right to sell their shares at an agreed price and in a pre-determined time frame. Under the terms of the agreement, the Essar put option became exercisable on May 8, 2010 and will remain open till the same date this year.

Under the put option, the Ruias can sell their full stake to Vodafone at a guaranteed floor price of $5 billion.

This option was secured by the Ruias after prolonged negotiations with Vodafone in 2007 when the latter bought a 67 per cent stake from Ruia’s erstwhile telecom partner Hutchison Whampoa Ltd for a little over $10 billion.

Later, Vodafone and Essar hammered out a fresh agreement where the Ruias-controlled group could get a higher value for their 33 per cent stake if a price discovery process threw up a bigger valuation.

Four objections

Vodafone listed four objections to Essar’s decision to move the 11 per cent stake from ETHPL to ISL through a scheme of amalgamation. First, Vodafone said there had been no disclosure to the shareholders of ISL on Vodafone Essar that it would become a substantial asset of ISL. This would leave the investors of ISL in the dark about the valuation of the company.

Second, Vodafone said ETHPL’s wholly owned subsidiary had stated in its information memorandum that it would use the proceeds of the bonds secured against Essar’s put option to invest abroad in assets such as coal, steel and refining. Vodafone has alleged that ISL has not made this disclosure and that these investments are not in line with ISL’s stated intentions.

“Therefore it is not clear what assets or liabilities ISL will have following the possible exercise of the underwritten put option or the fair market value option issued to Essar in 2007,” Vodafone said.

The third objection is that the valuation on which the conversion ratio for the new ISL shares was determined is based on the assumption that underwritten put option will be exercised even though Essar can exercise a fair market value option at what could be a different valuation. This fair market value option has not been disclosed to ISL shareholders.

Finally, Vodafone said, ISL is an illiquid vehicle and post merger, over 95 per cent of the shares will be under the control of the Essar group and two other shareholders.

On Vodafone’s allegations, the Essar group said, “Vodafone is neither a shareholder nor a creditor of ISL or ETHPL and as such have nothing to do with this merger scheme. We have received their communication and are studying it and will respond appropriately.”