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Reliance Communications: Research meeting excerpts - Views on News from Equitymaster

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Reliance Communications: Research meeting excerpts
Jan 9, 2007

We recently met the management of Reliance Communications Ltd. with a view to increase our understanding of the company’s business and its future plan of action. Here are the key excerpts from the meeting. Company’s business
Reliance Communication Ltd. (RCL) is the second largest private sector mobile telephony operator in India with a wireless (CDMA and GSM) subscriber base of 29 m across its 23 circles of operation. The business of the company is spread across three segments - global, enterprise and personal. The ‘Global’ business caters to voice and data market. In the voice market, it is the carrier of national and international voice traffic for telecom operators, telecom service providers and its internal customers. The data business owns the largest private submarine cable system in the world, which carries data to six continents.

The ‘Enterprise’ segment serves 750 of the top 1,000 enterprises in India, by offering a wide array of products that comprise of voice, data, Internet, and IT infrastructure management services. The ‘Personal’ segment offers voice, data and value added services for the individual consumers and enterprises, via its CDMA and GSM-based mobile and fixed wireless services.

Since its listing in March 2006, RCL has risen to the stature of ranking seventh (considering the market capitalisation at the close of 5th Jan 2007) amongst the top ten private sector companies in India in terms of market capitalisation.

Key excerpts
Dual expansion: Few would know that RCL began its operations in 1995 as a GSM operator and later turned its attention to the CDMA technology. The company has been targeting the CDMA markets aggressively over the past few years and has attained an almost pan India presence in the segment (operating in 21 of the 23 circles). RCL also operates its GSM services in seven circles. The company is about to change track once again, as it gears up to capture a larger share of the relatively faster growing GSM pie.

The Indian GSM market has been recording stupendous growth rates over the past few years (compounded annual growth of 120% during FY03 to FY06) and is expected to reap in the advantages of increasing penetration levels going forward. RCL’s management has indicated that the company is determined to take advantage of this growth story by leveraging its experience of the seven GSM circles that it operates in. Although it has only about 3% of the GSM market share currently, the company does rake in the highest profit margins on its operations in its GSM circles. What is more, in the five circles where its GSM and CDMA services overlap, it has got a higher market share than what it owns on a standalone basis, except Orissa where Bharti Airtel is the market leader.

The company has made its GSM intentions very clear. First it was through floatation of a tender for 100 m GSM and WCDMA (3G for GSM) lines. Second is its intention of acquiring Hutch-Essar, which is India’s fourth largest GSM mobile service provider with a subscriber base of nearly 24 m. The management has indicated that the company will continue to chart an aggressive growth path in the GSM space, whether Hutch-Essar comes to it or not.

Subscriber acquisition cost: RCL has been expanding its CDMA market very aggressively and operates in 21 circles currently, with a subscriber base of 26 m. While this rate of growth is in keeping with that attained by the leading GSM operators, there is an important distinguishing factor in case of RCL that needs to be borne in mind. While GSM service providers are able to add a subscriber merely by providing a SIM card (as the handset is bought by the customer), for a CDMA service provider like RCL, it requisitions the purchase of a mobile handset as well. What this means is that, in effect, the cost of acquisition for RCL is stupendously higher than what it is for GSM operators. The difference works out to be as high as 10 times, considering that a SIM card is available today for as low as Rs 100, while the cheapest handset that one can purchase of RCL is for Rs 1,040 (after RCL providing a subsidy of almost Rs 1,000 per handset). However, a higher entry cost also acts as an higher exit cost (due to the purchase of handset which does not accommodate any other network), the churn rate for RCL stands low at 1.9% against Bharti Airtel’s churn rates of 3.6% and 5.1% for postpaid and prepaid subscribers respectively (as in 2QFY07).

Hidden treasures: RCL, although is bullish on the spate of increase in net additions to its subscriber base, is also making attempts to diversify its presence in the global markets by way of inorganic and organic growth. It is the ever-increasing demand for data and bandwidth transfer that is exciting the management. The company has got presence in 6 continents vide its fibre optic cable system. It has got a 88,000 kms of fibre optic cable in India and 65,000 kms of international submarine cable network (the largest in the world). Also, the company has recently unveiled plans to lay another 50,000 kms of next generation networks (NGNs), which shall make its network the largest in the world.

The growth of traffic across its routes has been exponential in the recent past and is expected to continue to do so over the coming years as well. This is mainly owing to the increased needs for data transmission by both enterprise and retail consumers of international bandwidth. The company presently carries 40% of the retail voice traffic from the US to India over its cables. It has forecast its corporate data service revenue to touch US$ 1 bn by the end of FY07. The company has had capacity sales of over US$ 450 m on its FLAG Global Network since January 2006. The current capacity utilisation of its cable network stands at 5%.

ARPUs: As is depicted in the adjacent graph, the company has witnessed a decline in its gross as also the net average revenue per user (ARPU), in line with what its peers have reported. As a matter of fact, net ARPUs are arrived at after deducting access and license fee charges from gross ARPUs. The fall in gross ARPUs could be attributed to the increased share of prepaid customers in its wireless subscriber base (from 79.3% in March 2006, the prepaid share increased to 81.4% in September 2006). In fact, 94.6% of the incremental subscriber addition in 2QFY07 came in through the prepaid route. While the net ARPUs of RCL have also been on a decline, the rate of decline here has been lesser than that of gross ARPUs. This is largely due to the fact that the company has seen a relatively greater decline in its access and license fees charges, which is indicative of the operating leverage advantage of mobile telecom services.

Value added services: Empowered by its 1,650 Reliance World outlets spread across 5,000 towns in India, RCL sells more than a million handsets per month. The company scores strong on its value added service front owing to its integrated IP-enabled infrastructure platform, that allows it to offer a host of user friendly value added service, which can be downloaded at the press of a single button (unlike that of GSM services where content download is based on text messaging). The company has got an in-house content facility to produce and aggregate content. Having got 15 m subscribers on its Reliance Mobile World (over 3 times all GSM data enabled phones put together) and 8 m subscribers that use Reliance Mobile world per month, it is poised to gain tremendously from the increased data usage, as content downloads will become faster and better in quality with the launch of 3G services. Also, maintaining an in-house production and aggregating facilities means that RCL is not required to share revenues on value added services, unlike what most GSM operators are required to do.

What to expect?
The Minister of Telecom, Government of India had recently outlined a telecom subscriber base target of 500 m by 2010. This requires the country to add a net of 7 m subscribers every month for the next 48 months, or 2.6 subscribers per second (the current rate is 2 subscribers per second)! On the back of lower handset costs and reducing tariffs, we expect the target to be met or at least neared. And companies with pan-India presence will be the biggest beneficiaries of the same.

However, while a lot of attention is being focused on the growth of wireless telephony in the country, the segments of broadband and enterprise data also need due recognition. The exponential growth that is expected in RCL’s global business, the recent decision by the company to hive off its tower business into a separate subsidiary with a view to increase focus on it and create value for share holders, its efforts to get a foothold as an operator in the foreign markets and most of all its anxiously awaited entry into the GSM market of Indian telephony are what make a very compelling story about the company’s future outlook.

At the current price of Rs 436, the stock is trading at 46 times its trailing 12-months earnings (Bharti is trading at 43 times trailing 12-months earnings). While these valuations might say a lot about the strong growth that is expected of these companies, investors still have to bear in mind that these are long-term plays on India’s growth and expecting the moon from these companies in a 12-month timeframe can be fraught with risks. We shall soon initiate our coverage on RCL.

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