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Reliance Communications: What lies ahead?

Mar 13, 2006

Reliance Communications Venture Limited (RCVL), the telecom investments holding arm of the Reliance Anil Dhirubhai Ambani Group (ADAG) listed on the Indian bourses last week. RCVL is the holding company of the three telecom ventures of Reliance ADAG – Reliance Infocomm (RIC), Reliance Telecom (RTL) and Reliance Communications Infrastructure (RCIL). Reliance ADAG currently holds 37% stake in RCVL, which shall rise to 63% post restructuring of the group structure as decided by the company’s board yesterday. Further, Reliance ADAG’s current shareholding in RIC, RTL and RCIL stands at 58.6%, 77.3% and 71.7% respectively (combined through RCVL and directly). Post the restructuring process, RIC will merge with RCVL and RTL, RCIL and Flag Telecom will be converted into 100% subsidiaries of RCVL.

Through the three distinct business entities, RCVL serves around 20 m subscribers in the country and manages wireless traffic of 290 m minutes per day. In this write-up, we shall discuss the business of RCVL in detail and ascertain where the group stands in terms of growth and competition with the only other equivalent listed player – Bharti Televentures (BTVL). Let us understand the businesses at they are grouped into RIC, RTL and RCIL.

RCVL: Consolidated financial snapshot…
(Rs m) 1QFY06 2QFY06 3QFY06 9mFY06
Revenue* 25,400 27,870 33,270 86,540
Growth   9.7% 19.4% -
EBIDTA margin 6.6% 14.9% 25.5% 16.5%
PAT margin -9.8% -0.7% 9.3% 0.5%
Return on equity NA -0.2% 2.8% 0.4%
Debt to equity NA 0.4 0.3 0.3
Equity capital 1 6,120 6,120 6,120
Reserves - 101,530 104,640 104,640
Net debt - 42,680 37,020 37,020
EPS - - 0.5 0.5
Book value - - 90.5 90.5
* Includes other income

Reliance Infocomm Limited (RIC)
RIC offers CDMA technology based telecom services in 21 of the 23 telecom circles in India (except North East and Assam). Apart from the unified access license (for providing all kinds of telecom services using a single license) in these circles, RIC holds licenses to provide NLD and ILD services. At the end of February 2006, the company had a base of over 15.1 m wireless-mobile subscribers and 2.8 m wireless-fixed subscribers. The company thus, held over 20% and 39% share of the all India wireless-mobile and wireless-fixed markets respectively. RIC also provides broadband services in 29 cities. RIC is also amongst the larger players in the ILD segment, whereby, to augment capacity, it had earlier acquired Flag Telecom (owns submarine cables in international waters and has point of presence in 28 countries).

RIC: Financial snapshot
(Rs m) FY03 FY04 FY05 9mFY06
Revenue* 1 28,505 61,485 68,137
EBIDTA margin 0.8% 4.4% 15.1% 15.7%
PAT margin   -19.2% -38.1% 0.4%
Return on equity -0.2% -5.0% -28.2% 0.3%
Debt to equity 0.4 0.2 0.6 0.2
Equity capital 3,470 4,164 4,164 7,041
Reserves 16,839 105,638 78,990 76,652
Net debt 8,815 20,648 53,289 19,623
EPS (Rs) - (1.5) (5.7) 0.0
Book value 5.9 26.4 20.0 11.9
* Includes other income

Reliance Telecom Limited (RTL)
RTL provides GSM services in 315 towns in 11 Indian states. At the end of February 2006, the company had a base of around 1.8 m subscribers, a YoY growth of 62.4% and average monthly net addition of 56,700 subscribers (0.7 m for Bharti Tele). During the period FY03 to FY06, the company is estimated to grow revenues at a CAGR of 21%. While this growth (even on a lower base) is much slower and more volatile than what has been recorded by Bharti’s mobility division during this period, it is interesting to note that the former scores high when it comes to profitability. RTL’s operating margins stood at 50.1% in 9mFY06, almost 14% higher than what was recorded by Bharti Tele in the same period. Also, it is important to note that at around 1.8 m subscribers (in around August 2003), Bharti earned operating margins of sub-30%. Thus, the superior profitability of RTL at the current base is commendable.

RTL: Financial snapshot
(Rs m) FY03 FY04 FY05 9mFY06
Revenue* 3,564 3,612 4,529 4,708
EBIDTA margin 49.3% 53.1% 53.4% 50.1%
PAT margin -98.1% 11.0% 19.2% 19.5%
Equity capital 199 199 199 199
Reserves (1,819) (1,419) (546) 922
Net debt 4,751 3,500 2,735 1,748
EPS (Rs) (175.7) 19.7 43.4 46.2
Book value (Rs) - - - 56.3
* Includes other income

Reliance Communications Infrastructure Limited (RCIL)
RCIL is a provider of telecom infrastructure services to other telecom services provider and holds a Category-A ISP license. RCIL manages an 80,000 km of optic fibre cable that runs across the country. Through an agreement with RIC, RCIL has provided a part of its capacity to the former for a period of 20 years, and has received fees of Rs 47 bn is advance for the same. The company shall amortise this one-time consideration over the period of the contract. Annual fee from RIC thus, works out to Rs 2,350 m (14% of FY05 revenues).

RCIL: Financial snapshot…
(Rs m) FY03 FY04 FY05 9mFY06
Revenue* 452 2,470 16,757 13,695
EBIDTA margin 77.2% 61.6% 10.9% 9.1%
PAT margin -26.6% -22.6% -114.3% -5.5%
Return on equity 0.0% -1.2% -84.8% -3.0%
Debt to equity 0.6 0.2 0.4 0.6
Equity capital 2,000 2,000 2,000 2,000
Reserves 44,813 44,852 20,583 23,006
Net debt 30,402 9,225 8,782 15,648
EPS (Rs) - (0.3) (10.2) (0.4)
Book value 23.4 23.4 11.3 12.5
* Includes other income

While RCVL has an upper hand on a wider town coverage, better customer retention (as seen from lower churn rate) and higher traffic and minutes of usage, BTVL has seen a much faster growth in the subscriber base and outperforms RCVL in terms of higher ARPUs, which is a critical aspect. Interestingly, ARPUs are lower for RCVL despite it being a much larger player in the long distance (ILD and NLD) business, where realisations tend to be higher than those earned in the mobility business. Also, considering that the minutes of usage from RCVL subscribers are almost 33% higher than from those on BTVL’s network, it paints a grim picture for the former’s realisation per subscriber. This can probably be explained by RCVL’s higher rural coverage (where ARPUs tend to be lower due to affordability issues). The company’s networks covers 71.6% of India’s census towns and 40.3% of non-census towns and villages (both higher than Bharti’s coverage). We estimate Bharti’s ARPUs to decline further, as the company increases its coverage to smaller towns and villages.

RCVL Vs BTVL: Face off!
Coverage (Towns/Villages) 239,665 61,300
Towns 3,694 3,300
Coverage (%) 71.6 63.9
Villages 235,971 58,000
Coverage (%) 40.3 9.9
Subscriber base (m) 19.7 19.7
Growth (Feb'05-Feb'06) (%) 59.3 79.6
Market share (CDMA) (%) 63.6 4.6
Market share (GSM) (%) 2.7 28.3
Market share (CDMA+GSM) (%) 21.1 21.2
Churn (Blended) 2.2 5.2
ARPU (US$ per month) 9.2 10.6
ARPU (Rs per month) 411 470
Minutes of usage/month/sub. 547 411
Traffic (m minutes/day) 320 207
Rate per minute (Rs) 0.8 1.1
Pre-paid base (%) 81.0 77.5
Source: COAI, AUSPI, Company reports, Equitymaster Research

As far as segment-wise performance is concerned, RCVL has catch-up to do (in businesses like long-distance, broadband and enterprise solutions). On the wireless (mobility) business, BTVL scores over RCVL on both growth and profitability. RCVL however, seems to be bridging this gap at a faster clip and this is a positive for the company.

As per RCVL’s internal estimates, the broadband opportunity in India is expected to be of a size of US$ 12.2 bn. The company expects entertainment to spearhead this opportunity and projects the consumer/SOHO (small office home office) segments to take the lead. In order to realise this growth potential and ramp up the subscriber base, the company plans to leverage its 20,000 round kilometers of optic fibre capacity for last mile connectivity.

Segment-wise comparison
Long Distance 1QFY06 2QFY06 3QFY06
Revenue (US$ m)
RCVL 331 363 401
BTVL 117 125 142
EBIDTA margin (%)
RCVL 1.9 5.5 11.1
BTVL 35.6 36.3 33.7
Broadband & Enterprise
Revenue (US$ m)
RCVL 23 21 28
BTVL 113 121 128
EBIDTA margin (%)
RCVL (24.0) 15.0 19.0
BTVL 33.2 28.1 27.5
Revenue (US$ m)
RCVL 337 403 447
BTVL 393 428 489
EBIDTA margin (%)
RCVL 22.6 28.1 31.9
BTVL 34.7 36.5 36.5

How do valuations compare?
At the current price of Rs 390, BTVL trades at a price to earnings multiple of around 16 times our estimated FY08 earnings. Also, the stock commands an EV/subscriber of US$ 870 (market cap of US$ 16.3 bn and net debt of US$ 814 m). Compared to this, RCVL commands an EV/subscriber of US$ 744 (market cap of US$ 13.8 bn on the enhanced share capital and net debt of US$ 831 m). As such, RCVL currently trades at a 15% discount to BTVL’s valuations (on EV/EBDITA basis, while RCVL trades at 34 times, the same for BTVL is at 17 times. However, considering the fact that RCVL’s operating margins are 50% lower than BTVL, we believe that there is scope for improvement and to that extent, the EV/EBDITA multiple is higher currently). Considering the relative better performance at the operating levels, a more consolidated business structure and deeper management strength, we believe that BTVL shall continue to trade at a premium to RCVL, at least in the medium term.

On an overall basis, we expect RCVL to continue to reap in the opportunity that the Indian telecom sector provides for all its constituents, especially those having reach across the length and breadth of the country. As far as the company’s margins are concerned, we expect them to improve from hereon on the back of benefits of operating leverage. On the other hand, margins for Bharti, despite being much higher than what RCVL earns, have little room to grow from the current levels. This is especially considering the fact that the company’s ARPUs (despite remaining higher than RCVL’s ARPUs) are likely to take a bigger hit than RCVL’s due to the former’s bigger forays into the semi-urban and rural areas, where realisations tend to be lower. To this extent, the gap between margins of the two companies shall narrow, consequently reducing the discount in valuations for RCVL.

As far as Bharti is concerned, while it continues to remain our top pick from the sector, we believe that the ‘scarcity premium’ that the stock has commanded over the years due to absence of other key listed telecom stocks (RCVL, Hutch and Idea) might decline going forward. However, growth of the company shall be able to make up for the same.

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