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Reliance Comm.: Yipes in the bag - Views on News from Equitymaster

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Reliance Comm.: Yipes in the bag

Jul 17, 2007

India’s second largest mobile services company, Reliance Communications, yesterday announced the acquisition of the US based Yipes Holdings, which is a leading provider of data services for the global enterprises. Valued at US$ 300 m, this is the largest acquisition that Reliance Communications has ever made (its last major acquisition was of Flag Telecom at US$ 207 m in 2003). Yipes has been acquired by and will function as a subsidiary of Flag Telecom. About Yipes

Established in 1999, Yipes has been one of the leading data services for enterprise customers in the US. Yipes is strongly positioned in Ethernet, which is the fastest growing segment in the US data communications market, with an annual growth rate of over 30%. Yipes has nearly 1,000 enterprise customers, concentrated across 4 industry verticals – financial, legal, government and healthcare - which currently account for 50% of the Ethernet market. The company is the leading direct communications provider to the New York Stock Exchange, Chicago Mercantile Exchange and NASDAQ and interconnects with multiple market participants and intermediaries.It owns over 22,000 route kilometres of fibre across 14 large US cities, which covers around 40% of the total US data communications market. In addition, Yipes is present in London, Hong Kong and Tokyo. Yipes annual revenues grew more than 41% in 2006. The company became EBITDA positive in 2005 and operating cash flow positive in 2006. Primary investors in Yipes include Norwest Venture Partners, JP Morgan Partners LLP, Sprout Group (a venture capital affiliate of Credit Suisse), and Crosslink Capital.

What’s in the deal?

As reported by the management, the acquisition of Yipes will accelerate Reliance Communications penetration into the lucrative US$ 100 bn global enterprise data market. Reliance plans to expand Yipes coverage within the US and take it to nearly 40 new markets globally where the former is already present through Flag Telecom. Also, considering the fact that Ethernet is the fastest growing segment of the data communications market, driven by the migration of enterprise customers from older private network technologies, it would be a key growth driver for the company in its bid to capture the high margin enterprise data business globally. As a matter of fact, as per Infonetics Research, the global Ethernet market is expected to grow by over 30% per annum from 2006 to 2010 to reach a size of US$ 25 bn worldwide (currently at around US$ 10 bn).

Yipes is reported to have sales of US$ 100 m and operates at EBIDTA margins of over 50%. As such, the deal is valued at 3 times sales and 5.5 times EBIDTA, which seems reasonable considering the growth opportunity that its provides to Reliance Communications.

What to expect?

At the current price of Rs 573, Reliance Communications’ stock is trading at a multiple of 18.1 times our estimated FY09 earnings, which we shall soon be revising upwards considering the company’s strong performance in FY07. We maintain our positive view on the stock from a long-term perspective. While the foray into high margin businesses like enterprise data services and continued strong growth in the CDMA mobile services segment are expected to be the growth drivers for the company, we remain concerned about the availability of spectrum which is required for the company’s GSM expansion plans.

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