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Reliance Comm.: Catching up! - Views on News from Equitymaster
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Reliance Comm.: Catching up!
Aug 8, 2006

Performance summary
Reliance Communications Limited (RCL) recently announced strong sequential performance for the first quarter of FY07, reporting revenue growth of over 9% QoQ. More importantly, operating margins expanded by 180 basis points (1.8%), mainly on the back of lower license fee and access charges. Consequently, net profits grew at a relatively superior rate of 27% QoQ, duly helped by lower extraordinary expenses.

Consolidated financial performance: A snapshot…
(Rs m) 1QFY06 1QFY07 YoY Change 4QFY06 1QFY07 QoQ Change
Total revenues* 22,830 32,501 42.4% 29,704 32,501 9.4%
Expenditure 21,240 20,439 -3.8% 19,228 20,439 6.3%
Operating profit (EBDIT) 1,590 12,062 658.6% 10,476 12,062 15.1%
Operating profit margin (%) 7.0% 37.1%   35.3% 37.1%  
Interest 269 999 272.1% 479 999 108.6%
Depreciation 3,760 5,514 46.6% 5,457 5,514 1.0%
Profit before tax (2,439) 5,549 -327.6% 4,540 5,549 22.2%
Extraordinary income/(expenditure) - (150)   (374) (150)  
Tax 60 272 353.3% 137 272 98.5%
Profit after tax/(loss) (2,499) 5,127   4,029 5,127 27.3%
Net profit margin (%) -10.9% 15.8%   13.6% 15.8%  
No. of shares         1,223.1  
Diluted Earnings per share (Rs)**         9.9  
P/E ratio (x)**         27.3  
* Includes other income;  ** Based on annualised EPS

What is the company’s business?
RCL is one of India’s largest integrated telecommunication service providers. Through its pan-India services like wireless, long distance and broadband, the company serves around 23 m subscribers. The company holds a 20.6% share of the Indian wireless market (GSM and CDMA combined). Apart from the domestic business, the company also has a strong international presence through the provision of international long distance, data and Internet services and submarine cable network infrastructure. RCL also boasts of the largest retail distribution and customer service facilities of any communications services provider in the country.

What has driven performance in 1QFY07?
Wireless leads topline growth: RCL’s wireless revenues, with growth of 15% QoQ and contribution of 63% to the company’s total revenues, has led the overall topline performance during 1QFY07. Strong addition to the subscriber base and stable realisations (ARPU, or average revenue per user per month), have helped the company rake in a strong growth for the segment during the quarter. While the ARPU performance is in line with its peer, Bharti Airtel (BTVL), which also maintained realisations on a QoQ basis, the decline in RCL’s minutes of usage was the differentiating factor in the two companies’ relative growth in the wireless segment. Against a 2% QoQ growth that BTVL had recorded in its average minutes of usage per subscriber, RCL reported an 8% QoQ decline.

Another area where RCL lagged BTVL during this quarter was the increase in reach across census towns (CT) and non-census towns and villages (NCTV). While BTVL added 248 CT to its folio during the quarter, RCL’s score was way low at 57. Also, in terms of spreading across NCTV, BTVL outperformed RCL in adding 20,927 to its coverage, against just 2,914 by the latter. Investors should, however, appreciate the fact that RCL already has wider pan-India coverage than BTVL, with the latter stepping up into the fourth gear now.

Segment-wise performance
  4QFY06 1QFY07 Change (QOQ)
Wireless
Revenue (Rs m) 21,200 24,320 14.7%
% of total revenues 56.8% 62.5%  
EBIDTA margin 35.7% 36.0%  
Global (ILD & NLD)
Revenue (Rs m) 14,158 12,340 -12.8%
% of total revenues 38.0% 31.7%  
EBIDTA margin 18.6% 23.0%  
Broadband
Revenue (Rs m) 1,948 2,271 16.6%
% of total revenues 5.2% 5.8%  
EBIDTA margin 31.1% 38.8%  

In terms of the other business segments of broadband and long distance, RCL has underperformed BTVL (see adjacent chart). However, in these businesses, the former is still into a relatively aggressive expansion phase and it would not be right to compare the companies on the current performance of these two segments.

Reliance Vs Bharti
(Rs m) RCL BTVL
Key metrics: 1QFY07
Total revenues 32,501 38,421
EBIDTA margins 37.1 39.7
Net margins 15.8 21.6
Wireless / Mobility business
Total revenues 24,320 28,411
EBIDTA margins 36.0 36.4
Circles operational 23 23
Census towns covered 3,881 4,026
Non-census towns/villages covered 245,728 101,614
Subscribers (m) 22.5 23.1
Market share (%) 20.6 22.5
Net adds (m) 2.3 3.5
Pre-paid (% of total wireless) 79.4 84.4
ARPU (Rs per subscriber per month) 379 441
Total minutes of usage (m minutes) 31,440 28,194
Minutes of usage per sub per month 491 441
Revenue per minute (Rs/min) 0.77 1.01
EBIDTA per minute (Rs/min) 0.28 0.37
Cumulative investment (Rs m) 155,117 177,633
Capital investment per subscriber (Rs) 6,887 7,699
Broadband business
Total revenues 2,271 5,182
EBIDTA margins 38.8 23.0
Cities covered 30 92
Subscribers ('000) 322 1,505
Net adds ('000) 66 158
ARPU (Rs per subscriber per month) 2,618 1,202
Long distance business
Total revenues 12,340 9,033
EBIDTA margins 23.0 40.8
Total ILD minutes (m minutes) 1,214 753
Total NLD minutes (m minutes) 3,085 2,882
Gross revenue per minute (Rs) 2.87 2.49
EBIDTA per minute (Rs) 0.66 1.01
Balance sheet comparison
Debt to equity 1.0 0.2
Debtor days* 53 55
Sales/Net fixed assets* 0.66 0.81
Return on equity (%)* 9.9 25.0
Return on invested capital (%)* 8.2 18.1
Valuation comparison
Market cap (Aug 4 2006) 330,245 757,560
Add: Debt 119,075 40,891
Less: Cash 94,665 3,062
Economic value (EV) 354,655 795,389
EBIDTA* 35,178 33,376
EV/EBIDTA (x) 10.1 23.8
EV per subscriber (US$) 342 749
Price to earnings* 27.3 30.3
Price to earnings (1Q annualised EPS) 16.3 22.8
Price to book value 2.7 7.6
* Sales, EBIDTA, PAT and EPS are on trailing 12-month basis
Lower license costs aid margins: Considerable decline in license fee and access charges has helped RCL post a 180 basis points (1.8%) expansion in operating margins during 1QFY07. These costs declined from 34.6% of revenues in 4QFY06 to 28.6% in 1QFY07. Network, staff and sales & marketing costs, however, increased as percent of sales during the quarter, thus paring the margin expansion. Based on segments, all the three divisions reported margin expansion, with the best performers being long distance and broadband. The wireless division reported EBIDTA margins of 36% during 1QFY07 (35.7% in 4QFY06), just marginally lower than the 36.4% margins reported by BTVL for the quarter. On a QoQ basis, however, the improvement in margins is similar for both the companies. As for the other segments, while RCL earns higher margins than BTVL in the broadband business, the latter scores over the former in the long distance stream.

Margin expansion aid bottomline: Expansion in operating margins and lower extraordinary expenses has helped RCL report a strong sequential bottomline growth during 1QFY07. Consequently, net margins have expanded from 13.6% in 4QFY06 to 15.8% in 1QFY07. These margins are, however, still much lower then BTVL’s 1QFY07 margins of 21.6%, and are indicative of relatively lower profitability per subscriber. This should, however, be seen in context of the fact that CDMA is a relatively cheaper technology than GSM (where BTVL operates) and consequently, ARPU and profit per subscriber are bound to be low.

What to expect?
At the current price of Rs 270, RCL is trading at a price to earnings multiple of 27.3 times its trailing 12-month earnings and 16.3 times annualised 1QFY07 earnings. These valuations are at discount to what BTVL trades at currently (30.3 times and 22.8 times respectively). Even on an EV/EBIDTA basis, while RCL trades at 10.1 times trailing 12-months EBIDTA, BTVL trades at 23.8 times. Apart from fundamental factors, as indicated in the comparative table above, the technical factor of higher foreign ownership also works in the favour of BTVL commanding a premium to RCL.

Also, if one compares the two stocks on an EV per subscriber basis (a valuation metric used for calculating acquisition value), BTVL trades at US$ 749 per subscriber, more then double of RCL, which trades at US$ 342 per subscriber. Considering the relative better performance at the operating levels, a more consolidated business structure (One Airtel) and deeper management strength, we believe that BTVL shall continue to trade at a premium to RCL, at least in the medium term. However, we expect RCL 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 further on the back of benefits from operating leverage. The unresolved royalty issue with Qualcomm shall, however, remain a medium term issue.

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