Underweight rating on Reliance Communications: Fighting hard for its relevance

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Updated: January 18, 2016 12:30:13 AM

Reliance Communication (RCom, UW) has announced several newsworthy corporate actions in the recent past.

Reliance Communication (RCom, UW) has announced several newsworthy corporate actions in the recent past. Primary among the items making news are (i) RCom’s ongoing attempts to consolidate the industry at the lower end by announcing attempts at a three-way merger between the wireless units of itself, of Aircel & Sistema Shyam (SSTL). Such an envisaged entity would have ~12% revenue market share (RMS) in the industry with ~204m subs with top-3 market share position in 13 circles and overall the fourth player in industry on revenues, also with a vastly improved spectrum portfolio footprint almost rivaling Bharti’s, (ii) an extensive, deep partnership with Reliance Jio (Rjio) across all 22 circles to trade spectrum to mutual benefit though the gain to RCom will come in the form of premium that RJio is willing to pay over RCom’s costs to liberalise the administered 800/850 MHz spectrum, and finally (iii) monetisation of its assets most notably of its tower business—a definitive announcement of which is likely in January.

All these simultaneous corporate actions under way clearly attest to RCom’s strenuous efforts to radically strengthen its balance sheet while also attempting to increase its relevance in the market. As a starting point, it would need to pare down debt before it can hope to compete credibly again. So, tower asset monetisation is a requisite even though by itself it does not move the needle on investment view on RCom. Where things get more interesting is RCom trying to consolidate the market through its exploratory efforts at a potential merger with Aircel and of course, its elaborate deal with RJio. The most important question—do such moves by spurring consolidation at the lower end moderate the competitive intensity in India telcos and make the industry more disciplined as optimists believe?

rcomm

Our view—not really. Competitive intensity may not moderate—perversely, it might actually increase since it potentially introduces a stronger fifth player into the pan-India telco competitive mix, replacing two weak entities. For some time now, RCom has virtually stopped credibly competing in the market while Aircel is doing so only to a limited extent.

The clearest manifestation of this is per unit data/voice pricing and capex trends, which has degraded in almost every emerging market where there are just 2-3 players. Yes, we do expect ongoing consolidation at the lower-end ahead of RJio’s commercial services launch and 4G roll-outs, but there are still five large relevant private players (Airtel, Vodafone, Idea, RCom+Aircel+SSTL and RJio) in India—with 5 pan-India players, India will still have more pan-India telco players than other Emerging Markets.

Thus, we retain our UW rating on RCom even as we acknowledge that the company is making the right moves for relevance, which may well keep the stock buzzing in anticipation of fruition of the ongoing actions. Also, Rcom’s current valuations are not so supportive, its EV/Ebitda at ~7.7x FY16 and ~7x FY17E is more expensive than Bharti/Idea despite near-absent organic growth. We discuss the development of the various corporate actions in detail below:

Action 1: Ongoing attempt to consolidate the industry at the lower end by efforts to merge the wireless divisions of RCom, Aircel and Sistema Shyam to create a pan-India entity with ~12% RMS and a much improved spectrum footprint almost rivaling Bharti’s. Talks on integration are still in initial phase though. RCom has entered into a 90-day exclusivity period with Aircel promoters (Maxis Communications Berhad and Sindya Securities & Investments) to consider integration of RCom & Aircel’s wireless business. Both Aircel and RCom will likely spin off their wireless business, which it is envisaged gets integrated into a single listed entity. RCom will retain its Global business and other ex-wireless assets.

First, such a combine will improve RCom’s market standing. Both RCom and Aircel have 5-6% revenue market share (RMS) and both are struggling to sustain/improve their RMS. RCom is consistently losing market share, while Aircel’s RMS has stagnated around 5.6-5.8% over the past 7 quarters. The integrated entity will have ~12% RMS and will be among three largest players in 13 of the 22 circles. Second, the terms of integration will likely ensure more balance sheet strength by reducing leverage for the combined entity. RCom and Aircel, each brings ~R100 bn as debt to the combined entity. Currently RCom has about R430 bn net debt on its balance sheet, while Aircel has another R200-250 bn of debt.

Action 2: Extensive/deep partnership with RJio to trade/share spectrum across all 22 circles. But what would be the net gain to RCom net of spectrum liberalisation costs is key. Rcom has sizable 800/850 MHz spectrum in all 22 circles, ideal for 4G services after liberalising the spectrum. RJio has also purchased 5 MHz spectrum in 800/850 MHz band in 10 circles in the Mar-15 auction. In the 10 circles, where RJio and RCom both own 800 MHz spectrum, the two players might get into spectrum sharing agreement. The two together own 10 MHz spectrum in all these 10 circles (except UP East), which will allow each of them more than sufficient spectrum to provide 4G services.

Action 3: Monetisation (disposal) of RCom’s assets – more likely, RCom’s tower assets. But just a Tower sale deal is unlikely to be game-changing in absence of success of other initiatives. RCom has signed a non-binding agreement with private equity firms TPG and Tillman Global to sell its tower assets for R220 bn.

We conclude that such a deal for Reliance Communication would be only modestly beneficial for its stock and leverage reduction. We estimate the net NPV gain/share of R9-10 per share as a result of this deal. More important, we assess that just tower sales will likely help RCom modestly shave off its Net Debt/FY17e.

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