Reduce Reliance Communications says BNP paribas,

Challenge in monetizing 3G
􀂃 Debt concerns re-emerge with annulment of tower sale to GTL.
􀂃 Higher capacity unlikely to be an advantage over incumbents.
􀂃 Existing EVDO data card revenue may come under pressure.
􀂃 REDUCE with a TP of INR160, implying 7.8x FY12E EV/EBITDA.
Debt concerns re-emerge
GTL Infrastructure (GTLI IN, CP:
INR45.70, Not rated) had agreed to buy
50,000 towers of Reliance
Communication (RCOM) in June 2010.
The deal was cancelled after the term
sheet signed by the two companies
expired. We expected a cash inflow of
USD3b-4b for RCOM, which would have
enabled RCOM to deleverage its balance
sheet. RCOM had net debt of USD6.2b as
of 1QFY11. RCOM intended to
deleverage its balance sheet through: 1)
the sale of tower assets, and 2) a 26%
stake sale to a strategic investor. There
has been no progress on strategic stake sale and the tower deal is
cancelled. RCOM has a highly leveraged balance sheet and will have to
raise funds to repay its USD1.3b FCCBs, due in FY12.
Higher capacity is not an advantage over incumbents
On 5MHz of 3G spectrum, with HSPA networks providing 14.4Mbps
download speed, the incumbent GSM operators would have sufficient
spare capacity after accommodating ~700 subscribers offering 1Mbps
download speed with a contention ratio of 1:50. We see a strong
likelihood of operators providing 3G services with Unlimited Plans to
attract subscribers in the initial days. The adequate capacity with GSM
incumbents should prevent RCOM from benefiting from greater wireless
broadband capacity by virtue of its higher spectrum holding.
EVDO data revenues could come under pressure
RCOM’s CDMA net additions had dropped with the introduction of its
pan-India GSM service. To make matters worse, the subscribers
attracted to RCOM’s GSM offering were primarily bargain hunters and
dual SIM connections, which dragged down ARPUs. However, in the last
year, dual-tech operators such as RCOM and Tata Teleservices (not
listed) were able to monetize on the lead offered by CDMA EVDO
network by providing high-speed wireless data services on USB dongles.
Our channel checks suggest these CDMA operators are selling ~100,000
USB dongles per month with ARPU of over INR750, which were reduced
recently in anticipation of the launch of 3G GSM networks. On the launch
of 3G GSM services, we expect pressure on EVDO data revenues.
Maintain REDUCE; Raise TP to INR160.00
We lift our TP to INR160.00 (from INR140) to reflect the valuation switch
from EV/EBITDA to DCF to reflect the long-term impact from 3G
services. At our TP, the stock would trade at FY12E EV/EBITDA of 7.8x.
Risks: decline in debt due to equity infusion by strategic investor at a
premium valuation and increase in revenue market share.