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Reliance Communications
Reuters: RLCM.BO Bloomberg: RCOM IN Exchange: BSE Ticker: RLCM
Stabilising operations but growth is the key imperative
Wireless business consolidates; revenue scale-up is the next challenge
We maintain a Hold rating on Reliance Communications (RCOM) with an
unchanged Rs150 target price. RCOM’s key challenge remains to increase
revenues and maintain profitability in the currently competitive environment. Over
the last eight quarters RCOM’s revenue-share trended downwards and the topline
remained stagnant despite its dual networks (CDMA and GSM). However, we
note that EBITDA margins and revenue per minute in the wireless business have
been stable over the last three quarters, underpinning our Hold rating
FCFF over the next two years likely adequate to repay outstanding FCCBs
We estimate RCOM’s FCFF at approximately Rs64bn over the next two years
(FY12-13) which equates to USD1.3bn currently outstanding on its two FCCBs.
One FCCB matures in May 2011 (USD297m) and another in March 2012
(USD925m). However, we note that our forecasts imply RCOM’s cashflows will
increase from its current annualised rate range of Rs22-30bn.
RCOM trades growth for profitability; key changes to estimates
We have changed our FY11/12 revenue estimates by -12%and -15% and EBITDA
by +18% and 0%, respectively. The basic driver for our change in FY11 estimates
is better-than-forecast revenue/min, leading to better margins. However, this has
been offset by slower-than-expected traffic growth. We remain below consensus
on our estimates and target price. We do not ascribe any value to infrastructure sharing (previously Rs20/share) due to minimal visibility on that front.
Two-year EBITDA CAGR (FY11-13E) of 15%, trading at 8xFY12E EV/EBITDA
Our DCF-based target price for RCOM is Rs150, implying 8.5xFY12E EV/EBITDA.
Our DCF assumptions are a RFR of 6.4%, risk premium of 7.2%, CoE at 15.8%,
Kd of 10.5%, WACC of 13.4% and terminal growth rate of 4%. Upside risks
include higher-than-expected traffic growth. A lower-than-expected increase in
margins is a key downside risk.
Key highlights
Changes in key assumptions
RCOM has traded growth for profitability in the wireless business. The basic driver for our
change in FY11 estimates is the better-than-forecast revenue per minute (RPM) for RCOM.
The lower fall in tariffs also drives RCOM’s margins, which have been trending higher than
our previous forecast. However, our FY11 revenue estimates for the wireless business have
changed minimally as the higher RPM was offset by a slower-than-expected growth in traffic.
In essence, RCOM has traded growth for profitability in the wireless business. Overall, FY11
revenue estimates have been deceased due to the lower-than-expected traction experienced
in the long distance and enterprise businesses.
Our EBITDA estimate for FY12 remains unchanged as the positive change in margins is offset
by lower revenues. The change in EPS stems from RCOM’s interest costs, which have been
volatile, resulting in a larger forecasting error. In addition, FY12E EPS is also affected by
interest and depreciation relating to launch of the 3G network.
Deutsche Bank vs. consensus
As seen in Figure 2, we are in line with consensus on revenues, 5-9% below consensus on
EBITDA and 30-44% below consensus on EPS estimates. We note that RCOM’s consensus
EBITDA estimates have been lowered by approximately 27% for FY11/12. The decrease in
consensus EPS estimates is higher for FY11/12, at approximately 50%. The significant
variation between our estimates and that of consensus on EPS estimates is due to RCOM’s
interest and tax charges which have been volatile on a quarterly basis. Hence, the forecasting
error could be large. We have assumed normalised interest costs, taking into account
RCOM’s net debt at approximately Rs300bn and accounting for approximately USD1.3bn of
zero coupon FCCBs. We have also assumed the effect of the company’s recent launch of a
3G network for 4QFY11E onwards.
Sensitivity analysis
We calculate a 5% increase in revenue per minute would lead to a 180bps increase in the
wireless EBITDA margin and an 11% increase in wireless EBITDA. On an overall basis, we
estimate EBITDA and EPS would increase by 8% and c. 40%, respectively. Our analysis
assumes that the increase in revenue per minute does not affect either traffic or network and
other discretionary costs which together account for approximately 68% of sales.
Wireless business
Stable for now but growth is the key imperative
RCOM’s wireless business has consolidated over the last three quarters, which is reflected in
the company’s stable revenue per minute at Rs0.44 and modest uptrend in network traffic.
The EBITDA margin has been flat at approximately 29% during the same period. However, it
is imperative for RCOM to scale up its revenue and EBITDA base which remain below the
level it enjoyed prior to the launch of its GSM network. We note that RCOM has not
managed to gain any revenue market share over the last two years
3QFY10 expectation: modest pick-up in revenue growth and
stable margins
We forecast revenue of Rs52bn (3.7% QoQ), EBITDA (Rs16.1bn, 3.3% QoQ) and EBITDA
margin (31%, flat QoQ). Key metrics to watch are revenue per minute (Deutsche Bank
estimate: Rs0.44) and wireless division EBITDA margin (Deutsche Bank estimate: 29%). We
would also focus on management’s commentary regarding the progress of the 3G launch
and the impact of mobile number portability
Financial analysis and valuations
Revenues – Two year CAGR (FY11-13E) of 11%
We expect RCOM’s wireless revenues to grow at a CAGR (FY11-13E) of 10% driven by 11%
pa growth in minutes and a 1% pa contraction in pricing. We estimate revenue/min to fall by
12% in FY11 and stabilise thereafter. On the non-wireless side, we expect reasonable
revenue traction in the global and other (mainly DTH) businesses, leading to revenues at a
CAGR (FY11-13E) of 14% in the non-wireless businesses.
RCOM’s wireless margins have fallen significantly (940bps) since FY09 due to the tariff war
which started in October 2009. We believe pricing should stabilise forwarding the future,
leading to an increase in EBITDA/min for RCOM. We forecast RCOM’s EBITDA/min to
increase by 2% pa. over FY11-13, leading to a 200bps improvement in the EBITDA margin to
31% in FY13 (vs. 29% in FY11). Margins in other businesses are also expected to trend
upwards marginally. Overall, we expect consolidated EBITDA margins to increase by 190bps
from 30.5% (FY11) to 32.4% in FY13. Consolidated EBITDA is forecasted to grow at a CAGR
(FY11-13) of 15%.
Positive FCF should aid in paying down maturing FCCBs
RCOM would be modestly negative FCF in FY11E if we normalised the one-time effect of 3G
licence fee of Rs85bn paid by the company. Over the two years (FY12-13), we expect the
company’s capex to stabilise and forecast investments of Rs63bn. This compares with an
operating cashflow of Rs128bn, resulting in the generation of Rs64bn (UDS1.4bn) free cash
over FY011-13E. We note that RCOM has FCCB repayments of USD1.2bn due over the next
12 months. Consequently, we expect the company’s net debt to fall from Rs313bn in FY11E
to Rs245bn in FY13.
Net profit growth could outpace EBITDA due to reduced burden of depreciation and
interest
We expect net profit CAGR (FY11-13E) at 33% driven by a pull back in FY12E resulting from
the wireless business. While interest and depreciation could be higher in FY12E, they do not
offset the positive effect of the expected momentum in the wireless business. Our FY13
estimates reflect a normalised growth scenario and we forecast EPS growth of 14.4%.
Valuation and risks
Valuation methodology and target price
We value RCOM on a DCF basis at Rs150/share. Our DCF assumptions are a risk-free rate of
6.4%, risk premium of 7.2%, CoE at 15.8%, Kd of 10.5%, WACC of 13.4%, and a terminal
growth rate of 4%. Our terminal growth rate is in line with our expected growth rate of Indian
households.
We have used a 15-year period for our DCF forecasts. We assume revenue growth should
initially rise to 12% and then trend downwards over our forecast period to 6%. Capex/sales
should decrease from 10% in FY12E to 8% by the end of the forecast period (FY26E).
We do not ascribe any value to infrastructure sharing (previously Rs20/shr)
Our previous target price of Rs150 was based on a Rs130/share for core business (DCFbased) and Rs20/share to compensate for the impact of tower sharing. RCOM had
announced a ten year tower-sharing deal with ETISALAT. The valuation was based on a 50%
discount to its DCF-based value. However, we have not seen any material progress on the
deal and believe there is low probability of any cashflows from the deal in the medium term.
Our target price implies a marginal discount to our valuation for Bharti
Our target price of Rs150 for RCOM implies a FY12E EV/EBITDA of 8.5x, which is a 6%
discount to our implied valuation of Bharti’s Indian operations (9xFY12E). Our implied
valuation is at the lower end of RCOM’s historical range. We believe valuations are likely to
remain at the current level, reflecting the lower growth and higher competitive intensity in the
Indian telecom sector.
Risks
Upside risks
„ Greater increase in minutes and revenue market share – We forecast RCOM’s minutes
growth to be in line with the industry and we are not expecting a material change in its
revenue marketshare. However, a higher-than-expected growth in traffic would be an
upside risk to our estimates.
„ Better-than-expected traction in global revenues – We forecast RCOM’s global business
to grow at 10% pa over FY11-13. If RCOM is able to beat the competition and increase
its market share in the international voice and data segment, our revenue estimates will
likely be at risk.
Downside risks
„ Lower-than-expected increase in margins – We forecast RCOM’s EBITDA margins to
improve over FY11-13. However, if margins are stagnant or deteriorate further, it would
pose a downside risk to our estimates.
„ Resumption of tariff wars in India - The tariff competition that was restarted by the
entrants in October 2009 led to a significant decrease in the rate per minute for all
operators. The pricing environment has been relatively benign over the last quarter, and
we expect industry tariffs to stabilise by the end of FY11. However, if the new entrants
(including RCOM) attempt to acquire subscribers by providing lower rates again, there
could be a downside risk to our revenue and margin estimates.
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