India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Communications
Upgrade to Neutral on valuation
See limited impact on operations from the CAG reportrelated
actions, but expect sentiment to weigh on the stock
Break-up value of assets to provide downside support
Upgrade to N from UW (removing V flag); cut target price to
INR152 from INR170
The stock has declined 7% y-t-d (–22% in last two months) and now trades at a 12-
month forward PE of 13x. We believe the sell-off is due to: a) overall market weakness,
and b) concerns related to the Comptroller and Auditor General of India (CAG) report that
alleges that the Department of Telecommunications (DoT) gave undue benefit to RCOM
while issuing the dual technology license, and violation of the cross-holding norms by
RCOM. The company has denied these allegations. Although we see minimal impact on
operations from any finding of the CAG report, the related overhang is likely to continue
to weigh on the stock for the next few quarters. Separately, we believe visibility on
strategic initiatives (26% stake sale and tower monetisation) has diminished, given market
conditions. Consequently, we are lowering our target PE multiple from 15x to 13x and cut
our target price to INR152. However, given the sell-off, we raise our rating to Neutral.
Expect the stock to be range bound. We believe the value of RCOM’s assets is likely to
provide downside support at the current level, which we estimate at INR130. That said, we
also see limited upside, given balance sheet concerns.
How have we computed NAV? We derive NAV using separate values for the GSM, CDMA,
3G business and tower/fibre assets held by the company. We value all businesses based on the
potential value of the spectrum and we have used a discount to the 3G spectrum to arrive at the
fair values. Our base-case NAV implies an EV/subscriber of USD125 for the GSM business
(about 35% discount to Bharti’s wireless business) and USD102 for the CDMA business.
Key positives are a) MNP and benefits from churning high-end subscribers – we see limited
upside given RCOM’s underinvested GSM network, and b) improved tower tenancy due to
BWA launches. Key negatives are a) a PE de-rating on account of potential fines on the back
of any CAG report findings, and b) loss of CDMA subs post MNP introduction.
We upgrade RCOM to Neutral from UW(V), but cut the target price to INR152 as we lower
our target PE multiple to 13x (15x). The key upside risk is RCOM’s ability to sell a 26% stake
and monetise the tower assets. Further acceptance of the TRAI recommendation in the current
format would also be positive for the stock. The key downside risks are lower-than-estimated
ARPU and slower-than-estimated ramp-up in data.
Analysis and computations
We value RCOM based on its spectrum bank and other assets, such as towers and optic fibre network, as
in our view these provide downward support for the stock.
Bear case: We value RCOM’s GSM and CDMA spectrum at 5x the license fee paid to acquire these
licenses from the government. We value its towers at an EV/tower of USD5m and not EV/tenant (as the
external tenancy on its towers is very low), as implied by recent tower transactions. We value its 3G
spectrum at 65% of the price paid for the auction and, as such, view it to be value destructive. We value
its fibre business at USD2bn. This implies a value per share of INR130.
Bull case: We value RCOM’s GSM business at 60% of the 3G prices on the premise that the company
will shift its high-end subs to 3G, which will allow it to better utilise its 2G spectrum. We value its
CDMA spectrum at 50% of the 3G prices and view it as complementing its 3G data card business. We
value its tower assets at an EV/tower of USD6.3m, as implied by the deal with GTL Infra. We project the
3G capex to yield a return of 10% of the price paid for the auction and, as such, view it to be value
accretive. We value its fibre business at USD2bn. This implies a value per share of INR184.
Catalysts
Mobile number portability
While mobile number portability (MNP) gives RCOM an opportunity to grab high-end subscribers from
its competitors, its poor coverage in 2G remains a concern. Nevertheless, MNP also exposes it to the risk
of losing CDMA subscribers, who so far had limited options. Although shifting to GSM will require
subscribers to invest in 2G handsets, for some this may coincide with the handset replacement cycle.
We believe CDMA subscribers did not change operators for two reasons: 1) to retain their numbers; and 2) not
to waste their investment in the CDMA handset. We note on average, a handset has a useful life of up to three
years. Post MNP, subscribers who are at the end of their handset life will likely start shifting to GSM, as they
no longer have to be locked to an operator. Also, they can change the operator without changing the number.
Given this possibility, we do not see clear positives for RCOM from MNP introduction.
3G and data business
RCOM currently offers data cards on its CDMA network and is expanding the coverage of its EVDO
cards to 150 towns. The company has won 3G spectrum in 13 circles, including all of its eight 900 MHz
band markets. It was the second private operator to launch 3G services in India, in December 2010. While
it is suitably positioned to benefit in the data card segment, we believe its ability to benefit from wireless
broadband is limited, given the lack of high-end subscribers. RCOM’s current GSM coverage is
insufficient and it needs to invest more in tower infrastructure to meaningfully attract high-end
subscribers. We estimate RCOM’s 3G adoption rate at 11% by FY15, and expect the company to be
focussed more on the devices and data card market.
Valuation and rating
We value RCOM using a 12-month target price based on a blended approach of PE and DCF (equal weight).
For our DCF valuation, we assume a cost of equity of 13% (HSBC’s Strategy Team has computed a baseline
cost of equity of 11% for India, and we assume a rate 200bp above that to factor in competitive intensity,
accounting issues and risks associated with a stretched balance sheet), cost of debt of 10.5%, WACC of 13%
and a terminal growth rate of 3.5%. This produces a fair value of INR186 per share.
For the PE valuation, we have lowered our target multiple to 13x from 15x. Our earlier target multiple of
15x factored in the potential benefits from RCOM’s plans to monetise the tower assets and to introduce a
strategic investor by selling a 26% stake. As we do not see any visibility on this in the near future, we
lower our target multiple to 13x, which at FY12e EPS implies a value of INR110 per share. Blending
both approaches, we arrive at a fair value of INR152 per share for the core business.
Under our research model, for stocks without a volatility indicator, the Neutral band is 5 percentage
points above and below our hurdle rate for Indian stocks of 11%, or 6-16% around the current share price.
Our INR152 target price represents a potential return of 12%, which implies a Neutral rating for the
stock; hence, we upgrade RCOM to Neutral from UW(V).
No comments:
Post a Comment