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Reliance Communications (RLCM.BO)
Upgrade to Buy: Good Asset Now Available at a Discount
Upgrade to Buy (from Sell) — RCOM stock has fallen sharply in the last 1 month
on newsflow around the 2G spectrum controversy. However at current levels, the
stock trades at a 12% discount to Bharti, below its replacement cost and in our
view factors in most of these concerns. Besides we have also built in part of the
extra spectrum payment which the company may be required to pay and revised
risk rating to High (Medium) to account for the business/leverage risks.
Lowering target price to Rs127 (from Rs155) — Our RCOM TP comprises core
business at Rs110, based on 6.3x FY12E EV/EBITDA which is at a 25% discount
to Bharti and net towerco value accretion of Rs25/share. RCOM’s FY11-13E
EBITDA is down 5-7% on overall weak business momentum which gets reflected
in the decline in core business value. We reduce Rs8/share from the on cash
outgo based on a 50% probability of the Government charging the “market” value
for the GSM spectrum allotted in 2008 for Rs16.5bn (market value estimated at
~Rs49bn for 4.4MHz based on 3G spectrum thrice as efficient as 2G).
Attractive assets available below replacement cost — RCOM’s asset basket
consisting of CDMA/GSM/3G spectrum, fiber network and tower portfolio is geared
towards mobile data growth. We estimate RCOM’s replacement cost at
Rs120/share. The stock is currently trading below this making it an attractive
acquisition candidate, in our view.
Re-rating contingent upon business momentum and leverage — The
company has been experiencing lackluster business momentum with low
utilisation of its GSM network vs. its larger peers, besides hurting from MNP in
both of its networks. We believe kick starting of the business momentum (minutes
growth) and any steps towards de-leveraging (gives company breathing space) will
be critical for a sustained re-rating.
Upgraded to Buy (Sell) with Rs127/share TP
We cut RCOM's FY11-13 EBITDA estimates by 5-7% on overall weak
momentum across business segments. The decrease at the EPS level gets
accentuated due to higher capitalization charge.
RCOM's core business value of Rs110/share is based on 6.3x FY12E
EV/EBITDA, i.e. at a 25% discount to Bharti's imputed multiple on its DCF
(domestic business). We believe that discount to Bharti is justified given:
– Inherent risks in dual network and lower capacity utilisation in GSM.
– High leverage (FY11E net debt at Rs313bn) with FY11E net debt/EBITDA
at 4.7x leaves RCOM's BS exposed to any adverse regulations (read
retrospective 2G spectrum payments).
RCOM's net towerco value based on Mar-11E DCF is at Rs25/share. The value
has declined given low visibility on external tenancy especially as Etisalat DB
(signed up for bulk tenancy) is currently embroiled in the 2G spectrum
controversy and is unlikely to undertake additional Greenfield roll-out. Beside,
Etisalat has publicly announced its intention of looking to buy a running
business.
The current 2G controversy surrounding the allotment of spectrum at allegedly
below market price to the new entrants in 2008 means that there is a risk that
the Government could charge market value of 2G spectrum on a retrospective
basis. While the probability of this is low, given it would hurt India’s "investment
climate", assuming a 50% probability of this event, hit on RCOM would be
Rs8/share which we include in our TP (based on Rs41bn for 4.4MHz based on
3G spectrum 3x more efficient versus 2G).
RCOM’s stock has taken a big hit in the last 1 month, falling 20% on concerns
of being embroiled in the 2G spectrum controversy. We believe the stock at
current levels provides decent risk adjusted returns. Besides, it currently trades
below its replacement value and given its asset portfolio (CDMA, GSM and 3G
spectrum, fiber network, towers), geared towards the upcoming data
opportunity, is an attractive acquisition candidate, in our view.
Figure 1. RCOM replacement value assumptions
Rs m Bear case Comments
Number of towers 50,000
EV/Tower 3,825,000 US$85k/tower
Value of towers ( 191,250
Active equipment 112,500 50% discount to the Rs3m cost per BTS
Under sea cable (Km) 87,000
Cost per Km (Rs) 900,000 3x the cost of laying out domestic fiber
Under sea cable 78,300
Domestic fiber business 190,000
Cost per km (Rs) 300,000
Domestic fiber business 57,000
Others 27,615 Book value
Spectrum
Value of 3G 64,388 75% of price paid
Value of GSM spectrum 48,987 One third the value of 3G spectrum with 3G thrice as
efficient as 2G
Value of CDMA spectrum 11,550 Valued at 70% of the value of Rs16.5bn paid for GSM
spectrum in 2008
Total replacement value 591,589
Net debt + equipment supplies payable 345,991
Equity value 245,598
Per share 120
Current share price 98
% discount -19.3%
Source: Citi Investment Research and Analysis estimates
Reliance Communications currently lies in the Extreme corner of the Contrarian
quadrant of our Value-Momentum map with relatively weak momentum but
strong value scores. having been a resident there since the past 12 months.
Compared to its peers in the Telecoms & Media sector, Reliance
Communications fares better on the valuation metric but worse on the
momentum metric. Similarly, compared to its peers in its home market of India,
Reliance Communications fares better on the valuation metric but worse on the
momentum metric.
From a macro perspective, Reliance Communications has a high Beta to the
region so is likely to rise (or fall) faster than the region. It is also likely to benefit
from falling Commodity (ex-oil) prices, and a weaker US Dollar
Reliance Communications
Valuation
Our target price of Rs127 comprises (i) core business value of Rs110, based on
6.3x Mar-12E EV/EBITDA, at a 25% discount to Bharti's implied target multiple;
plus (ii) towerco value accretion of Rs25 based on long-term external tenancy
of 0.5x. We believe a 25% discount to Bharti on the core business valuation is
justified on account of the inherent risks of dual network and higher leverage.
Our towerco net value accretion of Rs25 is based on the following assumptions:
1) Long-term tenancy of 2.15x with captive tenancy of 1.65x; 2) Capex recovery
of 12%, 3) WACC of 11.3% and terminal growth rate of 3%. Note that the
incremental value accretion to RCOM is calculated after netting off the
contribution from the captive tenancy. Thus, it only reflects the value of the
external revenues. We reduce Rs8/share from the on cash outgo based on a
50% probability of the Government charging the “market” value for the GSM
spectrum allotted in 2008 for Rs16.5bn (market value estimated at ~Rs49bn for
4.4MHz based on 3G spectrum thrice as efficient as 2G).
Risks
Our risk-rating system, which tracks 260-day share price volatility, assigns a
Medium Risk rating to RCOM. We however believe a High Risk is appropriate
given lackluster business momentum and possible penalties by the
Government on 2G spectrum especially in the context of its high leverage. Key
downside risks that could prevent the stock from reaching our target price
include: 1) Further deterioration in core business, 2) higher-than expected
penalties related to GSM spectrum allotted in 2008 and 3) inability to
deleverage through asset sale.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Communications (RLCM.BO)
Upgrade to Buy: Good Asset Now Available at a Discount
Upgrade to Buy (from Sell) — RCOM stock has fallen sharply in the last 1 month
on newsflow around the 2G spectrum controversy. However at current levels, the
stock trades at a 12% discount to Bharti, below its replacement cost and in our
view factors in most of these concerns. Besides we have also built in part of the
extra spectrum payment which the company may be required to pay and revised
risk rating to High (Medium) to account for the business/leverage risks.
Lowering target price to Rs127 (from Rs155) — Our RCOM TP comprises core
business at Rs110, based on 6.3x FY12E EV/EBITDA which is at a 25% discount
to Bharti and net towerco value accretion of Rs25/share. RCOM’s FY11-13E
EBITDA is down 5-7% on overall weak business momentum which gets reflected
in the decline in core business value. We reduce Rs8/share from the on cash
outgo based on a 50% probability of the Government charging the “market” value
for the GSM spectrum allotted in 2008 for Rs16.5bn (market value estimated at
~Rs49bn for 4.4MHz based on 3G spectrum thrice as efficient as 2G).
Attractive assets available below replacement cost — RCOM’s asset basket
consisting of CDMA/GSM/3G spectrum, fiber network and tower portfolio is geared
towards mobile data growth. We estimate RCOM’s replacement cost at
Rs120/share. The stock is currently trading below this making it an attractive
acquisition candidate, in our view.
Re-rating contingent upon business momentum and leverage — The
company has been experiencing lackluster business momentum with low
utilisation of its GSM network vs. its larger peers, besides hurting from MNP in
both of its networks. We believe kick starting of the business momentum (minutes
growth) and any steps towards de-leveraging (gives company breathing space) will
be critical for a sustained re-rating.
Upgraded to Buy (Sell) with Rs127/share TP
We cut RCOM's FY11-13 EBITDA estimates by 5-7% on overall weak
momentum across business segments. The decrease at the EPS level gets
accentuated due to higher capitalization charge.
RCOM's core business value of Rs110/share is based on 6.3x FY12E
EV/EBITDA, i.e. at a 25% discount to Bharti's imputed multiple on its DCF
(domestic business). We believe that discount to Bharti is justified given:
– Inherent risks in dual network and lower capacity utilisation in GSM.
– High leverage (FY11E net debt at Rs313bn) with FY11E net debt/EBITDA
at 4.7x leaves RCOM's BS exposed to any adverse regulations (read
retrospective 2G spectrum payments).
RCOM's net towerco value based on Mar-11E DCF is at Rs25/share. The value
has declined given low visibility on external tenancy especially as Etisalat DB
(signed up for bulk tenancy) is currently embroiled in the 2G spectrum
controversy and is unlikely to undertake additional Greenfield roll-out. Beside,
Etisalat has publicly announced its intention of looking to buy a running
business.
below market price to the new entrants in 2008 means that there is a risk that
the Government could charge market value of 2G spectrum on a retrospective
basis. While the probability of this is low, given it would hurt India’s "investment
climate", assuming a 50% probability of this event, hit on RCOM would be
Rs8/share which we include in our TP (based on Rs41bn for 4.4MHz based on
3G spectrum 3x more efficient versus 2G).
RCOM’s stock has taken a big hit in the last 1 month, falling 20% on concerns
of being embroiled in the 2G spectrum controversy. We believe the stock at
current levels provides decent risk adjusted returns. Besides, it currently trades
below its replacement value and given its asset portfolio (CDMA, GSM and 3G
spectrum, fiber network, towers), geared towards the upcoming data
opportunity, is an attractive acquisition candidate, in our view.
Figure 1. RCOM replacement value assumptions
Rs m Bear case Comments
Number of towers 50,000
EV/Tower 3,825,000 US$85k/tower
Value of towers ( 191,250
Active equipment 112,500 50% discount to the Rs3m cost per BTS
Under sea cable (Km) 87,000
Cost per Km (Rs) 900,000 3x the cost of laying out domestic fiber
Under sea cable 78,300
Domestic fiber business 190,000
Cost per km (Rs) 300,000
Domestic fiber business 57,000
Others 27,615 Book value
Spectrum
Value of 3G 64,388 75% of price paid
Value of GSM spectrum 48,987 One third the value of 3G spectrum with 3G thrice as
efficient as 2G
Value of CDMA spectrum 11,550 Valued at 70% of the value of Rs16.5bn paid for GSM
spectrum in 2008
Total replacement value 591,589
Net debt + equipment supplies payable 345,991
Equity value 245,598
Per share 120
Current share price 98
% discount -19.3%
Source: Citi Investment Research and Analysis estimates
Reliance Communications currently lies in the Extreme corner of the Contrarian
quadrant of our Value-Momentum map with relatively weak momentum but
strong value scores. having been a resident there since the past 12 months.
Compared to its peers in the Telecoms & Media sector, Reliance
Communications fares better on the valuation metric but worse on the
momentum metric. Similarly, compared to its peers in its home market of India,
Reliance Communications fares better on the valuation metric but worse on the
momentum metric.
From a macro perspective, Reliance Communications has a high Beta to the
region so is likely to rise (or fall) faster than the region. It is also likely to benefit
from falling Commodity (ex-oil) prices, and a weaker US Dollar
Reliance Communications
Valuation
Our target price of Rs127 comprises (i) core business value of Rs110, based on
6.3x Mar-12E EV/EBITDA, at a 25% discount to Bharti's implied target multiple;
plus (ii) towerco value accretion of Rs25 based on long-term external tenancy
of 0.5x. We believe a 25% discount to Bharti on the core business valuation is
justified on account of the inherent risks of dual network and higher leverage.
Our towerco net value accretion of Rs25 is based on the following assumptions:
1) Long-term tenancy of 2.15x with captive tenancy of 1.65x; 2) Capex recovery
of 12%, 3) WACC of 11.3% and terminal growth rate of 3%. Note that the
incremental value accretion to RCOM is calculated after netting off the
contribution from the captive tenancy. Thus, it only reflects the value of the
external revenues. We reduce Rs8/share from the on cash outgo based on a
50% probability of the Government charging the “market” value for the GSM
spectrum allotted in 2008 for Rs16.5bn (market value estimated at ~Rs49bn for
4.4MHz based on 3G spectrum thrice as efficient as 2G).
Risks
Our risk-rating system, which tracks 260-day share price volatility, assigns a
Medium Risk rating to RCOM. We however believe a High Risk is appropriate
given lackluster business momentum and possible penalties by the
Government on 2G spectrum especially in the context of its high leverage. Key
downside risks that could prevent the stock from reaching our target price
include: 1) Further deterioration in core business, 2) higher-than expected
penalties related to GSM spectrum allotted in 2008 and 3) inability to
deleverage through asset sale.
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