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Reliance Communications
(RCOM)
Corporate actions have been the catalyst but RCOM is likely to
find it difficult to unlock value in tower assets
No gains from MNP and uncertainty over CDMA given progress
on TD-LTE raise concerns for the stock
Retain Neutral (V) rating and target price of INR122
Investment summary
We have a Neutral (V) rating on RCOM shares
given concerns over balance sheet, a 2G
corruption probe and lacklustre operating
performance. We are also cautious on the
company’s ability to unlock value in tower assets.
Though unlocking is being perceived by the
market as both catalyst and downside support for
the stock, we believe unlocking value in the tower
assets will be tough, as the buyer of those assets
will have to take a longer-term bet on RCOM’s
GSM and CDMA businesses, both of which suffer
low network utilization. RCOM’s longer-term
commitment to continue with CDMA is critical
for tower valuations. However, with the rollout of
3G services and progress on TD-LTE (4G),
prospects for CDMA will be reduced in our view
and we expect tenancy from CDMA to decline;
this is negative for the RCOM tower business. We
note that RCOM has pulled out from tower listing
twice and after that the transaction with GTL was
also called off. In unlocking initiatives, markets
tend to assume asset-based valuations will provide
support, however, failure to close deals/execute
gives rise to concern.
The negatives weighing on the stock have
primarily been concerns about RCOM’s balance
sheet, a 2G corruption probe and lacklustre
operating performance. While we believe the
recent refinancing of short-term 3G debt with a
loan facility from China Development Bank
(CDB) is positive (preventing significant increase
in interest costs but not lowering them as 3G
interest cost is capitalised), leverage remains high.
As far as impact of the 2G corruption probe is
concerned, we don’t rule out the possibility of
new entrants paying a one-time start-up spectrum
fee; we estimate the impact for RCOM at
USD335m. Separately, business fundamentals
remain weak, as despite investments in GSM,
wireless revenues have been declining (refer
Figure 45). Initial porting data also suggests
vulnerability of CDMA.
However, RCOM has a diverse spectrum bank,
including national CDMA 800 MHz and GSM
1800 MHz in 14 circles and 900 MHz in eight
circles and 3G spectrum in 13 service areas.
Upside could stem from its ability to benefit from
sector consolidation.
Revenue per minute and
wireless margin assumptions
As observed in the case of Bharti, revenue per
minute (rpm) for RCOM since March 2009 has
declined by c27%. There has been some stability
over the past four quarters with revenue per
minute declining by only c2%. Given the impact
of MNP rollout, which puts pressure on revenues
from CDMA, we expect marginal pressures to
remain and as such estimate FY12e rpm at
INR0.44. Despite CDMA weakness, we expect
stability to continue and in FY13e expect rpm to
improve by c2%.
Estimate changes
As we model for rpm improvement, our FY12e
revenues are higher by c2% and FY13e by 1%.
While our FY13e earnings remain unchanged,
FY12e earnings are higher by c3%.
Valuation and risks
We continue to set our 12-month target price
based on a blend of PE and DCF values (equal
weight). We are rolling our valuation from FY12e
to FY13e in line with our valuation methodology
with respect to other Indian stocks. We believe
FY12e will be a year of consolidation for both
voice and data. With 3G launch to gain traction in
the next 9-12 months and the company’s focus on
voice improvements more visible in FY13e, we
believe investors should shift their focus
to FY13e.
For our DCF valuation, we assume cost of equity of
14% (HSBC’s Strategy Team has computed a
baseline cost of equity of 11% for India – risk-free
rate at 3.5%, equity risk premium of 7.5% and beta
of 1, and we assume a rate 300bp above that to
factor in risks associated with a stretched balance
sheet), cost of debt 10.5%, and a WACC of 13%.
We arrive at a DCF-based value of INR158 per
share. For the PE valuation, we use a multiple of
c10x applied to FY13e EPS given poor earnings
visibility and increased pressure on the CDMA
business as a result of MNP. Our target multiple
implies a 26% discount to the FY12e Sensex
multiple of c15x. The stock has traded at a c20%
discount to Sensex over the last 12 months.
Assigning equal weights to both DCF and PE and
providing for the possible negative impact of TRAI
recommendations, we maintain our target price at
INR122 per share (see Figure 41). We retain our
Neutral (V) rating on the stock. Our target price of
INR122 implies PE of 16x on FY12e EPS and 12x
FY13e EPS. The stock is currently trading at c11x
on our FY13e estimates. Our numbers for FY12e are
in line with consensus but FY13e numbers are c9%
below consensus estimates.
For Indian stocks with a volatility indicator, our
Neutral rating band is 10 percentage points above
and below a hurdle rate of 11.0%, or 1.0-21.0%
potential return. Our target price of INR122
implies a potential return of 14%, thus we
maintain our Neutral (V) rating.
The key downside risks are slower-than-estimated
ramp-up in 3G and rapid subscriber churn in
CDMA. Key upside risk would be ability to
introduce a strategic investor through a 26% stake
sale in the company.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Reliance Communications
(RCOM)
Corporate actions have been the catalyst but RCOM is likely to
find it difficult to unlock value in tower assets
No gains from MNP and uncertainty over CDMA given progress
on TD-LTE raise concerns for the stock
Retain Neutral (V) rating and target price of INR122
Investment summary
We have a Neutral (V) rating on RCOM shares
given concerns over balance sheet, a 2G
corruption probe and lacklustre operating
performance. We are also cautious on the
company’s ability to unlock value in tower assets.
Though unlocking is being perceived by the
market as both catalyst and downside support for
the stock, we believe unlocking value in the tower
assets will be tough, as the buyer of those assets
will have to take a longer-term bet on RCOM’s
GSM and CDMA businesses, both of which suffer
low network utilization. RCOM’s longer-term
commitment to continue with CDMA is critical
for tower valuations. However, with the rollout of
3G services and progress on TD-LTE (4G),
prospects for CDMA will be reduced in our view
and we expect tenancy from CDMA to decline;
this is negative for the RCOM tower business. We
note that RCOM has pulled out from tower listing
twice and after that the transaction with GTL was
also called off. In unlocking initiatives, markets
tend to assume asset-based valuations will provide
support, however, failure to close deals/execute
gives rise to concern.
The negatives weighing on the stock have
primarily been concerns about RCOM’s balance
sheet, a 2G corruption probe and lacklustre
operating performance. While we believe the
recent refinancing of short-term 3G debt with a
loan facility from China Development Bank
(CDB) is positive (preventing significant increase
in interest costs but not lowering them as 3G
interest cost is capitalised), leverage remains high.
As far as impact of the 2G corruption probe is
concerned, we don’t rule out the possibility of
new entrants paying a one-time start-up spectrum
fee; we estimate the impact for RCOM at
USD335m. Separately, business fundamentals
remain weak, as despite investments in GSM,
wireless revenues have been declining (refer
Figure 45). Initial porting data also suggests
vulnerability of CDMA.
However, RCOM has a diverse spectrum bank,
including national CDMA 800 MHz and GSM
1800 MHz in 14 circles and 900 MHz in eight
circles and 3G spectrum in 13 service areas.
Upside could stem from its ability to benefit from
sector consolidation.
Revenue per minute and
wireless margin assumptions
As observed in the case of Bharti, revenue per
minute (rpm) for RCOM since March 2009 has
declined by c27%. There has been some stability
over the past four quarters with revenue per
minute declining by only c2%. Given the impact
of MNP rollout, which puts pressure on revenues
from CDMA, we expect marginal pressures to
remain and as such estimate FY12e rpm at
INR0.44. Despite CDMA weakness, we expect
stability to continue and in FY13e expect rpm to
improve by c2%.
Estimate changes
As we model for rpm improvement, our FY12e
revenues are higher by c2% and FY13e by 1%.
While our FY13e earnings remain unchanged,
FY12e earnings are higher by c3%.
Valuation and risks
We continue to set our 12-month target price
based on a blend of PE and DCF values (equal
weight). We are rolling our valuation from FY12e
to FY13e in line with our valuation methodology
with respect to other Indian stocks. We believe
FY12e will be a year of consolidation for both
voice and data. With 3G launch to gain traction in
the next 9-12 months and the company’s focus on
voice improvements more visible in FY13e, we
believe investors should shift their focus
to FY13e.
For our DCF valuation, we assume cost of equity of
14% (HSBC’s Strategy Team has computed a
baseline cost of equity of 11% for India – risk-free
rate at 3.5%, equity risk premium of 7.5% and beta
of 1, and we assume a rate 300bp above that to
factor in risks associated with a stretched balance
sheet), cost of debt 10.5%, and a WACC of 13%.
We arrive at a DCF-based value of INR158 per
share. For the PE valuation, we use a multiple of
c10x applied to FY13e EPS given poor earnings
visibility and increased pressure on the CDMA
business as a result of MNP. Our target multiple
implies a 26% discount to the FY12e Sensex
multiple of c15x. The stock has traded at a c20%
discount to Sensex over the last 12 months.
Assigning equal weights to both DCF and PE and
providing for the possible negative impact of TRAI
recommendations, we maintain our target price at
INR122 per share (see Figure 41). We retain our
Neutral (V) rating on the stock. Our target price of
INR122 implies PE of 16x on FY12e EPS and 12x
FY13e EPS. The stock is currently trading at c11x
on our FY13e estimates. Our numbers for FY12e are
in line with consensus but FY13e numbers are c9%
below consensus estimates.
For Indian stocks with a volatility indicator, our
Neutral rating band is 10 percentage points above
and below a hurdle rate of 11.0%, or 1.0-21.0%
potential return. Our target price of INR122
implies a potential return of 14%, thus we
maintain our Neutral (V) rating.
The key downside risks are slower-than-estimated
ramp-up in 3G and rapid subscriber churn in
CDMA. Key upside risk would be ability to
introduce a strategic investor through a 26% stake
sale in the company.
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