A HOUSE OF CARDS
Reliance Communications Limited (“RCom” or the “Company”) is entering a
phase of maximum uncertainty. In our view, macro-economic conditions in
India are deteriorating at a rapid rate. Fractured policy making, high inflation,
an uncontrollable fiscal deficit, in addition to a hyper-competitive
telecommunication business, are highly detrimental to the prospects of RCom.
Exceedingly high financial leverage, accompanied with debt repayment
obligations of approximately $U.S. 2.2B over the next twenty-four months, at a
time when EBITDA in core business operations is stagnating, is a significant
challenge for the management team.
In order to tide over the cash crunch, we believe that RCom has been scaling
back its capital expenditures (“capex”) and has put assets on the block.
However, given the weak competitive position of the Company in the Indian
wireless sector, we believe that curtailed capex will be detrimental to the
Company’s prospects going forward. We believe that RCom is at a
disadvantage in terms of its GSM spectrum position in most of its footprint
compared to its peers, and to tide over its spectrum deficit the Company
needs to incur higher capex to maintain quality of service. RCom has been
disproportionally affected by the entry of new players in the market and its
ARPU has suffered more than its peers.
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Some of our findings are as follows:
1. Management’s admission of a soft market for tower assets
substantiates our assertion that buyers for Indian telecom assets are
scarce. We do not foresee any significant improvement in the tower
market over the next 12-18 months, given the stampede by all players
in the telecommunication tower market in India to monetize assets.
Moreover, we estimate that at best the Company can monetize its
Reliance Infratel (“RIF”) tower asset at a diminished value of INR
12,500C ($U.S. 2.36B), compared to rumors in the marketplace
ascribing a valuation upwards of INR 22,500C ($U.S. 4.2B).
2. We are also skeptical of the Company’s ability to reduce its financial
leverage meaningfully by undertaking an IPO of Flag
Telecommunication (“FLAG”), given that equity of Reliance
Globalcom Bermuda – whose only assets is FLAG as per Federal
Communications Commission (“FCC”) Filings – has been pledged by
its holding company, Reliance Globalcom BV Netherlands, to secure
debt of $U.S. 500M. Therefore, our estimate of Flag’s enterprise value
of $U.S. 891M, leaves very little deleveraging room for the ultimate
parent RCom. As reported in the media the Company is planning to
off-load a 75% stake in FLAG, for which it will receive $U.S. 668M and
those proceeds will be utilized to repay secured debt.
3. We believe that the Company’s accounting policies are whimsical
and do not provide a clear picture of the underlying operating and
business trends. We neither believe in the reported book equity of the
Company nor in its reported fixed asset base.
4. Given significant exposure to un-hedged foreign currency
denominated loans, we find the risk management and governance
practices of the Company sub-optimal. Moreover, the write-off INR
950C ($U.S. 179.2M) in F11, which was advanced to a supplier,
suggests either incompetence or chicanery.
5. For F12 the Company reported a profit before tax profit of INR 882C
($U.S. 166M), whereas in our normalized estimate we believe the
Company incurred loss before tax of INR 1,529C ($U.S. 288M)
Incorporating a 50% governance discount to our approximate equity value of
INR 30/share, we value the core business at INR 15/ share, suggesting 77%
downside from current levels. The Company has a tendency to report high
levels of other income which is not sustainable on a long term basis, given the
significant drop in its current cash balance. Furthermore, based on the
Company’s inclination to book expenses to reserves and include other
income in its EBITDA, reported EBITDA is an unreliable indicator of the
Company’s operating prowess. Therefore we ignore other income in our
valuation.
RCom is a house of Cards. Since our last report on the Company, the stock is
down approximately 32%. We believe there is significant additional downside.
SELL.
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