RCOM: Better To Avoid This Connection, For Now
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ABOUT INDUSTRY
India is the world's second largest telecommunications market with 1.19 billion subscribers as of Feb 2017.
During the last two quarters (Sept. 2016-Mar. 2017), the sector's financial and operational performance has been adversely impacted due to free offers, disruptive pricing and hyper competition.
The contribution of telecom services to GDP has declined from 2% of GDP in FY09 to just 1.2% in FY17.The adjusted gross revenue for the industry has declined 18.4% YoY to Rs.30,900 crore, the lowest in the last 11 quarters.
A sharper decline in industry revenue is observed mainly in the metros and class A circles as compared to class B and C circles due to Jio's initial focus being primarily in the said segments and lower penetration of smartphones as one moves from metros to class C.
The industry at this juncture is at its weakest because of the high degree of financial leverage and margins impacted by rising competition from new player Reliance Jio.
JIO EFFECT
The industry’s adjusted gross revenues for the March 2017 quarter declined by 17% or Rs.6300 crore in absolute terms to Rs.30,900 crore, as compared to Sept. 2016’s Rs.37,200 crore. By offering free services, Jio eroded the subscriber growth of rivals, while ramping up its own numbers by nearly half a million subscribers a day. Nearly all players are coming together to consolidate their subscriber base, reduce costs, improve network efficiencies and survive the cut-throat
Jio's aggresive tariff cuts are being met by matching offers and 4G network expansion to retain customers. Even as the Jio impact was felt across the industry, it was very clear that only stronger players would survive.
The middle-of-the-pack private operators, i.e. RCom, Aircel and TTSL suffered the most. RCom’s cumulative 2Q-4QFY17 revenue declined by 34% at the adjusted gross revenue level.
Airtel and Idea Cellular reported a 54.9% drop in net profits and Rs.383 crore loss, respectively, in Q4FY17, as compared to the corresponding period in FY16. While the intensity of competition has changed with the entry and exit of players, the capex intensity has risen because of spectrum auctions. There is excess of supply generated in the industry and consolidation is the only way to reach equilibrium.
India’s telcos are loaded with debt— around Rs.4.85 trillion at the end of December 2016—and face the burden of payments to the government for spectrum (close to Rs.3 trillion). They also face intense competition, with the average revenue per user (ARPU) of most telcos falling sharply since the launch of Reliance Jio in Sept. 2016.
ABOUT THE COMPANY
Reliance Communications Ltd is a telecommunications service provider having a pan-India presence in wireless(CDMA+GSM),wireline, and long distance, voice, data, video and internet communication services. The company operates through two segments- Indian operations and global operations.The company owns and operates IP-enabled connectivity infrastructure, comprising over 280,000 km of fibre optic cable systems in India, the United States, Europe, Middle East and the Asia-Pacific region.
FINANCIALS
The company's market capitalisation stands around Rs.4654.39 crore. For the financial year ended March 2017, RCom posted a consolidated net loss of Rs.1286 crore, as compared to a net profit of Rs.703 crore in FY16. The total revenue of the company stood at Rs.19,493 crore, which has decreased by 10.21 per cent from Rs.21,711 crore. The company's EBITDA for the period stood at Rs.5392 crore, a decrease of 27.32 per cent as compared to the financial year ended March 2016.
Following the above, the operating profit margins dropped 651 bps to 27.66% from 34.17%.
The net profit margin came in at -6.59%, which was 3.23% in FY16.
In Q4FY17, the company posted a net loss of Rs.948 crore, as compared to a net loss of Rs.489 crore in Q4FY16, an almost 94% jump in losses.
The company's revenue for the quarter has decreased 10.53 per cent to Rs.4,312 crore from Rs.4,820 crore in Q3FY17. Meanwhile, its EBITDA dropped 44.66% to Rs.1084 crore and EBITDA margin showed a variance of 998 bps. RCom's CMP/BV stands at 0.18x.
A STEP-UP
According to the management, the proposed consolidation of RCom’s wireless business with Aircel will give the combined entity, substantial benefits of scale, and capex and opex synergies with an estimated NPV of approx. Rs.20,000 crore. It is expected that the overall debt of RCom would reduce by Rs.14,000 crore, along with tranfer of liability for spectrum instalments of an additional Rs.6,000 crore.
Upon completion of the Aircel merger and sale of the tower business, RCom‘s debt will stand reduced by approx. Rs.25,000 crore and the company will hold highly valuable strategic stake of 50% in the Aircel JV and 49% future economic upside in the towers business, providing future monetisation opportunities for significant further deleveraging.
Post the signing of binding documents for the Aircel and Brookfield transactions, RCom has told its lenders that it will be making repayment of an aggregate amount of Rs.25,000 crore from the proceeds of these two transactions, on or before September 30.
The proposed merger of SSTL‘s wireless operations with RCom would add highly valuable 30 MHz of 850 band spectrum in 8 key circles, and will extend validity of spectrum in these circles till 2033, according to the management.
Further, the company's 850 MHz spectrum trading and sharing arrangements with Reliance Jio has been fully implemented and is now operational over the last 6 months. This unique arrangement has enabled RCom to deliver access and connectivity to nationwide 4G LTE network with minimal capex and considerably lower operating costs.
RCom is also expected to receive upfront cash payment of Rs.11,000 crore from the proposed transaction for sale of the tower infrastructure to Brookfield and the same will be fully utilised for reduction of debt. RCom will also receive 49% future economic upside in the towers business.
CONCLUSION
The Indian telecom industry is finally expected to come down to 4 players and there are signs that Rcom and Jio will work together, if not merge.
Further, TTL is talking to Rcom-Aircel combine for a possible merger, which might lead to the Jio-led block becoming even bigger and overtaking Idea-Vodafone in terms of spectrum holding and Airtel in terms of subscriber base.
As far as RCom is concerned, even post-merger, the combined entity (RCom-Aircel) is expected to have limited pricing power and high leverage that will constrain its ability to strengthen its network position.
Currently debt, a big concern for almost all telecom operators, collectively stands at Rs.3.81 lakh crore. The high debt level is not an issue as long as businesses generate enough profits to take care of debt repayments. But for RCom, according to Moody's, given the heavy debt load and the uncertainty regarding the cash flow-generating capabilities of the residual businesses post merger and asset sales, the capital structure of the remaining business will remain weak.
The significant asset quality issues of Indian banks is expected to be substantially affected by stress in the telecom sector, with companies such as Reliance Communications, Aircel and Tata Teleservices likely to face debt servicing issues.
However, loans to telecom, on the contrary, are generally backed by spectrum assets, which should provide a better chance of recovery. Given the low tariff environment and relatively low rural and semi-urban penetration levels, demand will continue to remain higher in the foreseeable future across all the segments.
Looking at the problems faced by the company and intense competition in the industry, we recommend investors to avoid investing in RCom.