Bros In Arms; Jio And RCom Synergy Will Boost RCom Investors’ Morale

Currently world’s second largest telecommunication market, India has the third highest number of internet users in the world. India’s telephone subscriber base has been expanding at a CAGR of 19.22 per cent to 1029 million over FY07–16.  Indian mobile economy is growing rapidly and expected to contribute immensely to the country’s gross domestic product (GDP), according to a report compiled by the GSM Association and Boston Consulting Group.

The government has fast-tracked reforms in the telecom sector and continues to remain proactive in providing room for growth for telecom companies with its flagship Digital India campaign. Of many policy initiatives, the government approved the rules for spectrum trading that will allow telecom companies to buy and sell rights to unused spectrum among themselves. Government also came out with spectrum liberalisation policy i.e. guidelines to liberalise the 2G spectrum whereby operators will be able to offer latest mobile services, including 4G, using the same radio waves.

Latest initiatives will aid companies in taking full benefit of spectrum sharing and trading. The development is likely to benefit almost all incumbent telecom operators including Reliance Communications (RCom). RCom, after the sale of tower business and acquisition of Aircel and Sistema, would make it a force to reckon with. RCom would be able to take advantage of the vast pool of resources bought in by the acquired entities. Company would be able to provide full scale mobility services across all the bands, making it a strong challenger for the market leadership position in the Indian telecom industry in near future.

About Company

RCom is the fourth largest telecom service provider in India with a total subscriber share of 11.1 per cent (October 31, 2015). RCom’s total subscriber base stands at over 118 million at the end of October 2015. Reliance Mobile is amongst the most recognizable mobile service brand in India. RCom also offers nationwide DTH (direct to home) services through our wholly-owned subsidiary, Reliance Big TV. RCom owns and operates the world's largest next generation IP enabled connectivity infrastructure, comprising over 280,000 kilometres of fibre optic cable laid underground in India, USA, Europe, Middle East and the Asia Pacific region. Company’s Global operations include internet network and lease of submarine cable infrastructure and metropolitan city networks. Reliance Communication is a part of Anil Dhirubhai Ambani Group (ADAG) whose business interests range from telecommunications, power to financial services.

RCom- Aircel- Sistema

As intensifying competition fuels consolidation in a crowded market, RCom recently announced that it has entered into merger talks with Aircel. The two telecom companies have entered into a 90-day exclusivity period for the talks. Separately RCom, in November agreed to buy Russian firm AFK Sistema’s Indian wireless unit in an all-stock deal to create a carrier with 118 million subscribers. Sistema offers mobile telephony services under MTS brand across 9 circles. As per the deal Sistema will hold 10 per cent in RCom. The deal makes Reliance the largest holder of the 800/850 megahertz (MHz) band for wireless 4G services.

A three-way combination involving telecom operators Reliance Communications, Sistema Shyam Teleservices (SSTL) and Aircel would have a combined presence that would surpass Idea Cellular and Vodafone India’s operations. According to an official statement issued by RCom, ‘The objective of a potential merger would be "to mutually derive the expected substantial benefits of in country consolidation, including opex and capex synergies and revenue enhancement’.

The combine entity would make RCom India’s second largest telecom company in terms of total subscriber base and fourth largest in terms of revenue market share. RCOM had 111 million subscribers as of September 2015. Aircel has about 85 million users while SSTL, has 9 million according to Telecom Regulatory Authority of India (TRAI). A combination of the three companies will have about 205 million customers in total. The deal would create an entity with revenue of around Rs 25,000 crore annually and EBITDA of around Rs 6,000-7,000 crore. The union would create a company that holds roughly 20 per cent of India’s rapidly growing cellphone market, and help close the gap between it and much bigger rival BhartiAirtel.

The bloc will have nearly a fifth of the entire industry spectrum holdings in all bands - 2G, 3G and 4G. According to a Goldman Sachs note, "A combined entity could offer 3G services in 18 circles, launch 4G services on the 2300 MHz band in eight circles and hold 2G spectrum in 22 circles. Whereas currently Vodafone offers services in 16 circles and Idea Cellular is present in 13 circles, hence, giving RCom an arsenal to fight the top players. In many of the 22 circles the joint entity will be the number two or number three operators. The proposed deal will entail forming a new listed entity that could see; Aircel's promoters hold 40 per cent of the ownership, Sistema 10 per cent and RCom the remaining 50 per cent. The RCom merger would likewise increase the residual licence period of RCom thus, significantly pushing up the combined entity's spectrum renewal burden till CY26. It will also help RCom address GSM coverage gaps in West Bengal, Bihar and Assam, where it did not win back 900 MHz airwaves in the auction.

Spectrum liberalisation & sharing

RCom had applied for liberalising its 800 MHz spectrum in 20 circles. Liberalise, in this context, means paying market-linked price to the government for spectrum which wasn't auctioned. Liberalisation will free up spectrum for providing services using any technology. Reliance Communications will convert nearly its entire CDMA spectrum into 4G spectrum by paying liberalization fees to the government, and then sell it to Reliance Jio. After the conversion RCom would have 4G airwaves in 800 MHz band in nearly all the telecom spectrum circles in India. Reliance Communications in September joined hands with Reliance Jio to share each other’s resources for the 4G networks after the government allowed operators to trade airwaves. As part of the agreement announced on 18th January 2016, RCom will receive payment from Reliance Jio for sale of 800 MHz spectrum in 9 circles and sharing of spectrum in 800 MHz band across 17 circles. RCom will benefit from network synergies, enhanced network capacity, optimised spectrum utilisation. The proceeds from the sale will be used to pay liberalisation fees to the government and repay debt. Liberalisation would also allow RCom an option to trade the spectrum with another operator having acquired spectrum through auctions.

The pact with Reliance Jio will benefit RCom as it will gain access to Jio's 4G network in the 9 circles at virtually zero incremental capex costs which would help the company keep its soaring debt levels under control thus having an edge over other incumbents as they would have to deploy additional capex. It would also place the company in a very strong position as this band is recognized as one of the most powerful spectrum bands as globally many operators have launched LTE services on this band thus giving RCom unique capability to launch 4G LTE services in an efficient manner compared to its peers like Bharti and Idea as they do not have enough spectrum in this band.
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RCom is also likely to enter into 2G roaming agreements with Vodafone. The deal will enable RCom to continue its 2G service by using Vodafone’s spectrum in Bihar, West Bengal and Assam, where it only holds 3G spectrum. The two companies are also in talks to share 3G spectrum in Delhi and Mumbai circles in order to bring down their operational expenses as well as improve the quality of service provided. The intra circle roaming agreements would help RCom in providing its customers a better service in circles which have congested network.

Financials

Financially RCom has been facing negative headwinds with revenue CAGR declining by 1 per cent over the period of five years due to intense competition being faced by the company leading to decline in the overall subscriber base from the peak of FY12 and ultimately reflecting upon its revenues. Company has been a laggard in terms of revenue growth when compared to peers. During the same period company’s EBITDA (earnings before interest, depreciation and amortisaton) CAGR decreased by 3 per cent, primarily due to promotional schemes and discounting offered to lure customers. CAGR of PAT too saw a drop of 12 per cent in the last five years. Declining financial performance has also been reflective on the share price of the company as the stock has declined by more than 47 per cent. On a consolidated basis, the company’s revenue for FY15 increased by 3 per cent to Rs 21770 crore from Rs 21238 in the previous fiscal. The EBITDA also increased to Rs 7190 crore from Rs 6643 crore, representing a growth of 8 per cent. The company was effective in expanding its margins by 200 basis points despite witnessing intense pricing pressure. PAT stood at Rs 620 crore down by 32 per cent in comparison to the previous year.

For the quarter ending Q2FY16 the subscriber base was 11.6 crore. Out of the total revenue generated in Q2FY16 Indian operations contributed 81 per cent and rest came from global operations. Voice revenue declined 2.5 per cent on a yearly basis, whereas non-voice revenue increased by 13.3 per cent. ARPU (average revenue per user) sequentially declined by 1.4 per cent to Rs 138 from Rs 140. Non- voice as percentage of Telecom revenue increased by 70 basis points to 27.1 per cent. Total data customers at the end of September quarter stood at 3.72 crore. However, data usage per customer remained flat at 895 MBs, whereas competitors like Bharti Airtel and Idea saw a decline in its data usage due to pricing pressure.

The company’s net debt stood at Rs 39,895 for the quarter ending Q2FY16 from Rs 38,597 in Q1 of the same fiscal. It was reflective in its interest expense also as it augmented by 7 per cent on a yearly basis. The company’s debt equity ratio was at 1.06 in FY15 in comparison to 1.29 in FY14 signalling a strong solvency position. Interest coverage ratio has improved from 1.04 in FY14 to 1.34 times in FY15, which is declarative of the fact that company has been able to improve its cash flow position over period of financial year in order to pay off its interest obligations.

One-year default probability for RCom has slipped to 0.34 per cent from 0.59 per cent on 30thSeptember, according to Bloomberg’s default-risk model that considers factors such as a company’s indebtedness, profitability, market value and stock volatility.

Deleveraging Plans

RCom is on an asset-monetisation spree as it looks to pare down its mounting debt levels in line with its asset light strategy. RCom subsidiary Reliance Infratel has signed a non-binding agreement with private equity firms TPG Asia and Tillman Global Holdings to sell its telecom towers and related infrastructure. The company has not mentioned the deal size, but according to an estimate the sale of 45,000-strong tower assets would fetch around Rs 21,500 crore. As per a report by brokerage house CLSA, RCom impending deal for tower asset sale would lower its consolidated debt by 60 per cent. In a separate development Tillman and TPG, would also evaluate purchase of its inter- and intra-city 1,90,000 km optical fibre assets and negotiations will take place simultaneously. The valuation of this deal is to be in the range of Rs 7,500 crore. After the deal RCom will continue as an anchor tenant on the towers.

Continuing with its monetisation drive RCom recently sold nearly 150 residential flats in Navi Mumbai for a shade over Rs 330 crore, as the telecom company takes more steps to repay debt which has been an overhang for several years now. The company also announced that it will shortly announce the sale of another prime four-acre property in New Delhi. The entire proceeds from the monetisation of real estate will be used for repaying debt as part of its overall deleveraging plans. Long standing debt paring attempts seems to be on right track as company goes ahead with its asset sale exercise, which would help company considerably save on its interest outgo and therefore improve its bottom-line and ultimately benefit the shareholders.

Conclusion

With the telecom sector in India continue to witness strong growth in the coming future as the young population of the country gives a fillip to the sector. India will emerge as a leading player in the virtual world by having 700 million internet users of the 4.7 billion global users by 2025, as per a Microsoft report. This growth would be aided by high speed wireless broadband and LTE deployment in the coming years. Reliance Communication is poised to take advantage of this mega opportunity by providing full range of mobility services. Ample wireless spectrum portfolio with long validity period linked with a pan-India presence and extensive network deployment would help the company in maintain leadership in data which would contribute a major chunk of the future revenues. Planned three-way merger would also be a value accretive for RCom as it would make them a formidable force in the Indian telecom market. Company’s data centre and cloud platform business would also contribute massively towards the revenue in the coming years. RComs’ longer-term outlook will also depend on how well it is able to leverage the partnerships with Reliance Jio.

The company’s fundamental appears to be improving with paring of debt and generating revenues through partnership pacts. RCom’s future growth would be determined by the progress made by the company in integrating all merged entities into one and driving synergies out of it. This makes Reliance Communication a worthy investment playact this stage.