Rcom Q3 Fy09 Result Update

India Equity Research I Telecom

Reliance Communication Ltd. Worsening Outlook

Result Update (Large Cap)

INR: 171 SELL

The Q3FY09 results are below our expectations. While subscribers grew 9.4% q-o-q, the MOU, ARPU and operating margins declined by 7.4%, 3.1% and 56 bps q-o-q respectively in spite of a range of promotional offers and schemes aimed at increasing MOU. The NPM declined by 301 bps. RCom remains confident of its GSM expansion and expects to increase market share. However, we are skeptical due to leveraged balance sheet and tariff wars which will further reduce profitability. Q3FY09 Results – Key Highlights

Price Outlook (INR): 150

January 27, 2009

Market Data Shares outs (Cr)

206.40

Equity Cap (Rs. Cr)

1032.0

Mkt Cap (Rs. Cr)

35,246

52 Wk H/L (Rs)

706/148

•

Net Sales: Rs 5,850.6 crore (↑20% Y-o-Y, ↑3.6% Q-o-Q)

•

Operating Profit: Rs 2,353 crore (↑ 11.7% Y-o-Y, ↑2.2%Q-o-Q)

Face Value (Rs)

5

•

Net profit : Rs 1,410 crore (↓7.7% Y-o-Y, ↓7.9% Q-o-Q)

Bloomberg Code

RCOM IN

• Higher Depreciation expenses continue to erode profit margins– The GSM rollout is taking its toll on the margins as depreciation expenses. Going forward, margins will be under pressure as we expect RCom to launch major initiatives to capture GSM market share by way of tariff cuts in the coming months. Lower tax rate of 1% compared to 9% in Q3FY08 increased profitability. • Continued Aggressive Accounting Policy – RCOM maintained its aggressive accounting policy, capitalizing Rs 770 crore of foreign exchange fluctuations in balance sheet. Moreover, it has not made any provision for Rs 210 crore on FCCB’s, which are currently out-of-the money and are likely to be converted into shares by due dates of FY2012. Adjusting the same, PAT would have been Rs 430 crore compared to reported profit of Rs 1,410 crore.

Valuations We expect RCom’s profitability to come under pressure because of the company being in investment phase, GSM rollout and additional capital expenses. We anticipate execution risks in GSM and higher debt burden related to upcoming 3G rollout. Hence, we have reduced our FY09E EPS from 32 to 31 and FY10E EPS from 31 to 27.2, based on lower EBITDA expectations and aggressive accounting policy related to finance costs. At the CMP of Rs 171, RCom is trading at 6.3x FY10E EPS of Rs 27.2. We downgrade RCom from BUY to SELL with a revision in target price from Rs 276 to Rs 150. At the target price the stock would be valued at 5.5x FY10E EPS.

27,35,690

: 9,004 : 2,771

Price Performance 125 100 75 50

RCOM

Jan‐09

Dec‐08

Oct‐08

Nov‐08

Sep‐08

Jul‐08

Aug‐08

Jun‐08

May‐08

Apr‐08

25 Mar‐08

• Worsening metrics – ARPU has maintained its declining trend over the past 5 quarters with an accelerated rate compared to its peers and stood at Rs 251, down 8% q-o-q. The MOU declined to 410, a decline of 3.1% q-o-q. The decline in ILD minutes by 2% was a negative surprise.

Market Info: SENSEX NIFTY

Jan‐08

• Revenue growth misses estimates - Declining subscriber growth and a significant drop in ARPU were key highlights this quarter; RCOM has lost market share by 10 bps. Revenue from the Wireless Business was up by only 1.9%, however Global Business was flat. EBITDA margin was down by 60 bps due to higher network expenses of GSM rollout.

Feb‐08

Q3FY09 Results – Brief Analysis

Avg Vol (1yr avg)

Sensex

Share Holding pattern (%)

Particulars

31/12

30/09

% Chg

Promoters

66.1

66.1

0.0

Institutions

9.1

9.0

0.1

FII

9.4

10.0

-0.6

Other Corp Holding

2.4

2.1

0.3 0.2

Public

13.0

12.8

Total

100.0

100.0

Analyst Kevin Trindade [email protected] ℡ 91-22-6696 5572 Maulik Patel [email protected] ℡ 91-22-6696 5574 www.krchoksey.com ℡ 91-22-6696 5203 ¬ 91-22-6691 9569

KRC Research is also available on Bloomberg KRCS, Thomson First Call, Reuters, Factset and Capital IQ

Reliance Communication Ltd.

Other Key Highlights •

FY09 capex reduced from Rs 30,000 cr to Rs 25,000 cr

RCom plans Rs 15,000 crore capital expenditure for FY10. The company claimed that it was at the peak of its capex cycle last quarter, and that peak capex was behind it this quarter. Capex guidance for Q4FY09 is expected be Rs 9,000 crore. Last quarter, the company reduced its FY09 tower guidance from 60,000 to 48,000 towers and this quarter capex for FY09 is reduced from 30,000 to 25,000 cr. According to us, this could be due to lower than anticipated cash flows from the initial rollout of GSM services.

•

EBITDA growth in Q3FY09 is mainly on the addition of GSM subscribers in the wireless segment and DTH customers in the Others segment. However, the

Internal tenancy ratio of RTIL at 1.7x but visibility of increase from current levels

wireless subscriber additions were mainly from the C Circles in the GSM market and B circles in the CDMA markets which are typically low ARPU circles (Refer to table Composition of net CDMA/GSM additions on pg.5) •

The rollout of the GSM network is expected to also support long-distance services (NLD and ILD) and increase revenue growth in these segments

•

The Enterprise Broadband services segment (which grew 8.6% q-o-q and has EBITDA margins of 42.2%) has shown considerable degrowth in profitability. We expect this segment to continue to be a primary growth driver. The Global

First 9 months losses of Rs 1,217crore were capitalized, and amount to 26.4% of its first 9 month reported profit.

business plans to increase coverage to 190,000 km of optic fibre network by FY09. •

RTIL’s internal tenancy ratio is currently at 1.7x but with the entry of foreign operators could increase substantially.

•

Adjust gain/losses relating to foreign currency loans against the carrying value since beginning FY09. It has capitalized Rs 824crore losses in the quarter and fort the first 9 months losses capitalized Rs 1,217crore, 26.4% of its first 9 month reported profit.

•

It has two tranches of FCCB’s outstanding, $1bn getting matured in Feb’12 converted at Rs 656 and $500mn getting matured in May’11 converted at Rs 476. Both the tranches are significantly out of money. Rcom is adjusting the premium payable on redemption of these instruments against the reserves rather than P&L. On the other hand, gains from recent buyback of FCCBs ($25mn) were routed through P&L and reflected in other income which inflates reported earnings.

2

KRC Equity Research

Reliance Communication Ltd.

Income Statement

Rs Crore

Income Statement

Q3FY08

Q2FY09

Q3FY09

4,874

5,645

5,850

20.0%

3.6%

Largely due to subscriber growth

Other Income

154

235

318

106.2%

35.7%

Notional saving of Rs 63 crore on buyback of FCCBs worth $25mn

Total Income

5,029

5,880

6,169

22.7%

4.9%

Access Charges & License fees

1,119

832

869

-22.3%

4.4%

545

1,027

1,167

114.2%

13.6%

Net Sales

Network Expenses

Y-o-Y(%)

Q-o-Q(%)

Staff costs

309

459

438

42.0%

-4.5%

Selling gen. & adm. Expns

796

1,026

1,024

28.6%

-0.2%

Total Expenditure

2,768

3,343

3,498

26.4%

4.6%

EBITDA (excluding OI)

2,107

2,302

2,353

11.7%

2.2%

Interest

(152)

(235)

(150)

na

na

PBDT

2,258

2,537

2,502

10.8%

-1.4%

Depreciation PBT Tax PAT Extraordinary Items APAT EPS

725

918

1,007

38.9%

9.7%

1,533

1,619

1,495

-2.5%

-7.6%

138

(57)

15

-88.9%

-127.0%

1,550

1,676

1,480

-4.5%

-11.7%

(22)

(145)

(70)

212.6%

-51.8%

1,527

1,531

1,410

-7.7%

-7.9%

7.52

8.13

7.18

-4.5%

-11.7%

Comments

Expect to increase going forward

Tax rate of 1% only.

Segment Revenue

(Rs million) Q3FY08

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Comments

Wireless

39,567.0

41,608.0

41,187.0

43,356.0

4,4190

Subscriber growth of 10.4% q-o-q; Flat MoU and 3.7% q-o-q decline in ARPM due to robust revenue growth

Global

13,299.0

15,257.0

15,260.0

16,915.0

1,6783

Growth supported by 10.3% q-o-q increase in MoU

Broadband

4,564.0

5,100.0

5,603.0

6,023.0

6542

Increase in geographic coverage and 10% increase in access lines

Others

1,544.0

683.0

1,437.0

2,346.0

3183

58,974.0

62,648.0

63,487.0

68,640.0

7,0627

(10,232.0)

(9,534.0)

(10,265.0)

(12,190.0)

(1,2125)

48,742.0

53,114.0

53,222.0

56,450.0

5,8502

Sub Total Eliminations Total

Includes revenues from DTH services

Operational Metrics Unit

Q3FY08

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Comments

Mobile services

3

Total Customers (000's)

000's

40,964

45,794

50,773

56,046

61,345

GSM (000's)

000's

6,002

7,016

8,065

9,206

10,354 0

Major contribution from C circles (57%)

CDMA (000's)

000's

34,962

38,777

42,707

46,840

50,991

Major contribution from C circles (42%)

Pre-paid %

%

89.0%

90.0%

90.9%

91.7%

92.4%

Pre-paid %

%

98.1%

98.9%

98.7%

99.1%

99.9%

RCom market share

%

17.9%

17.9%

18.0%

18.1%

18.0%

Sequential decline of 9 bps as Bharti, Idea and Vodafone increased market share by 12,

KRC Equity Research

Reliance Communication Ltd.

Unit

Q3FY08

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Comments 18 and 24 bps

ARPU (ARPU) (Rs)

Rs.

339

317

282

271

251

MOU (Min)

Minutes

449

430

424

423

410

ARPM(Rs/Min)

Rs/Min

0.75

0.74

0.66

0.64

0.61

SMS (% of ARPU)

%

1.2%

1.2%

1.2%

1.2%

1.3%

Non-voice (% of ARPU)

%

6.4%

6.9%

7.6%

7.3%

7.4%

Decline despite promotion plans to increment MOU. This is also explained by 57% of subscriber additions coming from C circles while peers focused on A and B circles

Global Services Unit

Q3FY08

Q4FY08

Q1FY09

Q2FY09

Q3FY09

Total ILD minutes

Mn Mins

1,747

1,769

1,726

1,946

1,906

Total NLD minutes

Mn Mins

5,795

5,964

6,641

7,856

8,576

Comments Seasonal decline management

as

per

Broadband Service areas operational

Nos

18

18

18

18

18

Towns active (wireline only)

Nos

42

42

42

42

42

Access lines

Nos

901,000

1,031,000

1,147,000

1,259,000

1,335,000

Access line net adds

Nos

109,000

130,000

117,000

112,000

76,000

ARPL

Rs/line

1,797

1,760

1,715

1,668

1,681

Buildings directly connected

Nos

727,229

787,567

821,638

857,982

892,301

Source: Company data, KRC Research Subscriber Additions (Sep-Dec 2008) GSM

Q3FY09 Additions

Marketshare

CDMA

Q3FY09 Additions

Marketshare

Bharti

8,171,518

33.3%

RCom

8,171,518

37.1%

Idea

4,032,938

16.4%

BSNL

4,032,938

18.3%

Vodafone

6,308,343

25.7%

6,308,343

28.7%

BSNL Aircel

2,194,791

8.9%

TTSL HFCL Infotel

2,194,791

10.0%

1,300,873

5.3%

Shyam Telelink

1,300,873

5.9%

BPL

283,763

1.2%

Total

Dishnet

896,693

3.7%

MTNL

219,556

0.9%

RCom Total

1,147,714

4.7%

22,008,463

24,556,189 Source: Company data, KRC Research

4

KRC Equity Research

Reliance Communication Ltd.

Composition of Net CDMA additions (Sep-Dec 2008)

Metros

RCom 730,547

A Circle B Circle C Circle India

BSNL

MTNL

TTSL

Shyam Telelink

HFCL Infotel -

Comments

8,529

10,805

851,219

-

1,351,584

36,403

-

322,504

-

-

1,726,325

88,896

-

957,777

21,387

243,824

343,078

35,934

-

296,906

-

-

4,151,534

169,762

10,805

2,428,406

21,387

243,824

ARPU @Rs111

Source: Company data, KRC Research Composition of Net GSM additions (Sep-Dec 2008)

Metros

Bharti 655,589

Idea 319,481

Vodafone 736,569

BSNL 112,792

MTNL 219,556

Aircel 323,712

BPL 283,763

Dishnet -

RCom 71,608

A Circle

3,117,876

1,604,687

1,952,955

695,170

-

977,161

-

-

0

B Circle

2,857,839

1,819,988

3,207,336

986,474

-

-

-

119,434

420,463

C Circle

1,540,214

288,782

411,483

400,355

-

-

-

777,259

655,643

India

8,171,518

4,032,938

6,308,343

2,194,791

219,556

1,300,873

283,763

896,693

1,147,714

Comments

ARPU @Rs212

Source: Company data, KRC Research

5

KRC Equity Research

Reliance Communication Ltd.

Rajiv Choksey

Co-Head Institutional Sales

[email protected]

+91-22-6653 5135

Anuj Choksey

Co-Head Institutional Sales

[email protected]

+91-22-6696 5500

Alok Agarwal

Head Research

[email protected]

+91-22-6696 5502

Reliance Communication 700

BUY

600

Rating

In next 12 months, expected to :

Buy

Appreciate over 15%

Accumulate/Hold

Appreciate upto 15%

Reduce

Depreciate upto 10%

Sell

Depreciate over 10%

500

BUY 400

SELL 300 200 Jan‐09

Dec‐08

Nov‐08

Oct‐08

Sep‐08

Aug‐08

Jul‐08

Jun‐08

May‐08

Apr‐08

Mar‐08

Feb‐08

Jan‐08

100

Other Stocks in the sector under our active coverage: Telecom Ticker

Company

Recommendation

Summary

Coverage 13

Avg Rating: 3.7

As of

Return

Bmk

Outper

-22.49%

-17.49%

-5.01%

BHARTI

IN

Bharti Airtel Ltd

buy

01/22/09

-17.85%

-20.11%

2.25%

MTNL

IN

Mahanagar Telephone Nigam

sell

12/31/08

12.19%

10.21%

1.99%

TCOM

IN

Tata Communications Ltd

reduce

12/31/08

14.96%

7.39%

7.57%

TTLS

IN

Tata Teleservices Maharashtra Ltd

hold

12/31/08

0.00%

1.73%

-1.73%

IDEA

IN

Idea Cellular Ltd

hold

12/31/08

-13.20%

-25.91%

12.71%

RCOM

IN

Reliance Communications Ltd

buy

12/31/08

-63.56%

-36.39%

-27.17%

TTSL

IN

Tulip Telecom Ltd

buy

12/31/08

-56.55%

-45.09%

-11.46%

BARR

3rd

_______________________________________________________________________________________________________ Disclaimer: This publication has been prepared solely for information purpose and does not constitute a solicitation to any person to buy or sell a security. While the information contained therein has been obtained from sources believed to be reliable, investors are advised to satisfy themselves before making any investments. Kisan Ratilal Choksey Shares & Sec Pvt Ltd., does not bear any responsibility for the authentication of the information contained in the reports and consequently, is not liable for any decisions taken based on the same. Further, KRC Research Reports only provide information updates and analysis. All opinion for buying and selling are available to investors when they are registered clients of KRC Investment Advisory Services. As per SEBI requirements it is stated that, Kisan Ratilal Choksey Shares & Sec Pvt Ltd., and/or individuals thereof may have positions in securities referred herein and may make purchases or sale thereof while this report is in circulation. __________________________________________________________________________________________________________ Please send your feedback to [email protected] Visit us at www.krchoksey.com Kisan Ratilal Choksey Shares and Securities Pvt. Ltd. Registered Office: 1102, Stock Exchange Tower, Dalal Street, Fort, Mumbai – 400 001. Phone: 91-22-6633 5000; Fax: 91-22-6633 8060. Branch Office: ABHISHEK, 5th Floor, Link Road, Dalia Industrial Estate, Andheri (W), Mumbai – 400 058. Phone: 91-22-6696 5555; Fax: 91-22-6691 9576.

6

KRC Equity Research