Investors can retain their exposure in the Reliance Communications stock. The proposed listing of Flag Telecom, the international undersea cable subsidiary at the London Stock Exchange, may be a near-term positive trigger for the stock. Fundamentally, Reliance Communications is likely to remain one of the key beneficiaries of the explosive multi-year mobile expansion story.
With steady improvement in its operating margin and return parameters and strong capital expenditure programme lined up for 2007-08, the company is in a good position to maintain its mobile market share in line with its peers. With tower-sharing coming into vogue, the network expansion and efficiency parameters will also improve over time. And the other non-mobile business such as enterprise broadband may offer additional fillip to the stock.
However, in a highly volatile market, investors can avoid fresh exposure in the stock which trades at Rs 420. While the price-earnings multiple at 30 times its likely 2006-07 earnings is not cheap, there are operational concerns that are to be addressed. Eligible players, including Reliance Communications, are still waiting for scarce spectrum to be allocated for their GSM business, which it has forayed into in addition to its CDMA business.
Second, competition has gone up sharply in the mobile space, with Vodafone snapping Hutch-Essar and the recently-listed Idea Cellular outlining its expansion plans. And till these prevail, the valuation gap between Bharti and Reliance Communications will take time to narrow.
POSITIVE CATALYSTS
Flag Telecom listing: The listing of Flag Telecom, Reliance Communications' wholly-owned subsidiary, is expected to unlock value for Reliance Communications. Deutsche Bank and Goldman Sachs have been appointed as lead managers for this proposed listing at London Stock Exchange. The details are sketchy at this point, but 10-15 per cent of equity may be issued. Reliance Communications has turned around the performance of Flag Telecom and it is now on a high growth path, with significant expansion plans such as its recently announced FLAG Next Generation Network.
Fundamentals intact: Reliance Communications may have lost out the Hutchison Essar deal to Vodafone, but its consolidated financials remain healthy. Not only have its operating margins and returns improved over the past three quarters, the company have also lined up aggressive network expansion plans. It has indicated that its capex for the year-ended March 2007 is expected to cross Rs 7,700 crore and it has announced that it will be investing about Rs 11,000 crore in the financial year 2007-08. During the year, it plans to add over 20000 new towers to support its wireless business.
It currently has tower-sharing agreements with Hutchison, Idea, Bharti Airtel, Spice and MTNL for Mumbai and Delhi.
The company management has also indicated that it plans the commercial launch of IPTV and DTH in the third quarter of 2007-08.
UNCERTAIN VARIABLES
GSM Spectrum Allocation: Reliance Communications will be disappointed with the Hutchison Essar outcome as, among the bidders, the company stood to gain the most from the acquisition. This would have fulfilled its aspirations of switching to GSM in a single stroke, with hardly any overlapping circles.
The acquisition could have also helped Reliance march past Bharti to garner a dominant market share.
This has inevitably brought the focus back to its organic strategy of growing its GSM business. While the company has lined up expansion plans for its GSM business on a pan-India basis, its execution will hinge on the availability of spectrum.
According to government policy indications, the allocation may happen only by the second half of 2007. Since Reliance is straddling both GSM and CDMA, the possibility of a slowdown in mobile subscriber addition during the transition phase and the seamless growth in GSM subscribers over the next year remains a live risk.
Intensifying competition: The entry of Vodafone through Hutchison Essar and the listing of Idea Cellular may have the potential to shake up the mobile market share in terms of incremental subscriber additions.
Since Reliance Communications operates both GSM and CDMA technology, it may be exposed to a greater risk of market share erosion.
It is likely to face the heat from Vodafone on several fronts that include aggressive promotional campaigns and schemes, lower price points and pan-India competition, once Hutch Essar completes its expansion programme.