Reliance_Comm

Reliance Communication Ltd. Earnings Review NEUTRAL Equity | India | Telecom Services-Wireless/Cellular 01 September 2008 FY08 annual report: key takeaways Reena Verma Bhasin, CFA >> +91 22 6632 8667 GSM margins down; h’set subsidies up; costs surprise RCom’s recently released FY08 annual report offers interesting insights: 1) its GSM (voice) EBITDA margin declined by an estimated 900bps YoY adjusting for tower-separation; 2) CDMA handset subsidies rose to ~US$7/sub, up ~200% YoY; 3) access & licence charges for RCom were up 6% YoY vs 37% revenue growth (Bharti’s access & licence charges grew 41% YoY vs 46% rev. grth); 4) average receivables were ~44 days for RCom vs ~33 days for Bharti; doubtful debtors were ~22% of gross receivables for RCom vs 20% for Bharti; 4) RCom’s tower portfolio totaled ~30,295 as of Mar ’08 vs the Co’s target of ~36-37K towers. Research Analyst DSP Merrill Lynch (India) reena_verma@ml.com Stock Data Price Price Objective Date Established Investment Opinion Volatility Risk 52-Week Range Mrkt Val / Shares Out (mn) Average Daily Volume ML Symbol / Exchange Bloomberg / Reuters ROE (2009E) Net Dbt to Eqty (Mar-2008A) Est. 5-Yr EPS / DPS Growth Free Float Rs395.20 Rs501.00 1-Aug-2008 C-2-7 HIGH Rs380.00-Rs844.70 US$18,563 / 2,063.7 10,306,560 RLCMF / BSE RCOM IN / RLCM.BO 21.3% 35.5% 14.0% / 14.0% 33.9% Nationwide GSM may pose downside risk to LT margin f’cast Based on FY08 perf, we foresee downside risk to consensus & our LT margin f’casts for RCom, on two counts: 1) The decline in RCom’s FY08 GSM-voice margin suggests to us that cost pressures from denser/deeper network rollout are not being offset by revenue ramp-up. In FY08, GSM voice-margin fell ~900bps YoY (MLe) despite ~200bps gain in sub. mkt. share & 14% YoY decline of voice-ARPU largely in line with Bharti & Idea. Reported GSM-voice margin fell from 45% in FY07 to ~21% in FY08 due to tower-separation. 2) Uplift in overall FY08 wireless margins (+300bps YoY) seems to us to be supported by lower access & licence costs, & robust non-voice growth – we are concerned about the sustainability of these factors Significant unhedged fx exposure; a/c policy changed in 1Q As of Mar ’08, RCom’s forex debt totaled ~US$4bn i.e ~67% of its gross debt. It appears to us from the annual report that ~75% of the Co’s forex debt exposure was unhedged as of Mar ‘08. Also, in FY08, RCom followed AS-11 (acct. standard) that allowed it to capture forex gains (~Rs4bn) in the P&L. However, in 1Q FY09, RCom changed its acct. policy to adopt Sch-VI of the Companies Act that allowed it to capitalize forex losses (~Rs14.6bn, incl. FCCB) related to fixed-assets. Estimates (Mar) (Rs) Net Income (Adjusted - mn) EPS EPS Change (YoY) Dividend / Share Free Cash Flow / Share 2007A 31,934 15.19 545.4% 0.500 22.29 2008A 55,097 25.54 68.1% 0.750 (39.36) 2009E 61,258 28.39 11.2% 0.968 (44.55) 2010E 58,448 27.09 -4.6% 0.924 (25.62) 2011E 59,693 27.67 2.1% 0.944 14.99 Valuation (Mar) 2007A P/E Dividend Yield EV / EBITDA* Free Cash Flow Yield* * For full definitions of iQmethod SM measures, see page 5. 2008A 15.47x 0.190% 13.33x -9.96% 2009E 13.92x 0.245% 10.91x -11.27% 2010E 14.59x 0.234% 8.86x -6.48% 2011E 14.28x 0.239% 7.21x 3.79% 26.01x 0.127% 19.11x 5.59% >> Employed by a non-US affiliate of MLPF&S and is not registered/qualified as a research analyst under the NYSE/NASD rules. Refer to "Other Important Disclosures" for information on certain Merrill Lynch entities that take responsibility for this report in particular jurisdictions. Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 10762608 Refer to important disclosures on page 6 to 7. Analyst Certification on Page 3. Price Objective Basis/Risk on page 3. Reliance Communication Ltd. 0 1 Se ptembe r 20 08 iQprofile Reliance Communication Ltd. SM Key Income Statement Data (Mar) (Rs Millions) Sales Gross Profit Sell General & Admin Expense Operating Profit Net Interest & Other Income Associates Pretax Income Tax (expense) / Benefit Net Income (Adjusted) Average Fully Diluted Shares Outstanding 2007A 144,683 57,206 NA 32,553 (4) NA 32,550 (616) 31,934 2,102 31,632 24,653 56,192 NA 182 112,658 (67,086) (11,925) (17,570) (96,581) 0 (1,196) 61,266 45,572 18,238 (14,579) 330,423 11,925 18,316 137,200 40,747 538,611 155,438 0 0 179,186 334,624 203,987 538,611 11.8% 19.9% 22.5% 39.5% 3.5x 2.7x 1.9% 8.9% 6.6x 2008A 190,678 81,989 NA 53,936 3,997 NA 57,933 (2,836) 55,097 2,157 54,011 28,053 47,447 NA 25,397 154,908 (236,140) (13,930) 3,039 (247,031) 13,528 (1,781) 71,990 (81,232) 99,700 81,462 522,153 25,855 27,224 115,981 46,893 738,106 215,681 0 0 241,687 457,368 280,738 738,106 13.6% 23.9% 28.3% 43.0% 2.8x 8.4x 4.9% 35.5% 8.0x 2009E 239,372 100,239 NA 64,839 (428) NA 64,411 (3,153) 61,258 2,157 63,817 35,399 36,669 NA 28,426 164,311 (256,250) (30,985) 0 (287,235) 0 (2,292) 61,426 (91,939) 253,342 122,657 743,004 56,840 28,585 26,058 59,346 913,832 279,400 0 0 292,170 571,570 342,262 913,832 11.4% 21.3% 27.1% 41.9% 2.7x 7.2x 4.9% 74.0% 10.0x 2010E 295,056 123,324 NA 69,287 (5,525) NA 63,763 (5,315) 58,448 2,157 58,448 54,036 37,276 NA 0 149,760 (202,639) 0 0 (202,639) 0 (2,188) 47,453 (52,879) 308,410 55,068 891,607 56,840 35,234 20,630 73,152 1,077,462 329,040 0 0 349,901 678,941 398,522 1,077,462 9.4% 16.9% 23.5% 41.8% 2.6x 3.8x 8.3% 77.4% 10.7x 2011E 362,345 151,720 NA 82,970 (15,646) NA 67,324 (7,631) 59,693 2,157 59,693 68,750 45,045 NA 0 173,488 (142,556) 0 0 (142,556) 0 (2,235) (22,434) 30,932 279,713 (28,697) 965,412 56,840 43,270 29,128 89,835 1,184,484 308,841 0 0 419,664 728,505 455,980 1,184,484 10.0% 14.8% 22.9% 41.9% 2.9x 2.1x 11.3% 61.3% 4.9x Company Description Reliance Communications ranks among the largest private telecom operators in India. It has dominant wireless, long-distance and enterprise businesses in India. RCom also owns 100% of the global undersea cable FLAG. RCom was listed in Mar '06 as a result of the de-merger of Reliance Industries. The Anil D. Ambani group is the promoter-shareholder of RCom. Investment Thesis Weak subscriber quality on CDMA and consequent vulnerability to tariff competition will likely drag RCom over next 2-3 quarters pending launch of nationwide GSM operations. Stock may be supported, however, by strong market position (No. 2 by subscriber market share) in the wireless industry and potential transformation post nationwide GSM launch. Key Cash Flow Statement Data Net Income (Reported) Depreciation & Amortization Change in Working Capital Deferred Taxation Charge Other Adjustments, Net Cash Flow from Operations Capital Expenditure (Acquisition) / Disposal of Investments Other Cash Inflow / (Outflow) Cash Flow from Investing Shares Issue / (Repurchase) Cost of Dividends Paid Cash Flow from Financing Free Cash Flow Net Debt Change in Net Debt Stock Data Price to Book Value 2.6x Key Balance Sheet Data Property, Plant & Equipment Other Non-Current Assets Trade Receivables Cash & Equivalents Other Current Assets Total Assets Long-Term Debt Other Non-Current Liabilities Short-Term Debt Other Current Liabilities Total Liabilities Total Equity Total Equity & Liabilities iQmethod SM - Bus Performance* Return On Capital Employed Return On Equity Operating Margin EBITDA Margin iQmethod SM - Quality of Earnings* Cash Realization Ratio Asset Replacement Ratio Tax Rate (Reported) Net Debt-to-Equity Ratio Interest Cover Key Metrics * For full definitions of iQmethod SM measures, see page 5. 2 Reliance Communication Ltd. 0 1 Se ptembe r 20 08 Price objective basis & risk RCVL (RLCMF) Our PO of Rs501/sh for RCom is based on 20% discount to DCF using 11% WACC and 5% terminal growth. Our PO pegs the long-term EV/EBITDA of RCom broadly on par with Bharti at 8-9x FY11E. In the medium-term, our PO pegs the valuation of RCom at 10-15% premium versus our target EV/EBITDA multiple of 9x FY10E for Bharti. After likely sharp correction on 1Q disappointment, we expect the stock to be supported by forecast 22-23% YoY EBITDA growth and potential improved competitiveness post nation-wide GSM launch. Unforeseen push back in nationwide GSM rollout, possible dramatic regulatory changes and irrational bidding for 3G licences are key risks to our outlook. Analyst Certification I, Reena Verma Bhasin, CFA, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report. Special Disclosures In accordance with the SEBI (Foreign Institutional Investors) Regulations and with guidelines issued by the Securities and Exchange Board of India (SEBI), foreign investors (individuals as well as institutional) that wish to transact the common stock of Indian companies must have applied to, and have been approved by SEBI and the Reserve Bank of India (RBI). Each investor who transacts common stock of Indian companies will be required to certify approval as a foreign institutional investor or as a sub-account of a foreign institutional investor by SEBI and RBI. Certain other entities are also entitled to transact common stock of Indian companies under the Indian laws relating to investment by foreigners. Merrill Lynch reserves the right to refuse copy of research on common stock of Indian companies to a person not resident in India. American Depositary Receipts (ADR) representing such common stock are not subject to these Indian law restrictions and may be transacted by investors in accordance with the applicable laws of the relevant jurisdiction. Global Depository Receipts (GDR) and the Global Depository Shares of Indian companies, Indian limited liability corporations, have not been registered under the U.S. Securities Act of 1933, as amended, and may only be transacted by persons in the United States who are Qualified Institutional Buyers (QIBs) within the meaning of Rule 144A under the Securities Act. Accordingly, no copy of any research report on Indian companies' GDRs will be made available to persons who are not QIBs. 3 Reliance Communication Ltd. 0 1 Se ptembe r 20 08 APR - Telecommunications & Media Coverage Cluster Investment rating Company BUY AirMedia Baidu.com-ADR Bharti China Netcom Gr China Netcom-ADR China Unicom China Unicom -A Chunghwa Telecom Chunghwa Telecom CJ Internet Cor Focus Media-ADR Idea Cellular KT KT -A LG Dacom Corp LG TeleCom Neowiz Games Netease.com-ADR NHN Perfect Worl-ADR Shanda Inter-ADR Sina Corp SingTel StarHub Taiwan Mobile Tencent Holdings NEUTRAL China Mobile China Mobile - A FarEasTone Giant Interactive MobileOne RCVL Tata Communications Limited Tata Communications Limited VisionChina Media UNDERPERFORM China Telecom China Telecom-H Hanarotelecom KTF MTNL MTNL NCsoft SK Telecom SK Telecom- A The9 Ltd-ADR RESTRICTED Sohu.com Inc ML ticker AMCN BIDU BHTIF CIGUF CN CUNCF CHU CHT CHWAF XCENF FMCN IDEAF KTCNF KTC DCMPF LTCLF XNGCF NTES XNHNF PWRD SNDA SINA SNGNF XHSBF TWMBF TCEHF CHLKF CHL FEOTF GA MBOFF RLCMF TCL VSLSF VISN CHA CHJHF HANTF KTFTF MTE XMTNF NCSCF SKMTF SKM NCTY SOHU Bloomberg symbol AMCN US BIDU US BHARTI IN 906 HK CN US 762 HK CHU US CHT US 2412 TT 037150 KS FMCN US IDEA IN 030200 KS KTC US 015940 KS 032640 KS 095660 KS NTES US 035420 KS PWRD US SNDA US SINA US ST SP STH SP 3045 TT 700 HK 941 HK CHL US 4904 TT GA US M1 SP RCOM IN TCL US TCOM IN VISN US CHA US 728 HK 033630 KS 032390 KS MTE US MTNL IN 036570 KS 017670 KS SKM US NCTY US SOHU US Analyst Eddie Leung Eddie Leung Reena Verma Bhasin, CFA Cynthia J.H. Meng Cynthia J.H. Meng Cynthia J.H. Meng Cynthia J.H. Meng John Kim John Kim Karen Cho, CFA Eddie Leung Reena Verma Bhasin, CFA John Kim John Kim John Kim John Kim Karen Cho, CFA Eddie Leung Karen Cho, CFA Eddie Leung Eddie Leung Eddie Leung Reena Verma Bhasin, CFA Reena Verma Bhasin, CFA John Kim Eddie Leung Cynthia J.H. Meng Cynthia J.H. Meng John Kim Eddie Leung Reena Verma Bhasin, CFA Reena Verma Bhasin, CFA Reena Verma Bhasin, CFA Reena Verma Bhasin, CFA Eddie Leung Cynthia J.H. Meng Cynthia J.H. Meng John Kim John Kim Reena Verma Bhasin, CFA Reena Verma Bhasin, CFA Karen Cho, CFA John Kim John Kim Eddie Leung Eddie Leung 4 Reliance Communication Ltd. 0 1 Se ptembe r 20 08 iQmethod SM Measures Definitions Business Performance Numerator Return On Capital Employed Return On Equity Operating Margin Earnings Growth Free Cash Flow NOPAT = (EBIT + Interest Income) * (1 - Tax Rate) + Goodwill Amortization Net Income Operating Profit Expected 5-Year CAGR From Latest Actual Cash Flow From Operations – Total Capex Cash Flow From Operations Capex Tax Charge Net Debt = Total Debt, Less Cash & Equivalents EBIT Current Share Price Current Share Price Annualised Declared Cash Dividend Cash Flow From Operations – Total Capex EV = Current Share Price * Current Shares + Minority Equity + Net Debt + Other LT Liabilities Enterprise Value Denominator Total Assets – Current Liabilities + ST Debt + Accumulated Goodwill Amortization Shareholders’ Equity Sales N/A N/A Net Income Depreciation Pre-Tax Income Total Equity Interest Expense Diluted Earnings Per Share (Basis As Specified) Shareholders’ Equity / Current Basic Shares Current Share Price Market Cap. = Current Share Price * Current Basic Shares Sales Basic EBIT + Depreciation + Amortization Quality of Earnings Cash Realization Ratio Asset Replacement Ratio Tax Rate Net Debt-To-Equity Ratio Interest Cover Valuation Toolkit Price / Earnings Ratio Price / Book Value Dividend Yield Free Cash Flow Yield Enterprise Value / Sales EV / EBITDA iQmethod SMis the set of Merrill Lynch standard measures that serve to maintain global consistency under three broad headings: Business Performance, Quality of Earnings, and validations. The key features of iQmethod are: A consistently structured, detailed, and transparent methodology. Guidelines to maximize the effectiveness of the comparative valuation process, and to identify some common pitfalls. iQdatabase ® is our real-time global research database that is sourced directly from our equity analysts’ earnings models and includes forecasted as well as historical data for income statements, balance sheets, and cash flow statements for companies covered by Merrill Lynch. iQprofile SM, iQmethod SM are service marks of Merrill Lynch & Co., Inc.iQdatabase ®is a registered service mark of Merrill Lynch & Co., Inc. 5 Reliance Communication Ltd. 0 1 Se ptembe r 20 08 Important Disclosures RLCMF Price Chart 1-Jun:B Verma PO:Rs360 12-Jun PO:Rs280 21-Aug PO:Rs345 20-Sep PO:Rs385 31-Oct PO:Rs425 1-Feb PO:Rs580 30-Apr 19-Jul PO:Rs540 PO:Rs690 1-Nov PO:Rs950 31-Jan PO:Rs810 30-Apr PO:Rs725 1-Aug:N PO:Rs501 Rs1,000 Rs800 Rs600 Rs400 Rs200 Rs0 RLCMF 1-Jan-06 1-Jan-07 B : Buy, N : Neutral, S : Sell, U : Underperform, PO : Price objective, NA : No longer valid 1-Jan-08 Prior to May 31, 2008, the investment opinion system included Buy, Neutral and Sell. As of May 31, 2008, the investment opinion system includes Buy, Neutral and Underperform. Dark Grey shading indicates that a security is restricted with the opinion suspended. Light grey shading indicates that a security is under review with the opinion withdrawn. The current investment opinion key is contained at the end of the report. Chart is current as of July 31, 2008 or such later date as indicated. Investment Rating Distribution: Telecommunications Group (as of 01 Jul 2008) Coverage Universe Count Percent Buy Neutral Sell 92 49 40 50.83% 27.07% 22.10% Inv. Banking Relationships* Buy Neutral Sell Count 20 13 8 Percent 26.32% 35.14% 24.24% Investment Rating Distribution: Global Group (as of 01 Jul 2008) Coverage Universe Count Percent Buy Neutral Sell 1664 803 1042 47.42% 22.88% 29.70% Inv. Banking Relationships* Buy Neutral Sell Count 441 224 217 Percent 29.46% 31.46% 22.84% * Companies in respect of which MLPF&S or an affiliate has received compensation for investment banking services within the past 12 months. For purposes of this distribution, a stock rated Underperform is included as a Sell. FUNDAMENTAL EQUITY OPINION KEY: Opinions include a Volatility Risk Rating, an Investment Rating and an Income Rating. VOLATILITY RISK RATINGS, indicators of potential price fluctuation, are: A - Low, B - Medium and C - High. INVESTMENT RATINGS reflect the analyst’s assessment of a stock’s: (i) absolute total return potential and (ii) attractiveness for investment relative to other stocks within its Coverage Cluster (defined below). 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Investment rating Total return expectation (within 12-month period of date of initial rating) Ratings dispersion guidelines for coverage cluster* Buy ≥ 10% ≤ 70% Neutral ≥ 0% ≤ 30% Underperform N/A ≥ 20% * Ratings dispersions may vary from time to time where Merrill Lynch Research believes it better reflects the investment prospects of stocks in a Coverage Cluster. INCOME RATINGS, indicators of potential cash dividends, are: 7 - same/higher (dividend considered to be secure), 8 - same/lower (dividend not considered to be secure) and 9 - pays no cash dividend. Coverage Cluster is comprised of stocks covered by a single analyst or two or more analysts sharing a common industry, sector, region or other classification(s). A stock’s coverage cluster is included in the most recent Merrill Lynch Comment referencing the stock. 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