India Equity Research I Telecom Result Update (Large Cap)

Reliance Communication Ltd. INR: 171

Worsening Outlook SELL

Price Outlook (INR): 150

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
Market Data January 27, 2009
offers and schemes aimed at increasing MOU. The NPM declined by 301
bps. RCom remains confident of its GSM expansion and expects to Shares outs (Cr) 206.40
increase market share. However, we are skeptical due to leveraged Equity Cap (Rs. Cr) 1032.0
balance sheet and tariff wars which will further reduce profitability.
Mkt Cap (Rs. Cr) 35,246
Q3FY09 Results – Key Highlights
52 Wk H/L (Rs) 706/148
• Net Sales: Rs 5,850.6 crore (↑20% Y-o-Y, ↑3.6% Q-o-Q) Avg Vol (1yr avg) 27,35,690
• 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

Q3FY09 Results – Brief Analysis Market Info:

• Revenue growth misses estimates - Declining subscriber growth SENSEX : 9,004
NIFTY : 2,771
and a significant drop in ARPU were key highlights this quarter; RCOM
has lost market share by 10 bps. Revenue from the Wireless Business Price Performance
was up by only 1.9%, however Global Business was flat. EBITDA 125

margin was down by 60 bps due to higher network expenses of GSM 100

rollout.
75

• Worsening metrics – ARPU has maintained its declining trend over 50

the past 5 quarters with an accelerated rate compared to its peers and
25
stood at Rs 251, down 8% q-o-q. The MOU declined to 410, a decline
Jan‐08

Feb‐08

Mar‐08

Apr‐08

May‐08

Jun‐08

Jul‐08

Aug‐08

Sep‐08

Oct‐08

Nov‐08

Dec‐08

Jan‐09
of 3.1% q-o-q. The decline in ILD minutes by 2% was a negative
surprise. RCOM Sensex

Share Holding pattern (%)

• Higher Depreciation expenses continue to erode profit margins–
The GSM rollout is taking its toll on the margins as depreciation Particulars 31/12 30/09 % Chg
expenses. Going forward, margins will be under pressure as we Promoters 66.1 66.1 0.0
expect RCom to launch major initiatives to capture GSM market share
Institutions 9.1 9.0 0.1
by way of tariff cuts in the coming months. Lower tax rate of 1%
compared to 9% in Q3FY08 increased profitability. FII 9.4 10.0 -0.6
• Continued Aggressive Accounting Policy – RCOM maintained its
Other Corp
aggressive accounting policy, capitalizing Rs 770 crore of foreign 2.4 2.1 0.3
Holding
exchange fluctuations in balance sheet. Moreover, it has not made any
Public 13.0 12.8 0.2
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 Total 100.0 100.0
FY2012. Adjusting the same, PAT would have been Rs 430 crore
Analyst
compared to reported profit of Rs 1,410 crore.
Kevin Trindade
Valuations kevin.trindade@krchoksey.com
℡ 91-22-6696 5572
We expect RCom’s profitability to come under pressure because of the
company being in investment phase, GSM rollout and additional capital Maulik Patel
expenses. We anticipate execution risks in GSM and higher debt burden maulik.patel@krchoksey.com
related to upcoming 3G rollout. Hence, we have reduced our FY09E EPS ℡ 91-22-6696 5574
from 32 to 31 and FY10E EPS from 31 to 27.2, based on lower EBITDA
www.krchoksey.com
expectations and aggressive accounting policy related to finance costs.
℡ 91-22-6696 5203
At the CMP of Rs 171, RCom is trading at 6.3x FY10E EPS of Rs 27.2.
¬ 91-22-6691 9569
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.

KRC Research is also available on Bloomberg KRCS<GO>, 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
Internal tenancy ratio of
RTIL at 1.7x but visibility
of increase from current
levels
First 9 months losses of
Rs 1,217crore were
capitalized, and amount to
26.4% of its first 9 month
reported profit.
2 KRC Equity Research
• 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
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
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.
Reliance Communication Ltd.

Income Statement Rs Crore

Income Statement Q3FY08 Q2FY09 Q3FY09 Y-o-Y(%) Q-o-Q(%) Comments
Net Sales 4,874 5,645 5,850 20.0% 3.6% Largely due to subscriber growth
Notional saving of Rs 63 crore on
Other Income 154 235 318 106.2% 35.7%
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%
Network Expenses 545 1,027 1,167 114.2% 13.6% Expect to increase going forward
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 725 918 1,007 38.9% 9.7%
PBT 1,533 1,619 1,495 -2.5% -7.6%
Tax 138 (57) 15 -88.9% -127.0% Tax rate of 1% only.
PAT 1,550 1,676 1,480 -4.5% -11.7%
Extraordinary Items (22) (145) (70) 212.6% -51.8%
APAT 1,527 1,531 1,410 -7.7% -7.9%
EPS 7.52 8.13 7.18 -4.5% -11.7%

Segment Revenue (Rs million)

Q3FY08 Q4FY08 Q1FY09 Q2FY09 Q3FY09 Comments
Subscriber growth of 10.4% q-o-q; Flat
Wireless 39,567.0 41,608.0 41,187.0 43,356.0 4,4190 MoU and 3.7% q-o-q decline in ARPM
due to robust revenue growth
Growth supported by 10.3% q-o-q
Global 13,299.0 15,257.0 15,260.0 16,915.0 1,6783
increase in MoU
Increase in geographic coverage and
Broadband 4,564.0 5,100.0 5,603.0 6,023.0 6542
10% increase in access lines
Includes revenues from DTH services
Others 1,544.0 683.0 1,437.0 2,346.0 3183

Sub Total 58,974.0 62,648.0 63,487.0 68,640.0 7,0627

Eliminations (10,232.0) (9,534.0) (10,265.0) (12,190.0) (1,2125)
Total 48,742.0 53,114.0 53,222.0 56,450.0 5,8502

Operational Metrics
Unit Q3FY08 Q4FY08 Q1FY09 Q2FY09 Q3FY09 Comments

Mobile services
Total Customers (000's) 000's 40,964 45,794 50,773 56,046 61,345
Major contribution from C circles
GSM (000's) 000's 6,002 7,016 8,065 9,206 10,354 0
(57%)
Major contribution from C circles
CDMA (000's) 000's 34,962 38,777 42,707 46,840 50,991
(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%
Sequential decline of 9 bps as
RCom market share % 17.9% 17.9% 18.0% 18.1% 18.0% Bharti, Idea and Vodafone
increased market share by 12,

3 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 Decline despite promotion plans
to increment MOU. This is also
explained by 57% of subscriber
ARPM(Rs/Min) Rs/Min 0.75 0.74 0.66 0.64 0.61 additions coming from C circles
while peers focused on A and B
circles
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%

Global Services
Unit Q3FY08 Q4FY08 Q1FY09 Q2FY09 Q3FY09 Comments
Seasonal decline as per
Total ILD minutes Mn Mins 1,747 1,769 1,726 1,946 1,906
management
Total NLD minutes Mn Mins 5,795 5,964 6,641 7,856 8,576

Broadband
Service areas operational Nos 18 18 18 18 18
Towns active (wireline
Nos 42 42 42 42 42
only)
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
Nos 727,229 787,567 821,638 857,982 892,301
connected
Source: Company data, KRC Research

Subscriber Additions (Sep-Dec 2008)

Q3FY09 Q3FY09
GSM Additions Marketshare CDMA 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% TTSL 6,308,343 28.7%
BSNL 2,194,791 8.9% HFCL Infotel 2,194,791 10.0%
Aircel 1,300,873 5.3% Shyam Telelink 1,300,873 5.9%
BPL 283,763 1.2% Total 22,008,463
Dishnet 896,693 3.7%
MTNL 219,556 0.9%
RCom 1,147,714 4.7%
Total 24,556,189
Source: Company data, KRC Research

4 KRC Equity Research

Reliance Communication Ltd.
Composition of Net CDMA additions (Sep-Dec 2008)

Shyam
RCom BSNL MTNL TTSL HFCL Infotel Telelink Comments
Metros 730,547 8,529 10,805 851,219 - -
A Circle 1,351,584 36,403 - 322,504 - -
B Circle 1,726,325 88,896 - 957,777 21,387 243,824 ARPU @Rs111
C Circle 343,078 35,934 - 296,906 - -
India 4,151,534 169,762 10,805 2,428,406 21,387 243,824
Source: Company data, KRC Research

Composition of Net GSM additions (Sep-Dec 2008)

Bharti Idea Vodafone BSNL MTNL Aircel BPL Dishnet RCom Comments
Metros 655,589 319,481 736,569 112,792 219,556 323,712 283,763 - 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
ARPU
C Circle 1,540,214 288,782 411,483 400,355 - - - 777,259 655,643
@Rs212
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
Source: Company data, KRC Research

5 KRC Equity Research

Reliance Communication Ltd.

Rajiv Choksey Co-Head Institutional Sales rajiv.choksey@krchoksey.com +91-22-6653 5135

Anuj Choksey Co-Head Institutional Sales anuj.choksey@krchoksey.com +91-22-6696 5500

Alok Agarwal Head Research alok.agarwal@krchoksey.com +91-22-6696 5502

Reliance Communication Rating In next 12 months, expected to :

700
BUY Buy Appreciate over 15%
600

500
BUY
400 Accumulate/Hold Appreciate upto 15%
SELL
300

200 Reduce Depreciate upto 10%

100
Apr‐08

Aug‐08
Feb‐08

Jun‐08

Sep‐08

Oct‐08

Nov‐08

Dec‐08
Jan‐08

Mar‐08

May‐08

Jul‐08

Jan‐09
Sell Depreciate over 10%

Other Stocks in the sector under our active coverage: Telecom

Ticker Company Recommendation As of Return Bmk Outper BARR

Summary Coverage 13 Avg Rating: 3.7 -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% 3rd

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%

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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
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Registered Office:
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Phone: 91-22-6633 5000; Fax: 91-22-6633 8060.

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Phone: 91-22-6696 5555; Fax: 91-22-6691 9576.

6 KRC Equity Research