Investing in Bharti or Reliance Communication

 The players in the domestic telecom sector couldn’t have wished for better times. Though Bharti Airtel (Bharti) has had the benefit of listing early on the bourses, coupled with robust performance, Reliance Communications (RCom) is not too far behind either.

Bharti has been commanding better valuations. However, the mist on the business and financials of RCom is getting cleared, and the same is reflecting in its stock price. RCom remains an attractive investment proposition, along with Bharti.

Both these telecom majors operate in 23 circles. Though they are vying for the same circles for their potential subscriber base, there is still substantial room for growth, as the wireless penetration in India continues to be low, at less than 10%.

Segments

RCom’s business segments are classified as wireless, global and broadband. The capital expenditure (capex) in the wireless segment stood at Rs 1,499 crore during the latest quarter. The company has a market share of 20.5% in the wireless segment, with 27 million wireless and mobile customers.

In the past one year, till September ’06, RCom’s subscriber base has risen at a rate of 99.9%. The revenue per minute stands at 77 paise. Under the global business segment, the company has operations and customer base in 28 developed countries, globally.

It has a market share of over 40% in the international long distance (ILD) market and 22% in the national long distance (NLD) market. During the September quarter, RCom commissioned its submarine cable system, Falcon was launched four months ahead of schedule at 80% of the projected cost.

The company has the largest next generation IP-enabled connectivity infrastructure, comprising over 1.5 lakh km of fibre optic cable systems, giving it a presence in six continents. The company’s global and broadband businesses will be the growth drivers in future. Its broadband business grew at 201% over the same quarter in the previous year to Rs 271 crore. The EBITDA margin of this sector stands at 44.8%.

Investment rationale

RCOM is hiving off its towers used for wireless communication into a separate company, which will be a subsidiary of RCom. Globally, tower companies attract a valuation of 20x EBITDA. Overall, this development is likely to have a positive impact on RCom as the depreciation and interest cost will fall, though network operating costs will rise.

The company is set to launch a new technology — Converged Home & Office Integrated Services (CHOIS) — which can be a substantial revenue-earner for the company, going forward. CHOIS is a complete end-to-end technology for constructing a fully dually-redundant, ethernet everywhere, fibre-to-home network.  Market leadership in the CDMA space has proved beneficial for the company. Though it is easy to switch service providers in the GSM space, this is not the case for CDMA technology. The company’s CDMA distribution reach for handsets in smaller towns has worked in its favour.

RCom has been a pioneer in e-charge and refill vouchers in small denominations. Reliance Netconnect allows the use of internet through the mobile phone. Reliance mobile phones, fixed wireless phones and data cards can be used to connect to the internet. This service is highly popular in B and C circles.

RCom currently provides GSM-based wireless services in eight circles in eastern and central India. In September ’06, the company had over 29 lakh GSM-based subscribers. It is looking at expanding it GSM-based services to metros and other areas. RCom is confident of successfully providing CDMA and GSM-based services simultaneously.

The company is well-placed to take advantage of growth in the telecom sector. Its focus on affordable schemes, coverage, and wider reach of handsets and recharge vouchers can help it to become a volume player, thus removing its susceptibility to margins. Adlabs Films, with which the Reliance group has a tie-up, can be an important mobile content provider, which can work in RCom’s favour.

Financials & valuations

RCOM’s revenues grew 40% to Rs 3,526 crore in Q2 FY07, compared to Rs 2,522 crore in the corresponding period last year. EDITDA and net profit for Q2 FY07 stood at Rs 1,353 crore and Rs 702 crore, respectively, compared to Rs 427 crore and a loss of Rs 19 crore, respectively, in the year-ago period. Interest costs fell significantly from Rs 65 crore in Q2 FY06 to Rs 5.6 crore in Q2 FY07.

Debt stood at Rs 2,057 crore at the end of the quarter. Access charges and licence fee dropped by Rs 125 crore over the same quarter in the previous year to Rs 906.8 crore. Based on expected FY07 results, the estimated earnings per share (EPS) works out to Rs 12.4. The stock currently trades close to Rs 390 and commands a P/E of 31x.

RCom has over 27 million subscribers, while Bharti has over 28 million subscribers. For Q2 FY07, Bharti’s revenues and net profit stood at Rs 4,357 crore and Rs 934, respectively. Bharti’s stock is trading close to Rs 540. Based on expected FY07 results, the estimated EPS works out to Rs 18.8; it commands a P/E of 29x.

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