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Reliance Communications Buy

CMP: Rs531 Target Price: Rs627
(12 Months)

Harit Shah Q1FY2008 Results Update

Tel: 022 – 4040 3800 Ext: 345 Performance Highlights
e-mail: harit.shah@angeltrade.com
„ Wireless Business powers Topline, aided by soaring ARPUs: Reliance
Communications (RCOM) recorded a 32.8% yoy and a 9.7% qoq Topline
Sector Telecom
growth in Q1FY2008. This was driven by the Wireless Business unit, which
recorded a 38.7% yoy and a 13.6% qoq growth in gross revenues. This
Market Cap (Rs cr) 1,08,487 business accounted for over 81% of incremental revenues of RCOM on a yoy
basis and over 84% on a qoq basis. The company’s mobile subscriber base
Beta 1.4 now stands at 31.9mn, which implies an increase of 3.9mn over the quarter.
This is the second-highest ever quarterly addition made by RCOM. This
52 WK High / Low growth comes after a fall of 2.0mn subscribers in the last quarter on account
592 / 254
of subscriber disconnections made to comply with the subscriber re-
Avg Daily Volume
1797002 verification norms. In fact, due to these disconnections, the company’s
Face Value (Rs) average revenues per user (ARPUs) rose significantly this quarter, by 10.0%
5 qoq. On a yoy basis, the fall was just 1.1%.
BSE Sensex 14,936
As regards the other segments, the Global Business, which includes long-
Nifty 4,346
distance services, carrier-related services and bandwidth capacity sales, grew
by a mere 5.6% yoy and by 0.7% qoq. The Rupee appreciation, to some
BSE Code extent, seemingly impacted revenue growth for this business. Revenues per
532712 minute continue to witness a secular decline, falling by as much as 37.2% yoy
NSE Code and by 11.2% qoq, even as minutes of usage have soared by an impressive
RCOM
68.2% yoy and by 13.4% qoq. As for the Broadband Business, this segment
Reuters Code clocked a strong 68.8% yoy and a 16.5% qoq growth during the quarter.
RLCM.BO
Bloomberg Code „ Margins continue to surge, at par with Bharti Airtel: RCOM recorded an
RCOM IN
impressive 580bp yoy margin expansion on account of operating leverage
Shareholding Pattern (%) and cost management. Even on a qoq basis, EBITDA margins rose by 82bp.
With this performance, RCOM’s EBITDA margins are now at par with those
Promoters enjoyed by industry leader, Bharti Airtel.
66.8
MF/Banks/Indian FIs
7.2
„ Bottomline steams ahead on margin expansion, forex gains: Due to the
margin expansion and forex gains (Rs204.2cr), RCOM witnessed a surge in
FII/ NRIs/ OCBs Bottomline by over 138% yoy and by 19.2% qoq during the quarter.
14.8
Indian Public/ Others
11.2 Exhibit 1: Key Financials
Y/E March (Rs cr) FY2006 FY2007 FY2008E FY2009E
Share Price Vs Sensex
Net Sales 10,628 14,262 19,599 26,264
600 16000 % chg 34.2 37.4 34.0
565 RCOM
Sensex
15450 EBITDA Margin (%) 22.5 38.7 41.3 42.8
530 14900
Net Profit 444 3,163 4,962 6,967
495 14350

460 13800
% chg 612.0 56.9 40.4
EPS (Rs) 2.1 14.7 23.0 32.3
Price (Rs)

Sensex

425 13250

390 12700 P/E (x) 257.7 36.2 23.1 16.4

355 12150 RoE (%) 7.6 19.7 21.8 24.7
320 11600
RoCE (%) 3.8 9.0 13.6 17.2
285 11050
Sales/GFA (x) 0.5 0.4 0.4 0.4
250 10500

EV/EBITDA (x) 46.6 20.0 14.0 10.2

1/8/2006

14/09/2006

31/10/2006

13/12/2006

31/01/2007

16/03/2007

4/5/2007

18/06/2007

31/07/2007

Date
ARPUs (Rs/user/month) 384.8 370.8 352.3 324.1
Source: Company, Angel Research

August 1, 2007 1
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Angel Broking Reliance Communications

Service Truly Personalized India Research

Wireless Business continues to witness robust growth

During Q1FY2008, RCOM recorded a 32.8% yoy and a 9.7% qoq growth in Topline. The key
growth driver for this performance was the Wireless Business, which grew by 38.7% yoy and by
13.6% qoq. At the end of June 2007, RCOM had a total of 31.9mn mobile subscribers on its
network, recording net adds of 3.9mn over the quarter, giving it an incremental share of 19.6% of
industry net adds over the period. The company has clearly made a strong comeback since
March, when it had to disconnect 5.6mn subscribers to comply with the subscriber re-verification
norms. In June, RCOM added its highest-ever monthly subscriber additions, at over 1.45mn. The
company remains the second-largest wireless operator in the country, with a total marketshare of
17.6% (up from 17.4% in March).

As far as average revenues per user (ARPUs) are concerned, these saw a spurt of 10.0% qoq to
Rs375.5 per user per month on a blended basis (Rs341.3 per user per month in Q4FY2007). On a
yoy basis, the fall was not that significant, at just 1.1%. This was primarily due to the low base
effect of the last quarter, when RCOM reported a 2mn fall in subscribers over the quarter. Thus,
even as the subscribers who were generating negligible revenues have been cleaned out from the
company’s network, its other customers and new additions to the network continue to generate
revenues at a strong pace, leading to the quarterly spike in ARPUs. However, we believe that this
is just a temporary phenomenon and that ARPUs will resume their downward trend going forward.

Exhibit 2: Wireless Business revenue break-up

Q1FY07 Q4FY07 Q1FY08 % chg yoy % chg qoq
Gross revenues (Rs cr) 2,432 2,969 3,373 38.7 13.6
Mobile subscriber base (Mn) 22.5 28.0 31.9 41.7 13.8
ARPUs (Rs/user/month) 379.6 341.3 375.5 (1.1) 10.0
Total minutes of usage (Mn) 31,440 42,500 45,800 45.7 7.8
Revenues per minute (Rs) 0.77 0.70 0.74 (4.8) 5.4
Minutes of usage (Per user/month) 491 541 510 3.9 (5.7)
Source: Company, Angel Research

A peculiar feature of this quarter’s results is that the minutes of usage (MoUs) in the Wireless
Business fell 5.7% qoq, while revenues per minute actually rose 5.4% qoq. Typically, these
metrics move in the opposite direction when compared with what RCOM has reported this quarter.
The reason attributed by the management for this is that the company, due to its strong focus on
selling its own ‘Classic-branded’ handsets rather than those of Qualcomm, gave out a lesser
number of free minutes. Thus, given this factor, subscribers this quarter ended up talking less on
their phones, which also resulted in revenues per minute rising. RCOM’s total MoUs on the
network rose 45.7% yoy and 7.8% qoq, while revenues per minute reduced by 4.8% yoy (rise of
5.4% qoq).

Exhibit 3: Minutes of usage – Strong growth trajectory

(Mn)
46,000

40,000

34,000 CQGR 12.4%

28,000

22,000

16,000
Q1FY06 Q2FY06 Q3FY06 Q4FY06 Q1FY07 Q2FY07 Q3FY07 Q4FY07 Q1FY08

Source: Company, Angel Research

August 1, 2007 2
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Angel Broking Reliance Communications

Service Truly Personalized India Research
Broadband business shows robust performance, Global business subdued
RCOM recorded an impressive 68.8% yoy and a strong 16.5% qoq growth in Topline this quarter
in its Broadband Business. This was driven by a strong increase in the number of access lines by
an outstanding 118.9% yoy and by 13.7% qoq. The company’s average revenues per line (ARPL)
per month saw a decline of 26.4% yoy, but a rise of 1.1% qoq.

Exhibit 4: Broadband Business – Powered by growth in access lines

Q1FY07 Q4FY07 Q1FY08 % chg yoy % chg qoq
Gross revenues (Rs cr) 227 329 383 68.8 16.5
Access lines ('000) 322 620 705 118.9 13.7
Average revenues per line/month 2,619.0 1,908.1 1,928.5 (26.4) 1.1
Buildings directly connected 180,759 488,661 593,805 228.5 21.5
Source: Company, Angel Research

However, as was the case in the previous quarter, RCOM’s Global Business Unit proved to be the
party spoiler, as this business grew by just 5.6% yoy and by a marginal 0.7% qoq. This was the
case, even as the minutes of usage soared by an impressive 68.2% yoy and by 13.4% qoq.
Clearly, the significant fall in revenues per minute was the chief culprit that restricted the growth of
this business, despite strong volume growth. Revenues per minute fell by as much as 37.2% yoy
and by 11.2% qoq.

Exhibit 5: Global Business – No respite from fall in realisations

Q1FY07 Q4FY07 Q1FY08 % chg yoy % chg qoq
Gross revenues (Rs cr) 1,234 1,294 1,303 5.6 0.7
Total minutes of usage (Mn) 4,299 6,376 7,229 68.2 13.4
Revenues per minute (Rs) 2.87 2.03 1.80 (37.2) (11.2)
Source: Company, Angel Research

Scale benefits result in margin expansion

RCOM recorded an impressive 580bp yoy expansion in EBITDA margins in Q1FY2008 and an
82bp expansion on a qoq basis. Continuing scale benefits led to this performance, with major cost
items, including Access charges and License fees, Network Expenses, Staff Costs and G&A
costs declining as a percentage of sales. However, a spike was witnessed in Selling and
Marketing (S&M) costs, which increased to 15.1% of sales (9.4% in Q1FY2007, 10.1% in
Q4FY2007).

Higher margins, forex gains lead to Bottomline soaring

Due to the impressive margin expansion witnessed this quarter, as also significant forex gains to
the tune of Rs204.2cr, RCOM’s Bottomline witnessed an astonishing 138.1% yoy and an
impressive 19.2% qoq growth.

Marks entry into the global enterprise data market through the acquisition of Yipes
RCOM during the last quarter acquired Yipes Holdings Inc, a US-based provider of managed
Ethernet and application delivery services. This is RCOM’s largest-ever acquisition so far.
Ethernet is the fastest-growing segment of the data communication market and as per various
industry sources, will record a CAGR growth of 30% over 2006-10, when it will achieve a size of
US $25bn (approximately Rs1,00,000cr) globally. Yipes has a total of nearly 1,000 enterprise
customers focused across four industry verticals – financial, legal, government and healthcare,
which account for 50% of the Ethernet market. The company has over 22,000 route-kilometers
(R-kms) of fibre across 14 US metros, covering 40% of the total US datacom market. Yipes also
has a presence in London, Hong Kong and Tokyo.

RCOM acquired Yipes for a total consideration of US $300mn (approximately Rs1,200cr). Yipes’
Topline stands at around US $100mn, with EBITDA margins of over 50%. Thus, the deal has
been valued at an EV/EBITDA multiple of around 6x, which appears reasonable, given the well-
established credentials of the company. With the acquisition, RCOM will also get access to the
global enterprise data market, worth US $100bn (approximately Rs4,00,000cr). The company will
also be able to better serve its international customers directly in the US. The acquisition has
been made through RCOM’s subsidiary, FLAG Telecom.

August 1, 2007 3
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Service Truly Personalized India Research

Places 5% stake in Tower company with leading institutional investors

RCOM during the quarter made a placement of 5% of its equity stake in its Tower company,
Reliance Telecom Infrastructure (RTIL) to a group of leading institutional investors across Asia,
Europe and the US. The total value of the transaction stood at US $337.5mn (approximately
Rs1,350cr). This implies a total equity valuation of RTIL of a significant Rs27,000cr (US $6.75bn).
Thus, in many ways, this transaction has set a benchmark for the future valuation of tower
companies in India.

The total implied value of RTIL leads to Rs135 per RCOM share, which is over 25% of the current
market price. Going forward, the management is evaluating various options including an IPO of
RTIL and/or strategic sale to unlock value for shareholders. We believe that there is significant
potential in the telecom infrastructure business, given the competitive dynamics and growth
potential of the Indian telecom sector and that this move is likely to unlock significant value for
RCOM shareholders going forward.

Marketshare performance
RCOM recorded a decent performance on the marketshare front this quarter, gaining 24bp over
the period. In terms of net adds, the company’s share stood at 19.6%. RCOM has made a strong
comeback after the subscriber disconnections made in March and going forward, we expect the
company to be one of the key beneficiaries of the Indian telecom growth story.

Exhibit 6: Marketshare trends

(%)
25

20

15

10

0
FY02 FY03 FY04 FY05 FY06 FY07 Q1FY08

Source: Company, COAI, AUSPI, Angel Research

Outlook and Valuation

RCOM has out-performed our Topline estimates by 5.7%, while the out-performance on the
Bottomline front has been a significant 21.3%. EBITDA margins also exceeded our estimates by
42bp. The company’s mobile subscriber base at the end of June has been slightly above our
projections, while ARPUs have also been higher than our estimates.

Going forward, we expect RCOM to record a 35.7% CAGR growth in Topline over FY2007-09E,
while Bottomline CAGR growth is expected to come in at 48.4%. We expect operating leverage to
drive a strong 410bp margin expansion over this period.

At the CMP, the stock trades at 16.4x FY2009E EPS and an EV/subscriber of US $358.2 on our
FY2009E mobile subscriber base. Given the strong growth expected in mobile subscribers and
visibility on various initiatives such as the global listing of FLAG Telecom and hiving off of the tower
business, there remain significant upside triggers for stock price movement. We maintain a Buy
on the stock, with a revised 12-month Target Price of Rs627.

August 1, 2007 4
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Service Truly Personalized India Research

Exhibit 7: Financial performance

Y/E March (Rs cr) FY2008 FY2007 % chg FY2007 % chg
Q1 Q1 (yoy) Q4 (qoq)
Net Revenues 4,248 3,199 32.8 3,874 9.7
Operating Expenditure 2,489 2,060 20.8 2,302 8.2
Operating Profit (EBITDA) 1,758 1,139 54.4 1,572 11.9
Other Income 56 51 8.8 63 (11.9)
Finance Charges (Net) (127) 84 (39)
Depreciation 619 551 12.3 638 (2.9)
Exceptional Items 1 (15) 3
Income before Income Taxes 1,324 540 145.2 1,039 27.4
Tax 103 27 279.6 15 590.4
Net Income 1,221 513 138.1 1,024 19.2
Diluted EPS (Rs) 5.7 4.2 35.1 4.8 16.9
EBITDA Margin (%) 41.4 35.6 40.6
Net Profit Margin (%) 28.7 16.0 26.4
Mobile ARPUs (Rs/user/month) 375.5 379.6 (1.1) 341.3 10.0
Source: Company, Angel Research

TM

Angel Broking Limited

Research Team Tel: 4040 3800 E-mail: research@angelbroking.com Website: www.angeltrade.com

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