Reliance Communications Ltd (R-Com) is acquiring Sistema Shyam Teleservices Ltd’s wireless business for equity worth Rs.2,100 crore. It has also committed to paying Sistema’s liabilities to the government, the present value of which is Rs.2,400 crore.
These look like extremely high valuations for Sistema’s loss-making operations, and the deal will only make sense if R-Com can monetize the spectrum assets through a favourable arrangement with Reliance Jio Infocomm Ltd.
R-Com has paid three times Sistema’s annual revenues of Rs.1,500 crore. This is much higher than Bharti Airtel Ltd and Idea Cellular Ltd’s enterprise value to sales valuation of around 2.2 times. While these companies have operating profit margins of over 30%, Sistema reported operating losses were well over 30% of its revenues.
Even if R-Com extracts all synergies possible and improves Sistema’s operating profit to 30%—a far cry—the valuation still looks unpalatable at 10 times, far higher than 6-7 times EV/Ebitda valuation of incumbents. Ebitda stands for earnings before interest, taxes, depreciation and amortization.
But Sistema holds 800 mega Hertz (MHz) spectrum in eight key circles, which can be extremely valuable for Reliance Jio. It will help in launching its LTE services, including voice over LTE, with much wider coverage, vis-a-vis spectrum in higher frequency bands.
Analysts at Kotak Institutional Equities said in a note to clients, “We see this transaction as just a precursor to a much larger transaction involving R-Com and R-Jio. We note that there is very little circle overlap between the ‘liberalized’ 800MHz spectrum holdings of R-Jio and MTS (Sistema).” Of the 10 circles in which Reliance Jio has 800MHz spectrum, six are in so-called C-level circles, which are the least lucrative in terms of revenue potential. Sistema holds spectrum in lucrative circles such as Delhi, Gujarat, Tamil Nadu, Karnataka and Kolkata.
Based on the discovered prices in this year’s auction (and using the reserve price in circles where there weren’t any bids), Sistema’s spectrum in these eight circles is worth Rs.7,955 crore. Not all of this will necessarily flow into R-Com’s books, even if Reliance Jio agrees to the price.
This is because the government’s spectrum-trading guidelines includes a clause that states that for any spectrum acquired in the March 2013 auction (such as Sistema’s), trading will be permitted only if the price differential vis-a-vis the latest auction price is paid. The spectrum was acquired for Rs.3,639 crore, which means a differential of Rs.4,316 crore will need to be paid before this spectrum can be traded.
Sistema has challenged this clause in the courts, and if it wins, R-Com will make it an additional payment of $300 million (approximately Rs.2,000 crore), according to a Sistema spokesman. R-Com’s statement states, “An appropriate payment/earn-out mechanism has been agreed in relation to disputed spectrum contiguity charges claimed by DoT.” On the other hand, if the department of telecom’s claim is upheld, Sistema will bear no liability. In either case, R-Com can only hope to recoup these additional costs when it sells the spectrum eventually to Reliance-Jio.
All told, much depends on the outcome of this case. More depends on how much Reliance Jio is willing to cough up for spectrum in these eight circles. Doubtless, it will seek to tweak its outgo depending on R-Com’s effective cost.
R-Com chairman Anil Ambani’s comments at the company’s annual meeting suggested that a deal with Reliance-Jio is imminent. R-Com’s market capitalization has risen by Rs.4,400 crore since then. It’s doubtful Reliance-Jio will leave so much on the table, especially considering the fact that its capex has already reached unusually high levels. Investors should tone down their expectations.
The writer does not own shares in the above-mentioned companies.
Reliance Group companies have sued HT Media Ltd, Mint’s publisher, and nine others in the Bombay High court over a 2 October 2014 front-page story that they have disputed. HT Media is contesting the case.