Reliance Jio: a worry for both competitors, RIL shareholders

Reliance Jio Infocomm Ltd’s (Reliance Jio’s) commercial launch is still some time away, but incumbents are already nervous. They have been increasing capital expenditure and front-loading investments in preparation for the Reliance Jio threat. Consider Idea Cellular Ltd’s latest spectrum purchase at a fairly high valuation, for instance (http://bit.ly/1OeH0It).

Investors have responded by exiting telecom stocks in droves; shares of Idea and Bharti Airtel Ltd have fallen by 20-24% in the past six months.

At the same time, shareholders of Reliance Industries Ltd (RIL)—Reliance Jio’s holding company—are also a worried lot. RIL’s current share price suggests that investors have built in room for negative surprises from the telecom venture. The response of investors suggests that Reliance Jio’s launch will be a value destroying proposition for the entire industry.

According to Kotak Institutional Equities’ estimates, at current prices, the markets are ascribing an enterprise value/Ebitda (earnings before interest, tax, depreciation and amortization) valuation of only 5.4 times to RIL’s core businesses. “Reliance’s inexpensive valuations reflect investors’ muted expectations from the company’s telecom foray,” Kotak’s energy analyst wrote in a note to clients after the company announced its September quarter results.

Most analysts value RIL’s core refining and petrochemicals businesses at around seven times Ebitda.

Already, Kotak has assigned zero equity value to the telecom business, which means that the ₹ 30,000 crore equity capital invested as on March 2015 is a complete write-off, in its calculations. The fact that the core business continues to trade at relatively low valuations reflects an expectation, at least in some sections of the market, that there is a possibility of more equity investments in the telecom business, which may end up being written off.

It’s worthwhile noting here that Reliance Jio’s balance sheet size as of March 2015 was ₹ 82,000 crore, and this is estimated to have risen to upwards of ₹ 1 trillion. All of this investment is chasing telecom subscribers that are largely interested in high-speed data on wireless devices. As of end-September, there were 104 million such subscribers, using 3G services on mobile devices and dongles. Bharti Airtel, the market leader, had 26.6 million subscribers.

In other words, the size of the addressable market is not all that huge, notwithstanding the fact that this category is growing at around 73% year-on-year. Private companies such as Bharti Airtel launched 3G services nearly five years ago, which shows that adoption has been slow. The response to Airtel’s recent 4G launch, too, appears to be lukewarm.

As a telecom analyst in an institutional brokerage firm puts it, “Making money on the telecom venture will be an uphill task for Reliance.” Even if adoption of 4G services is better than expected in the future and the addressable market grows sizeably, incumbents are in no mood to cede share, as their recent investments show.

Early signs, based on the large investments both Reliance Jio and incumbents are making, show that the battle is likely to be bloody. The message from investors is loud and clear: since June 2010, when RIL announced that it has re-entered the telecom space, RIL shares have fallen by nearly 5%, while the broad market has risen by around 55%.

Sadly, from the point of view of its own shareholders and those of incumbents, RIL has no intention to back off. Telecom investors, it looks like, will have to live with depressed return ratios for some time to come.