What will a Reliance Jio IPO mean for RIL, telco valuations?
Until early this year, there were not many takers for the Reliance Jio story. In January, analysts at Bank of America Merrill Lynch and CLSA pointed out that parent company Reliance Industries Ltd’s (RIL’s) shares were pricing in zero to even negative equity value for its telecom subsidiary.
But things were about to change soon. RIL had a rerating of sorts starting mid-February, after it announced that Reliance Jio will start charging subscribers.
Now, analysts at Jefferies India Pvt. Ltd point out, Reliance Jio is valued even higher than industry leader Bharti Airtel Ltd. They wrote in a note to clients last week that Jio’s implied enterprise value (EV) is $46 billion according to its estimates, or 15% higher than its estimate of Airtel’s India wireless EV. An analyst at another multinational brokerage firm concurs that Jio is being valued at a premium, albeit to a slightly lesser extent.
So while RIL has downplayed a Bloomberg report about plans for a Jio IPO (initial public offering) as speculation, the time seems ripe for a share sale. The report suggests the offering could hit the Street by late 2018 or early 2019, by which time investors will have better clarity about Jio’s inroads in the feature phone segment and non-wireless businesses such as broadband. If investors can see more revenue streams, valuations could reach far higher levels.
But what about the uncomfortable truth that Jio is already being valued at a 10-15% premium to Airtel despite being much smaller in size? Not only does Jio have a considerably lower market share than Airtel, it also continues to burn billions of dollars, with revenues lagging its operating and capital expenditure by a huge margin. In the September quarter, the shortfall was close to $1 billion. Cash burn at Airtel’s India wireless business was far lower at $300 million. To say that investors are pricing a fair degree of optimism about Jio’s future is an understatement.
Right now, Jio’s valuation is somewhat hidden. Will an IPO bring about a reality check, with investors realizing that a premium to Airtel may not be justified?
That is unlikely. A far more likely outcome is that telcos such as Bharti Airtel and Idea Cellular Ltd will get rerated on the back of euphoria that typically surrounds a mega IPO. Some analysts and investors are already justifying Jio’s high valuation, saying it doesn’t deserve to be valued as a mere telco. In their books, firms such as Tencent Holdings Ltd which provide value-added internet services are better for comparison purposes, on the belief that Jio will be able to monetize content and other offerings to its subscriber base.
Such theories will gather much more steam closer to an IPO. There’s little reason why peers such as Airtel wouldn’t be able to follow suit, which means they too would start getting valued as providers of value-added internet services.
Whether all of this plays out as bullish investors expect is another matter altogether. Jefferies India’s analysts, with bullish estimates of a doubling of Arpu (average revenue per user), a 2.5 times jump in subscriber base and a 63% Ebitda (earnings before interest, tax, depreciation and amortization) margin arrive at an Ebitda of $8.2 billion for Jio in fiscal year 2022 (FY22). They also point out that the aggregate Ebitda of Bharti, Idea and Vodafone India Ltd peaked at $7.4 billion in FY16. To expect Jio to alone make over $8 billion in Ebitda is “a leap of faith presuming vastly improved industry dynamics”, they say in a note to clients.
But that’s not all. Jio’s Ebitda ideally should reach $12 billion to justify RIL’s current valuations and price in a 15% annual return between now and FY22, according to Jefferies India.
This isn’t the first time RIL’s shares have rallied sharply on hugely optimistic expectations. They rose fivefold between 2004 and 2007, a period which included another unlocking story—the IPO of Reliance Petroleum Ltd. Jefferies India analysts say the rally was driven by “unbridled optimism on E&P, expectations of rapid value creation in organised retail, sustained double-digit refining margins and large potential upsides from infrastructure”. E&P is exploration and production.
But here’s the nub: “It took Reliance’s shares seven years to recover after these expectations began to reset from 2008. E&P proved geologically challenging, organised retail proved tough to scale up quickly and profitably, the infrastructure plans were put on the backburner and refining margins fell as the financial crisis took hold,” they add.
Optimism on Jio has helped RIL shares partly overcome years of underperformance; but by rising too fast, too soon, it may also set it up another long patch of underperformance.