Bharti Airtel vs Reliance Communications - The race is on

Ashok Jain, 50, Chairman And Managing Director, Arihant Capital Market, a listed stock broking firm, prefers the Reliance Communications stock compared to that of Bharti Airtel. And why not? In the current financial year (till November 19, 2007), Reliance Communications has posted the biggest gains among telecom stocks, rising 69 per cent against 19 per cent by Bharti Airtel. The average for telecom companies is 54 per cent.

Until last fortnight, Reliance Communications was the only telecom stock in Jain’s portfolio. However on November 2, 2007, when the gap in market capitalisation of the two companies narrowed down to about Rs 8,500, Jain bought 1,000 shares of Bharti Airtel. “But, I still prefer Reliance Communications to Bharti Airtel because of its aggressive promoter and the fact that compared to its peers, it has superior distribution and infrastructure reach.” What clinches the argument for Jain is that Reliance Communications is unlocking the value in its tower and the undersea cable businesses.

“Unlocking of value from the tower businesses of both companies and the listing of (submarine cable company) Flag Telecom are the triggers for the stocks. Growth in the sector will continue unabated over the next two years,” says Jain.

Bharti Airtel and Reliance Communications, which together account for 42 per cent of total cellular subscribers in India, are the primary drivers of the sector's impressive performance on the bourses.

Consequently, both have improved their ranking on the BT 500 list; Bharti Airtel has jumped to #2 in the pecking order from #4 last year, while Reliance Communications climbed three places to #6. Barring Reliance Industries, which maintained its numero uno position, Bharti Airtel and Reliance Communications have gained the most in absolute terms.

For the first half of this financial year, the average M-cap of Bharti Airtel surged 114 per cent, or Rs 85,621 crore, to Rs 1.60 lakh crore compared to Rs 75,121.5 crore in the comparable period last year.

Similarly, the M-cap of Reliance Communications surged 181 per cent, or Rs 67,480 crore, to Rs 1.05 lakh crore from Rs 37,206 crore. But the gap in their M-caps has been narrowing as the Reliance Communications share gallops faster than Bharti Airtel (see Playing Catch Up).

Advantage Reliance

Says Shriram Iyer, Head (Research), Edelweiss Securities: “The recent rally in the Reliance Communications stock is driven by its intention of launching GSM services within one year of receiving spectrum.”

The company enjoys a market share of nearly 18 per cent, but in circles where the company provides both CDMA (Code Division Multiple Access) and GSM (Global System of Mobile Communication) services, this rises to 30 per cent.

Although the seven circles where it has dual services are small, the market expects Reliance Communications to significantly improve market share once it launches GSM operations.

The proposed new regulatory measures tightening subscriber-linked criteria for spectrum allocation, increasing annual spectrum usage charges, permitting dual technology under USAL (Unified Access Service Licence) and mobile number portability have also been positive for Reliance Communications and negative for existing GSM operators; these have also helped the Reliance Communications stock.

The Numbers Game

So, can R-Comm topple Bharti Airtel in M-cap and market share? In terms of financials and market share, Anil Ambani’s company still has some catching up to do with Sunil Bharti Mittal’s flagship. For the first half ended September 30, 2007, Bharti Airtel reported an 85 per cent rise in net profit to Rs 3,125.5 crore (Rs 1,688.7 crore) on a 49 per cent jump in net sales to Rs 12,242 crore (Rs 8,213 crore).

Reliance Communications, on the other hand, posted a 108 per cent jump in net profit to Rs 2,525.6 crore (Rs 1,215.4 crore) on a 31 per cent increase in net sales to Rs 8,882.5 crore (Rs 6,776 crore). Interestingly, both had operating profit margins of 28 per cent.

FAQs

Can Reliance Communications overtake Bharti Airtel’s M-cap? Both companies are unlocking their tower businesses, and this will provide the trigger for the expected upsurge in their stocks. Here, Bharti Airtel, which is the world’s biggest player in the tower business, with 50,000 towers, has a clear edge. So, despite Reliance Communications’ superiority in the undersea cable business and its imminent rollout of GSM operations across India, it still seems to have a lot of catching up to do. Are valuations overstretched in the telecom sector? Analysts are divided on this. Some, like Quantum MF feel that the sector offers little scope for future appreciation. But others cite future growth potential and say that telecom stocks, though expensive, still offer good upside potential. Is there scope for further consolidation in the industry? Analysts feel Reliance Communications lost its chance to acquire stake in Hutch, which could have given its customer base a huge boost, and the company an edge over Bharti Airtel. At current valuations, a consolidation seems highly unlikely as players who may be up for grabs are too insignificant in size. Can the share of the value-added services in the pie increase? Value-added services and non-mobility business will be big and are already contributing over one-third of the total revenues of Bharti Airtel and Reliance Communications. The value-added business will focus on select and niche audiences, which will drive higher margins due to higher ARPUs, but this business will still take another three-to-five years to reach critical mass.

The wireless business accounts for a lion’s share of revenues at both companies. In the case of Bharti Airtel, it makes up nearly 71 per cent of revenues, while for R-Comm, the figure is 66 per cent. Says Akhil Gupta, Joint Managing Director, Bharti Airtel: “It’s purely a volumes game and our focus (in the mobile business) continues to be on revenues that will help increase our market share and widen the leadership gap between us and our competitors.” R-Comm executives did not respond to phone calls and e-mails from BT.

Till October 2007, Bharti Airtel, with 51 million subscribers, had a 24 per cent share of the 213-million subscriber market in India. The comparable figures for Reliance Communications are 37.8 million subscribers and 17.8 per cent market share.

 Says Gupta: “In a scenario were ARPUs (average revenue per user) are moving south, volumes growth is the only way to grow. Most estimates say that the total subscriber base will double from 213 million to more than 400 million by 2010. However, we estimate that it will grow to 450-500 million.”

Why then, in such a scenario of robust growth, are fund houses like DBS Chola Mutual Fund and Quantum Mutual Fund booking profits in telecom stocks. Interestingly, Quantum Mutual Fund has completely exited the sector. Says R. Rajagopal, Chief Investment Officer, DBS Chola Mutual Fund: “We are still overweight on the sector.” Adds I.V. Subramanian, Director, Quantum Advisors: “Fundamentally, there is inherent strength in the sector, but valuations are expensive.

The market is giving it higher multiples based on future growth potential. But at current levels, there isn’t any value in these stocks.” That may well be true. Bharti Airtel and Reliance Communications are trading at P-Es of 42 and 38, respectively. The average P-E of their Asian peers is 28.

Bharti Ahead

Says Iyer: “A lot depends on the unlocking of value following the disinvestment of the tower businesses of both companies. This will act as the trigger for the stocks.” Agrees Gupta: “We will hive off our tower business and operate it as a separate unit. This will unlock significant value.” And here, Bharti Airtel enjoys a decisive advantage over its rival—an advantage that almost nullifies all the other benefits that R-Comm expects to generate by entering the GSM space as well the regulatory advantages it currently enjoys. Bharti Airtel is the world’s biggest player in the towers business, and its 50,000 towers give it an edge over all others.

Currently, the company’s network is present in 4,876 census towns and 290,000 non-census towns and villages, covering 65 per cent of the country’s population. Reliance Communications currently has 14,000 towers and its network covers 10,000 towns and 300,000 villages, thus, covering 54 per cent of the population.

But it has announced that it will add another 23,000 towers to its network by the end of the year, giving it a footprint covering 27,000 towns and 600,000 villages, and effectively reaching over 90 per cent of the country’s population. Despite this, consumer preference for GSM services gives Bharti Airtel a decisive advantage which R-Comm is trying to negate by entering the space, but it will take time for it to match its rival. It also plans to list its undersea cable business, Flag Telecom, on the London Stock Exchange. Both Bharti Airtel and R-Comm are also planning to get into other value added businesses like DTH and IPTV.

Says Subramanian: “Despite all these—the unlocking of value from their tower businesses, their entry into other value-added businesses like DTH and IPTV and the listing of Reliance Communications’ undersea cable business triggering an expected spurt in the value of the stock—the shares of both the companies are currently overvalued on fundamentals. Then, it will take a minimum of three-to-five years for the value-added businesses to attain critical mass.” Analysts and investors are, therefore, concerned about margins. Will the companies be able to maintain their margins in a scenario where they continue to spend massive amounts on capital expenditure on the one hand and face low incremental ARPUs on the other? “We are value investors and we will find value in telecom stocks only at P-Es of around 20 times earning,” he adds.

So, what does the future hold for the two companies, both of which are led by relatively young, dynamic and ambitious promoters? The consensus among analysts that BT spoke to was that though Reliance Communications does enjoy superiority in the undersea cable business and even though its imminent rollout of GSM operations across India will give it some momentum, it still has a lot of catching up to do with Bharti Airtel.

That means Mittal’s crown as India’s telecom king, though under attack, is likely to stay with him for some more time.