Reliance Communications Plunges Over Veritas Research Report

Reliance communications (RCom) has tanked 6% as investors are selling the stocks on the latest report of Canada based Equity research company Veritas. We at DSIJ had already said the same in our magazine Dalal Street Investment Journal (Vol XXVII, No. 5, dated 26, 2012). We had said that the counter will keep underperforming as its financial performance is not satisfactory. Besides company is also facing several issues like high debt, lower ARPU, unhealthy cash flows etc which will are negative on the stock of the company.

The research firm has gone few steps ahead and has called the company as a ‘House of Cards’. It has said that company is entering in the phase of maximum uncertainty as macro economic conditions in the country are deteriorating rapidly.

Veritas has also said that it has highly leveraged balance sheet and in next two years it has a debt obligation of USD 2.2 billion. This looks very negative for the company which is seeing erosion of the EBITDA margins. Besides in the very competitive Indian telecom market, RCom has lowered its capex which will be detrimental for the company. Following are the key points mentioned by the research firm.

1. Veritas is bearish on the telecom tower market in next 12-18 months and has said that RCom at the best can only monetize its Reliance Infratel tower assets at the value of Rs 12500 crore against the rumored valuation in the market of Rs 22500 crore. (We were also of the same opinion).
2. Reliance communication has received an approval to list its subsea telecommunications infrastructure network business ‘Flag Telecommunications’ in Singapore. Veritas is skeptical of the ability of RCom to deleverage the balance sheet. The rational that it has given is that the assets in Flag Telecommunications have already been pledged by the holding company in Netherlands to secure the debt of USD 500 million. RCom may use the IPO proceeds to repay this secured debt giving little scope to deleverage it consolidated balance sheet.
3. Besides its Veritas has alleged RCom for having unusual accounting policies.
4. Company has a mammoth debt of over Rs 30000 crore most of which is in US dollars. Company has significant un-hedged exposure to these loans indicating sub-optimal risk management policies. Recently company has written off amount of Rs 950 crore advanced to supplier indicating incompetence of chicanery.
5. In the last rationale Veritas said that company would have made a loss of Rs 1529 crore against reported profit of Rs 882 crore for the year FY12.

By considering all these factors, Veritas has valued its shares at Rs 15/share giving nearly 76% discount to its current market price. Our view on the stock has not changed as the telecom sector remains highly competitive. The report by Veritas Investment Research reaffirms our original call to Sell / avoid the stock.