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It is India’s largest start-up with billions of dollars of investment on the ground matching that of the current market leader, Bharti Airtel, which is also its biggest potential competitor. However, analysts are worried whether Reliance Jio can justify the top dollar investment in a new venture when most of its existing competitors are struggling with poor profitability and stretched balance sheets even after years of operations.
Reliance Jio, the telecom arm of Reliance Industries (RIL) is set to launch its commercial operations later this year, five years after it won its first airwaves in the 4G spectrum auction in 2010. Since then, Jio has been on a spending spree and has bought additional spectrum in subsequent auctions of airwaves including the latest one early this year. In all, RIL has spent around Rs 34,000 crore in buying airwaves alone in the past five years and a similar amount in putting up a matching pan-India telecom network, which can carry high-speed data as well as voice, according to conservative estimates by various brokerages.
“Reliance Jio has made significant progress in being ready to start services, including physical network infrastructure, systems and processes, sales and distribution network, applications and services and content. Reliance Jio plans to provide seamless 4G services using LTE in 800 MHz, 1800 MHz and 2300 MHz bands through an integrated ecosystem. The combined spectrum footprint across frequency bands that we have, provides significant network capacity and deep coverage to offer differentiated network quality,” says an RIL Jio spokesperson.
According to RIL, globally, LTE launches in 2300 MHz, 1800 MHz and 800 MHz bands including a combination thereof, have been highly successful and there has been exponential growth in the number of customers accessing high-speed digital services. “The capital employed in RIL’s telecom business increased to Rs 52,400 crore as of March 31, 2015 compared to Rs 37,800 crore in March 31, 2014,” says a recent report by Kotak Institutional Equity.
The report noted that this figure excludes Rs 15,000 crore of deferred payments pertaining to the airwaves acquired by the company in February 2014 and March 2015 spectrum auctions.
In the just-concluded spectrum auctions, Jio won a total of 76.75 Mhz of spectrum in the 800/1800 Mhz band for Rs 10,077.50 crore.
Others put an even higher figure to RIL’s exposure in the telecom venture. According to Morgan Stanley, the company has already invested Rs 84,000 crore ($13.5 billion) in its telecom venture, which is expected to grow to Rs 1.2 lakh crore ($19 billion) by FY17, accounting for nearly a fifth of RIL’s consolidated capex in that year. Motilal Oswal puts the figure at around Rs 85,000 crore, making it the most capitalised telecom operator in the country.
Jio’s investment in spectrum and networks now exceeds that of Idea Cellular and Reliance Communications, the third and sixth largest mobile operators by revenue share, and comparable to Bharti Airtel’s. For example, at the end of December 2014, Idea’s total capital employed was around Rs 60,000 crore. The corresponding figure for Bharti Airtel India mobile business and Reliance Communication mobile business was around Rs 80,000 crore and Rs 67,000 crore, respectively.
Thanks to its parent’s deep pockets, Jio now has the second largest portfolio of spectrum after Bharti Airtel and ahead of incumbents such as Vodafone, Idea, Reliance Communication and Tata Teleservices. According to calculations by Morgan Stanley Research, after 2015 auctions, Reliance Jio holds 376 Mhz of spectrum across three bands, behind Bharti Airtel’s 485 Mhz and ahead of Vodafone (301 Mhz) and Idea (276 Mhz). Reliance Jio claims to own the largest chunk of liberalised spectrum – not linked to any specific technology.
The big difference is that the incumbents invested over the years and have already recovered a significant chunk of their past investment through depreciation allowances. For example, Bharti Airtel, Idea Cellular and Reliance Communications have already recovered 50 per cent, 40 per cent and 38 per cent, respectively, on their cumulative capex by the end of March 2014. Jio will start recovering its investment only when it commences commercial operations. Given its larger balance sheet, the amortisation would be a big drag on its profitability and return ratios.
Analysts say Jio will need a large customer base to recover the record capex. “Our working shows that Reliance Jio will require at least 20 per cent market share (in terms of revenue) within three years of launch to justify its large investment in the mobile venture,” says a telecom analyst on condition of anonymity.
This looks a tall order given the struggles that incumbents have gone through. So far, only two operators — Bharti Airtel and Vodafone — have been able to cross this threshold. At the end of December 2014 quarter, Bharti Airtel had a 30.1 per cent revenue share in the mobile business while Vodafone controls another 20.9 per cent.
Idea Cellular, the fastest growing operator in recent years, accounts for only 15 per cent of industry revenues. The company reported return on capital employed of 7.1 per cent in FY14 and 8.7 per cent in the December 2014 quarter, which is lower than the cost of capital despite doubling its revenue share in the past five years.
Obviously, analysts and brokerages remain unsure about Jio’s contribution to RIL’s incremental revenues and profits in the near to mid-term. In his recent report, Prakash Joshi of IDFC Securities just assigned a value of Rs 20 a share to RIL’s telecom business, less than two per cent of RIL’s total sum-of- parts valuation of Rs 1,069 apiece. In comparison, Jio accounted for 15-17 per cent of RIL’s consolidated capital employed at the end of March 2015 quarter.
Morgan Stanley, which seems to be most bullish on Jio, expects the company to grab 12 per cent revenue share of the total wireless market in the third year of its launch. This will translate into the company posting revenues of around Rs 34,000 crore in FY18 at the current rupee-dollar exchange rate and estimated wireless market growth during the period. It will yield Jio an operating profit of around Rs 11,500 crore (based on Idea’s current margins) or less than 10 per cent of its estimated capex by FY18. At this level, the company might post a net loss after accounting for interest, depreciation and amortisation.
According to analysts, the poor earnings visibility of the telecom venture has played a role in RIL’s under performance on Dalal Street in the past five years.
When RIL chairman Mukesh Ambani rises to speak at the company’s forthcoming annual general meeting, he will have a lot to answer to anxious investors.
