Is investment in Reliance Communications a good bet?

Demerger of Reliance Property may not be a good idea

Reliance Communication  is shedding weight, resulting in the stock price moving higher. The stock has delivered one of the biggest returns in recent times. The stock has gained almost 200%, in a matter of only one quarter.

From a low of Rs 50.20 on March 26, 2013, the stock has touched a high of Rs 148.35 today (July 8, 2013).Ironically,this has come at a time when the broad indices have been very volatile and its peer group stocks have delivered comparatively flattish returns.

A series of measures announced by the company has resulted in a strong move for the stock. Being pushed to the wall, the company had little option but to shed weight so that it could reduce its huge debt burden of nearly Rs 40,000 cr.

Having failed to sell its tower infrastructure company despite repeated attempts due to poor market conditions and valuation related differences, It then did the next best thing it could.

RCom entered into a long term lease arrangement with Reliance Industries who are planning a roll-out of its 4G network.By collected the lease rentals in advance, RCom has managed to reduce its external commercial borrowings by nearly $1 billion.

The company has also announced that it would be selling a sizeable stake in Flag undersea cable asset  and its Direct to Home venture.

Just when everything seems to be going right for the company, Reliance Communication seems to have committed a mistake. The company announced that it is spinning its real-estate assets into a separate company. The company announced on Sunday that its board has cleared a proposal to create a company called Reliance Properties to unlock value. RCom seems to be again playing the market capitalisation game by creating different entities and looking at a sum-of-part valuation. However, in the long run it might not add too much value to the RCom shareholders.

Consider this-Reliance Communication currently operates from these real estate properties, at least in Mumbai and Delhi. By hiving off the property to a separate company,Reliance Communication will have to pay a rental to the property company. For those investors who do not want to be a part of Reliance Properties, this would be an additional expense.

Further, there is no clarity on how much debt will be transferred to Reliance Properties.Chances are that most of the debt will remain in the books of RCom while substantial amount of assets will go into the new company.

And what may hurt the investors more is the possibility of the latest move not resulting in any debt reduction for RCom.By creating a new company and transferring the real estate assets, RCom shareholders  would only get shares of Reliance Properties.

Only if RCom dilutes its stake in Reliance Properties, will it be able to bring down its debt. It is unlikely that the promoters would be interested in reducing their stake in the real estate company. This deal is clearly meant to improve the stock price of RCom in the short term and post better valuations, but in the end it will fundamentally weaken the telecom company.