Neeraj Monga of Veritas Investment Research believes various mergers and amalgamations have led to the Rs 22,000 crore 'inflated book equity' of Reliance Communications.
Neeraj Monga of Veritas Investment Research believes various mergers and amalgamations have led to the Rs 22,000 crore “inflated book equity” of Reliance Communications. “The stock is trading at Rs 60. So the market doesn’t really believe in the book value of the company. We’ve just come out and said it very clearly,” he claims.
In its June 8 report, the Canada-based equity research had assigned a value of Rs 15 to the stock of Anil Ambani-promoted telecom firm, citing high debt, "whimsical" accounting policies and poor corporate governance standards as the key reasons.
“We believe there are several governance issues at R-Com,” he told CNBC-TV18 in an interview.
Over the last two years, R-Com has been looking to hive off its telecom towers business in order to bring down debt, but hasn’t been able to conclude a deal so far. “We expect R-Com’s tower deal to happen at not more than 3 million per tower,” Monga says.
He believes the situation in India is grim with respect to telecom tower assets and multi-tenancy is going to become a difficult issue for most tower companies.
In response to the Veritas report, Reliance Communications told CNBC-TV18 that the report "lacked credibility", was "full of factual inaccuracies, baseless allegations masquerading as research" and that Veritas was destroying investor confidence through sensationalism.
Below is an edited transcript of Monga’s interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.
Q: Your report says that you do not believe in the reported book equity of Reliance Communications or their fixed asset base which has been reported. That is a fairly serious allegation, what do you base it on?
A: One of the things which we had discussed previously and we highlight in our current report as well is that a significant proportion of the book equities reported by a company is on account of various mergers and amalgamations that the company has done of subsidiaries, of holding companies. At the end of the day, these are all related parties controlled by the same management and stock and no fair valuation reports are available on these assets.
We believe approximately Rs 22,000 crore over time has been contributed by various schemes of mergers and amalgamations of subsidiaries to the company’s book equity. Over time, the company has also written off some of its cash expenses through these reserves. But basically there are 206 crore shares outstanding in the market place and Rs 22,000 crore of book equity of approximately Rs 100 per share.
I guess this fact is kind of reflected in the company’s current valuation in the market place. The company disclosed the book equity of approximately Rs 174 or thereabout and the stock is trading at Rs 60. So the market doesn’t believe in the book value of this company, we have just come out and said it very clearly.
Q: You have also talked about Reliance Infratel and ascribed a much lower value than what is being talked about. Is that a function of what you see as the real value of the asset or a function of how poor you think the market is and in that Reliance Communications will have a tough time selling this?
A: I think the situation in India is grim with respect to telecom tower asset specifically. With the Supreme Court of India cancelling the licenses of many of the operators in India, clearly multi-tenancy is going to become a difficult issue for most tower companies. With a growing telecommunication business and many companies getting into the business, there have been very few deals which have actually been done between arm’s length parties in order to assess the valuation of these assets.
One of the deals which was done was by SBI Macquarie which bought some assets from an operator at approximately Rs 34 lakh per tower. GTL Infra and Aircel had also undertaken a deal a couple of years ago whereby Aircel had actually agreed to rent 20,000 additional towers from GTL for a period of three years valued at around Rs 30 lakh or thereabouts as well.
Now looking at Reliance, which is now going to lose Etisalat and STel as its tenants on the towers, and given the balance sheet of Reliance Communications itself, any tower buyer will be exposed to a company which is in financial stress. We do not believe that the assets sold for much more than they have been sold in the past in the Indian markets, and that’s approximately Rs 30 lakh a tower.
Q: You are talking about a 50% governance discount on the stock, so your primary concern with this company is corporate governance issues or do you think it just lacks the momentum to perform from hereon in terms of its core business?
A: Clearly the company is having a difficult time in its core business. Most recent press release from Vodafone says that they have also joined Reliance Communication and Bharti Airtel in lowering their price for their 3G services, which is supposed to be the next growth engine for the wireless operators in India where the competitive environment is pretty intense.
The governance discount comes from the whimsical accounting policies that we have discussed in our report. In FY11 for instance the company wrote off approximately Rs 950 crore of advances which was a fine to a supplier. What we failed to understand is how a company can have such poor risk management practices whereby they have advanced monies of Rs 950 crore, which is more than 20% of the EBITDA, to a supplier who failed to deliver. Why isn’t the company initiating actions to undertake this recovery?
Also, when we look at company’s loans and advances, which amount to approximately Rs 7,200 crore of assets on its book, then what is the legitimate reason to believe that any of these loans and advances are ever going to come back. Secondly, why should a company which has approximately Rs 40,000 crore in debt have advances outstanding of Rs 7,000 crore to parties related or unrelated or otherwise. They should call in all these loans and repay their lenders and improve the balance sheet of the company. So we believe there are significant governance issues in this organization and that the management needs to deal with them before we will change our expectation of this company’s performance.
Our valuation of Rs 30 from core operations excludes any other income that the company might be generating because we are not sure what the sources of this other income are. The company has actually drawn down its cash balances during FY12. Right they have approximately Rs 1,400 crore of cash balance, but I would believe that they would need that cash balance in order to ensure liquidity in the business to run operations, so they can’t generate enough other income on that. Also, the company tends to include its other income in its EBITDA, but its cash expenses are written through reserves, and therefore you have to jump through a few hoops to actually figure out the underlying operating trends of this company.
Q: The hope in the market has been that the company will be able to successfully deleverage its balance sheet with the Flag IPO and the Infratel sale. You think the company will be unsuccessful in deleveraging its balance sheet significantly?
A: As far as Flag is concerned, it is interesting because most recently Vodafone bought the business of Cable and Wireless and they are competitive to Flag internationally. Their assets are pretty similar except for the fact that Cable and Wireless also had some legacy work assets in the UK. The multiple that Vodafone paid for that business was around 3.5 times EBITDA and we value Flag at approximately 5 times and give it a 20% premium. We think that is a realistic valuation, although I do not believe that unless the company sells off its entire asset they are even going to get their 5 times EBITDA multiple that brings in approximately USD 891 million enterprise value.
But what is interesting is that Reliance Global Comm has bled the equity of Flag, which is the subsidiary, and raised USD 500 million from banks to fund its operations there or somewhere else. So once that asset is put on the block and goes on sale in the market, then debt at the subsidiary level which has been pledged or equity which has pledged needs to be released. So we don’t see a great possibility for this company to be delisted significantly.
But I think the most important thing to understand is that an asset sale is not going to be value accretive for equity owner unless the assets that are being disposed off in the market place are trading at a discount in the current valuation of the company. But if you look at Reliance Communications valuation from a core business standpoint, it is trading at approximately 8-9 times FY13 core EBITDA already. It is looking to dispose off assets at EBITDA multiples of 5-6, so there is no way there is going to be any value accretion for current equity owners of the business. Anybody who thinks otherwise is going to be wrong over time.The Great Diwali Discount!
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