Reliance accepts need for deleveraging pain

June 8, 2010

Reliance Communications  is facing up to reality in its attempts to deleverage. The mooted sale of a 26 percent stake in India’s second largest telecom operator could raise almost $2 billion and halve net debt. But with current market valuations a long way from their peak, it must have been painful for Reliance’s board to give the green light for a strategic investor to come in.

The group is the only one of the top Indian operators without a foreign partner experienced in rolling out next generation networks. It was also the late to India’s telecoms boom, and racked up debts trying to catch up. In May, Reliance agreed to pay $1.8 billion for third generation licences in an auction where prices exceeded analysts’ highest expectations. Meanwhile, fierce competition has driven down Reliance’s EBITDA margin by over four percentage points to 35 percent in the last year. Fitch estimates Reliance’s net debt to rise from 2.5 times EBITDA last year to 3.9 times by the end of 2010.

Abu Dhabi’s Etisalat or South Africa’s MTN are possible buyers of a stake in Reliance. Such a deal would bring Reliance needed industry expertise. The proceeds from a stake sale could cut net debt down to 1.3 times EBITDA. That multiple could fall further if Reliance continues with plans to sell 10 percent of its towers business in an initial public offering, which analysts say could raise up to $1 billion.

Reliance would have pocketed four times more cash from a stake sale at the start of 2008 when the market was less competitive and regulatory hurdles to consolidation looked less daunting. These days, Reliance looks cheap, trading on a forward price-to-earnings multiple of barely 12 times — an 8 percent discount to the sector, according Reuters estimates.

The lowly valuation looks deserved. Any new investor will remain a minority to billionaire tycoon Anil Ambani, who owns 68 percent of the group. The resolution of a business feud with his older brother Mukesh may make it easier to sell a stake, but any outside investor will still worry about a revival of fraternal hostility. Reliance is doing the right thing by seeking outside help — but will pay dearly for having taken so long to do so.

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