June 08, 2012

COMMUNICATIONS LTD.
Delayed Release
BSE - RCOM Previous Close: INR 66.15

RELIANCE

A House of Cards

India Research

Neeraj Monga nmonga@veritascorp.com Jaishankar Krishnamurthy jai@veritasaisa.com

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TABLE OF CONTENTS
A House of Cards.................................................................................................................................................. 1 Veritas Recommendation .................................................................................................................................. 3 Financial Statements are Unreliable ................................................................................................................. 3 Revenue and EBITDA Past Untrustworthy, Future Uncertain ...................................................................... 6
Interest Coverage Ratio to Worsen .................................................................................................................. 7 Accounting to the Rescue in the Past .............................................................................................................. 8

Lower Capital Expenditures Compromise Competitive Position ................................................................. 9 Asset Divestiture Valuing Overseas Operations ......................................................................................... 11
Flag Ireland Subsidiary of Flag Telecom Has Qualified Audit Opinion ................................................................ 13 Valuation of Flag Telecom Best Case Estimate ...................................................................................................... 13 Flag IPO will Provide Relief Only to Secured Creditors ............................................................................................. 14

Sale of Tower Assets not Imminent .................................................................................................................. 15

Too Many Sellers on the Block ...................................................................................................................................... 15 Likely Scenario Sale of Partial Stake at a Diminished Valuation of $U.S.2.4 Billion ............................................ 16 Divestiture of Majority Stake in Tower Assets will Result in Lowering EBITDA by 20%............................................. 17 Un-Hedged Exposure Increased Loan Repayment Obligations by Over $U.S.1.02 BN ....................................... 17

Competitive Position is Weak in All Business Segments ............................................................................... 18

Why the Discrepancy in Subscriber Count? ............................................................................................................... 20 RCOM Disadvantaged on GSM Spectrum Holdings ............................................................................................. 22 Lower Revenue from Rural Areas ................................................................................................................................. 22 Difficult to Increase Revenue without Incurring Capex ........................................................................................... 23 3G Adoption Rates are Quite Low; Subscriber Base Less 2% .................................................................................. 23 One Bright Spot: Wireless Broadband is Showing Excellent Growth....................................................................... 23 RILs 4G Plans Pose a Serious Threat to RCom`s Growing Revenue from Wireless Broadband ......................... 24

Global Enterprise Business Unit ......................................................................................................................... 24

NLD Negative Revenue Growth and Market-share ............................................................................................... 24 Acquisition of Yipes Holding: No Headway in ILD or Enterprise Broadband ......................................................... 25 Flag Telecom ................................................................................................................................................................... 25

Conclusion ........................................................................................................................................................... 27 Appendices .................................................................................................................................................. 28-34

Reliance Communications Limited

A HOUSE OF CARDS
Reliance Communications Limited (RCom or the Company) is entering a phase of maximum uncertainty. In our view, macro-economic conditions in India are deteriorating at a rapid rate. Fractured policy making, high inflation, an uncontrollable fiscal deficit, in addition to a hyper-competitive telecommunication business, are highly detrimental to the prospects of RCom. Exceedingly high financial leverage, accompanied with debt repayment obligations of approximately $U.S. 2.2B over the next twenty-four months, at a time when EBITDA in core business operations is stagnating, is a significant challenge for the management team. In order to tide over the cash crunch, we believe that RCom has been scaling back its capital expenditures (capex) and has put assets on the block. However, given the weak competitive position of the Company in the Indian wireless sector, we believe that curtailed capex will be detrimental to the Companys prospects going forward. We believe that RCom is at a disadvantage in terms of its GSM spectrum position in most of its footprint compared to its peers, and to tide over its spectrum deficit the Company needs to incur higher capex to maintain quality of service. RCom has been disproportionally affected by the entry of new players in the market and its ARPU has suffered more than its peers. Some of our findings are as follows: 1. Managements admission of a soft market for tower assets substantiates our assertion that buyers for Indian telecom assets are scarce. We do not foresee any significant improvement in the tower market over the next 12-18 months, given the stampede by all players in the telecommunication tower market in India to monetize assets. Moreover, we estimate that at best the Company can monetize its Reliance Infratel (RIF) tower asset at a diminished value of INR 12,500C ($U.S. 2.36B), compared to rumors in the marketplace ascribing a valuation upwards of INR 22,500C ($U.S. 4.2B). We are also skeptical of the Companys ability to reduce its financial leverage meaningfully by undertaking an IPO of Flag Telecommunication (FLAG), given that equity of Reliance Globalcom Bermuda whose only assets is FLAG as per Federal Communications Commission (FCC) Filings has been pledged by its holding company, Reliance Globalcom BV Netherlands, to secure debt of $U.S. 500M. Therefore, our estimate of Flags enterprise value of $U.S. 891M, leaves very little deleveraging room for the ultimate parent RCom. As reported in the media the Company is planning to off-load a 75% stake in FLAG, for which it will receive $U.S. 668M and those proceeds will be utilized to repay secured debt. We believe that the Companys accounting policies are whimsical and do not provide a clear picture of the underlying operating and business trends. We neither believe in the reported book equity of the Company nor in its reported fixed asset base. Given significant exposure to un-hedged foreign currency denominated loans, we find the risk management and governance practices of the Company sub-optimal. Moreover, the write-off INR
June 8, 2012

Atimeof maximumrisk

Towersalenot imminent

2.

FlagIPOnota Panacea

3.

4.

Reliance Communications Limited

Significantdebt refinanceobligations
950C ($U.S. 179.2M) in F11, which was advanced to a supplier, suggests either incompetence or chicanery. 5. For F12 the Company reported a profit before tax profit of INR 882C ($U.S. 166M), whereas in our normalized estimate we believe the Company incurred loss before tax of INR 1,529C ($U.S. 288M)

Incorporating a 50% governance discount to our approximate equity value of INR 30/share, we value the core business at INR 15/ share, suggesting 77% downside from current levels. The Company has a tendency to report high levels of other income which is not sustainable on a long term basis, given the significant drop in its current cash balance. Furthermore, based on the Companys inclination to book expenses to reserves and include other income in its EBITDA, reported EBITDA is an unreliable indicator of the Companys operating prowess. Therefore we ignore other income in our valuation. RCom is a house of Cards. Since our last report on the Company, the stock is down approximately 32%. We believe there is significant additional downside. SELL.

June 8, 2012

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