>RELIANCE COMMUNICATION LIMITED (MERRILL LYNCH)

■ Cutting rating and PO to Rs185 on 2Q disappointment
We downgrade Reliance Com from Neutral to Underperform on disappointing 2Q results and consequent 14-17% EBITDA cut for FY10-11E. 2Q FY10 EBITDA came 17% below our expectations, but profit was 15% higher, as depreciation and tax accounting boosted PAT. The EBITDA miss was led by wireless, and we expect the pressure on margins to continue.

Struggle on earnings visibility resumes

■ Surprise factors knock down wireless revenues & margins
In 2Q FY10, RCom’s wireless ARPU fell 23% QoQ vs. a 9-10% QoQ fall for other majors, and EBITDA margin fell ~580bps QoQ versus a 110-140bps fall for other majors. On its earnings call, RCom indicated that the revenue hit was owing to: 1) change in accounting for handset revenues, 2) lower rural (DEL) rollouts and, hence, lower subsidy income, and 3) lower VAS revenues. Wireless margins were hurt by sharply higher network expenses (+15% QoQ) and higher SG&A. Both the revenue & EBITDA factors appear to be company-specific, leading to our
discomfort on earnings visibility.

■ “Simply Reliance” tariffs make strong margin uplift unlikely
RCom’s 2Q revenue per minute, at ~47p, ranks lowest among the listed majors, suggesting limited downside from the recently introduced “simply Reliance” tariff plan that implies an rpm of ~35p. Our estimates factor relatively modest margin decline (~60-110bps) going forward, but any strong margin uplift seems unlikely. Stock valuations are unattractive; Bharti is preferred pick RCom currently trades at a PE of 15x FY11E and EV/EBITDA of ~8x FY11E; these valuations imply a premium of 10-25% versus Bharti (Buy, Rs292.85). We expect RCom to underperform, as low consistency of company-level performance will add to industry-level risks due to heightened tariff competition.

To read the full report: RELIANCE COMMUNICATION