Spectrum trading rules could have a short-term marginal respite for RCOM, if 4G entrants find it appropriate to have a short-term coverage and capacity boost as Reliance Communication (RCOM) spectrum holdings in the 850 spectrum band come up for renewal in c5 years. RCOM 850 spectrum can allow 4G entrants to have 10MHz in the attractive 850 spectrum band, allowing them to have both capacity and coverage, which incumbents may find tough to replicate in a few markets. However benefits for 4G entrants will be short term, unless they renew these radio waves as and when they are put to auction. Separately, if the pending RCOM-SSTL merger is approved, 4G new entrants can access an additional 5MHz of spectrum in 850 in eight additional markets, and this could be used for coverage.
However, the spectrum trading arrangements will be complex as they will need to meet several conditions
(a) five-year validity: RCOM spectrum comes up for renewal in five years and, therefore, any sharing or trading arrangements will be short term;
(b) one-time fee: RCOM will need to pay a one-time fee of $400m to get spectrum liberalised before it can trade spectrum in overlapping circles with 4G players;
(c) CDMA is revenue generating: RCOM CDMA spectrum is presently being used for data cards and voice, and RCOM will need to be compensated for the loss in CDMA revenues by 4G entrants over and above the one-time fee. In other words, it is not a pure upside, as RCOM will have to sacrifice present CDMA revenues before it opts for trading the spectrum
(d) regulatory support: RCOM 850 spectrum band is not contiguous in four markets, and 4G entrants don’t have contiguous spectrum in five markets where they own 850. The regulator will need to help to harmonise this spectrum and get it contiguous;
(e) separately, RCOM will need to pay $600m to the government for the SSTL spectrum before it can trade spectrum. Further regulatory support will be required to get this spectrum contiguous and harmonised.
Reiterate Reduce rating with a TP of Rs 55. We believe the upside for RCOM will not be much and, therefore, we are not making any changes to our estimates. Complex short-term spectrum trading arrangement comes with several costs.
We highlight the costs 4G entrants may have to bear to benefit from RCOM 850 via spectrum trading in the short term.
(a) One-time fee to liberalise spectrum: As stated above, RCOM’s present spectrum in most markets is not liberalised, and there is a need to pay a one-time fee of $400m before the spectrum can be used for spectrum trading. Further, RCOM will need to pay $600m to the government for the SSTL spectrum before it can trade this spectrum, assuming the merger goes through. In other words, 4G players will need to compensate RCOM for such regulatory levies to use the RCOM 850 spectrum band.
(b) Compensation for loss in CDMA revenues on subsidised migration: RCOM is using the 850 spectrum band today for voice and data cards, and once the spectrum is deployed for 4G, the 4G entrants will need to compensate RCOM for the loss in CDMA revenues or facilitate the migration of existing RCOM CDMA subscribers to 4G by subsidising devices.
(c) 10MHz spectrum will need fibre backhaul: That is not all; any network with 10MHz of spectrum will have to be backed by investment in fibre backhaul as well. This may not have been the case if it was a mere 5MHz but with 10MHz it becomes mandatory.
(d) Regulatory support to harmonise spectrum: A large part of the spectrum is with both 4G entrants, and RCOM is not contiguous in nature, so regulatory help will be needed to harmonise spectrum. This may take time as such activities require the cooperation of other telcos.
(e) Spectrum comes up for renewal in five years: RCOM spectrum in 850 markets will come up for renewal in five years and it is not necessary that 4G entrants will win the spectrum from auctions. Moreover, the current auction format allows everyone to participate in spectrum auctions and the competition will attempt to be disruptive or make the spectrum expensive for 4G entrants.
(f) Regulatory ambiguity: Present M&A norms suggest a spectrum cap at 10MHz for the 800 spectrum band.
However, the 2015 auction document published by the regulator suggests a spectrum cap as 50% of the total spectrum in the 800 band. We await more regulatory clarity on the issue. The pending RCOM SSTL merger meets the 10MHz rule in all markets but is not meeting the 50% cap in most markets (refer Figure 2).
Conclusion: The complexity of this aforesaid spectrum arrangement makes it expensive and time consuming and will leave little value in hand for 4G players to incentivise RCOM, in our view. Non-cash incentives could be easy, such as allowing RCOM to use the 4G network and allowing RCOM to sell 4G services. Such incentives may not help, as RCOM has been struggling with subscriber traction on one hand and on the other it needs to repay debt and reduce leverage. We don’t see much upside for RCOM in the current format.
How will such complex short-term spectrum sharing arrangement help 4G entrants?
We have been highlighting that 4G entrants need spectrum in the sub-1Ghz spectrum band to offset the coverage issues as in the present form they have too much dependence on the poor quality 2300 spectrum band. Even though temporary in nature, the access to the 850 spectrum band seems to be the only near-term solution available to 4G players, in our view. Access to good quality sub-1GHz spectrum on a long-term basis is not an option today. So, 4G entrants are faced with two options—either launch with a network of around 2,300, which may prevent them to have a good subscriber value proposition, or take a more short-term approach and leverage 850 using spectrum trading. That said, we highlight that access to 850.
Valuation and risks
We continue to value Reliance Communications on a DCF-based sum-of-the-parts approach. For our DCF valuation, we use a cost of equity of 14.5%, a cost of debt of 11% and a WACC of 13.6%, arriving at a fair value of Rs 40 per share for its core operations adjusted for regulatory levies. We value its real estate assets at Rs 15 per share (valuing them at a 20% discount to management estimates) as the company plans to unlock value in its real estate to cut debt. Our valuation leads to an unchanged target price of Rs 55. As this implies downside of c11% to the current share price, we reiterate our Reduce rating.
Key upside risks: ability to monetise non-core assets may allow the company to bring down leverage and will be positive for the stock price. Further approval of the merger with SSTL (which is pending now) may allow RCOM to consolidate spectrum in 800 and raise its ability to monetise overall spectrum holdings and boost near-term earnings.
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