Call lost for Reliance Communications

Efforts of Reliance Communications (RCom) to contain its mounting debt suffered a setback with the scrapping of a proposed deal to merge its passive infrastructure arm with GTL Infrastructure Ltd.

The deal has been cancelled as the non-binding agreement entered into by the two companies in the last week of June expired on August 31 in the absence of further extension by either party.
At the end of the first quarter, RCom’s net debt stood at Rs28,481 crore, mainly because of the huge outgo on 3G and BWA spectrum auctions.

As a result, its net debt to annualised earnings before interest, tax, depreciation and amortisation ratio has increased to over 4, significantly above those of its peers Idea and Bharti, both of which have leverage close to 3 times.

The deal would have helped RCom get cash of Rs18,000 crore, thereby improving its leverage ratio.

However, the management has not given up and is now in discussion with other strategic and financial investors for sale of stake in the tower business. Also, it is considering an IPO for Reliance Infratel (Rtel), its passive infrastructure arm.

But analysts are less optimistic on the same as the cancellation of the deal with GTL could hamper Rtel’s valuations.

“We think failure to consummate the transaction with GTL Infra will likely revive investor concerns about the seriousness of RCom’s balance sheet deleveraging plans. RCom’s tower monetisation plans via IPO and mergers and acquisitions appear to be fraught with execution and valuation risks. Based on our interactions with GTL Infra, it seems unlikely to us that deal-financing was a major bottleneck.” said Reena Verma Bhasin, CFA and research analyst at Bank of America-Merrill Lynch.

Analysts do not rule out the two parties resuming discussions, with revised terms. However, they have lowered the valuations of Rtel.

The deal may also lead to RCom toning down its aggressive stance once mobile number portability gets implemented in November 2010. “The risks of increase in competitive dynamics in 2G/3G market led by an “aggressive RCom” (had the deal gone through) have now been mitigated,” Sachin Salgaonkar, Piyush Mubayi and Paras Mehta, analysts at Goldman Sachs, wrote in their event update of September 6.

RCom’s hopes of deleveraging its balance sheet now rest on its 26% strategic equity stake sale plans, but that too is uncertain at this point in time.

The company’s shares have been under pressure post the dismal first-quarter results with consolidated net income from operations dropping 13.25% to Rs5,068.50 crore and net profit plunging almost 85% to Rs250.90 crore.

Shares of RCom, which went past Rs200 on June 28, after the GTL deal announcement, have since lost 19% and closed Monday almost flat at Rs162.90. Most analysts are underweight on the stock post this event.