Q 1. What is the business strategy that RCom should adopt?

Short term strategy:

Since RCom had a negative net income in 2017, and negative cash flows due to high interest obligations, the first and most important strategy that RCom should adopt is to reduce the debt on its books. Reducing debt would help it to at least survive in the short term because interest obligations would be reduced. It could adopt the following strategies of reducing debt in the short term:

a) Reliance Communications can hive off the wireless telephony business and merge it with Aircel which will reduce its debt by around Rs 14,000 Cr.

b) Sale of majority stake in the telecom tower business to Canadian Private Equity Fund Brookfield. This will reduce the debt by around 11,000 Cr. RCOM will retain minority interest in the tower business with a stake of approximately 49%

c) RCOM can also sell stake in its international undersea cable arm Global Cloud Exchange (GCX). It is predicted to reduce the debt by Rs 1,000 Cr.

d) Waiver of interest and principal payments till September 2017 of loans of about $1 billion (Rs 6,300 crore) by the following Chinese lenders:

(i) China Development bank

(ii) Industrial and Commercial Bank of China

(iii) Export and Import Bank of China

All these steps are expected to bring down its debt by 60%

The company’s credit rating has been reduced to Ca by Moody’s. Ca rating in India has an approximately 5.5% spread over 10 year government bond yield.

Therefore, Cost of debt = 6.44% + 5.5%= 11.94%

After reducing their debt, we assume that their credit rating would increase to Baa3. Baa3 rating in India has a 2.54% spread over 10 government bond yield.

New Cost of debt= 6.44%+ 2.54%= 8.98%

Existing Debt ( in Rs Cr)

44,585

Interest expense @ 11.94% (in Rs Cr)

5,323

D/E

7.70

Debt after reduction (in Rs Cr)

17,834

Interest expense @ 8.98% (in Rs Cr)

1601

New D/E

3.08

The calculations have been shown in the excel

All these strategies are expected to bring change in financial statements of Q4 as deals are expected to be completed by the end of Q3 or starting of Q4

Long term strategy:

1. Saving on Capital Expenditure – As RCom already has a deal in place with Reliance Jio to share 1,00,000 towers, it would end up saving on taking debt to build towers which other companies would have to do to match Jio’s onslaught.

Cost of 1 tower = Rs 70,00,000

Cost of 1,00,000 towers (in Rs Cr)= 70,000

Saving in costs (in Rs Cr) = 70,000

2. Cost saving and increase in revenue due to merger with Aircel- RCom currently has validity till 2022 inn 800 MHz spectrum. Due to merger with excel, the validity is going to extend till 2033. This will lead to cost savings RCom wouldn’t have to spend to renew spectrum license.

Total savings= Rs 4000 Cr

Due to this merger, the combined user base of new entity would be around 180 million. At an ARPU of 157, this entity would produce an additional revenue of 2826 crore

3. Growth in subscriber base or ARPU through additional schemes- RCom is looking at adapting a three-pronged approach to protect and grow their subscriber base. RCom’s ARPU of Rs 157 is on par with that of the market leader, Bharti Airtel while it is higher than that of Vodafone and Idea. Therefore, it is imperative for RCom to focus on subscriber growth to boost overall profitability. Therefore, RCom can adopt the following:

●          Unlimited Voice

RCom is proposing a Rs 149 pack with unlimited voice over IP (VoIP) calling and 300 MB 4G data targeting their predominant voice customers.

●          Discounted Tariff

RCom is proposing a Rs 19 pack with 20 paise/min tariffs and 500 MB data that is targeting the rural subscribers and migrants

●          Aggressive 4G Data

RCom is proposing a Rs 99 pack that provides 1GB 4G data and a voice tariff of 20 paise/min targeting the urban subscribers and the youth

Calculations have been shown in excel

 

 

Q2. How should it restructure its capital to survive?

Reliance communication has a debt of Rs 44,585 Crore in its books, leading to a Debt/Equity ratio of 7.70, against an industry average of 3.26. Due to such a huge amount of interest obligations and falling revenue, Reliance Communications has defaulted on its loan servicing obligations with more than 10 local banks. These banks have also put the telecom operator in “either SMA1 or SMA2 category. Moody’s has downgraded its rating to Ca level. Lenders have given a moratorium till December 2017. If it is not able to pay loans by then, lenders will exercise their right to convert the debt.

It can reduce its debt by doing the following the things mentioned in Question 1, which will reduce its cost of debt and D/E ratio.

Based on Current Capital Structure:

Debt (in Rs Cr.)

44,585.60

Equity (in Rs Cr.)

5,786.88

Beta

1.63

Cost of equity

14.20%

Cost of debt (post tax)

7.76%

WACC

8.50%

 

 

 

D/E of RCOM with its competitors:

RCOM

7.70

Bharti Airtel

0.61

Idea

1.55

Tata Teleservices

3.20

Industry average

3.26

Based on New Capital Structure:

Debt (in Rs Cr.)

17,834.24

Equity (in Rs Cr.)

5,786.88

Beta

1.63

Cost of equity

14.20%

Cost of debt (post tax)

5.84%

WACC

7.89%

RCOM’s new Debt/ Equity after reducing its debt: 3.08

If everything goes according to plan, Reliance Communication will be able to pay off 27,000 CR of its debt, which will improve its credit rating, share price and also improve its ability to refinance.

Calculations have been shown in excel