INSIGHT: Reliance Comm vs Bharti

Reliance Comm vs Bharti

Reliance Communication Ventures Ltd (RCVL), which houses the telecom business of the Reliance group, disclosed its results for the first time ever. In the nine months ended December 31, 2005, RCVL reported a proforma consolidated net profit of Rs 42 crore on revenues of Rs 8,654 crore. Bharti Televentures, Reliance’s main competitor in the mobile telephony space, had lower revenues of Rs 8,252 crore, but a net profit of Rs 1,576 crore, nearly 40 times more than RCVL’s.

Things look better at the EBITDA (earnings before interest, tax, depreciation and amortization) level for RCVL, which reflects the performance of four companies, Reliance Infocomm, Reliance Telecom, Reliance Communications Infrastructure and FLAG Telecom.

In the nine months, its EBITDA stood at Rs 1,431 crore. Bharti’s EBITDA stood at Rs 3,082 crore during the same period, about 2.2 times that of RCVL.

The quarterly break-up provided by RCVL gives the impression the gap is narrowing by the quarter. In the December quarter, RCVL’s EBITDA stood at Rs 848 crore, just 24% lower than Bharti’s EBITDA of Rs 1,120 crore. Just two quarters ago, RCVL’s EBITDA was at Rs 167 crore, much lower than Bharti’s EBITDA of Rs 941 crore. The closer RCVL gets to Bharti in terms of profit, the higher would be the valuation it gets on listing.

But before getting excited about the fact that RCVL is closing in on Bharti on the profitability front, it needs to be noted that these are proforma numbers and do not adjust for minority interests in any of the four operating companies.

For instance, RCVL holds only 65.9% of Reliance Infocomm, and when the profit pertaining to the balance 34.1% stake is carved out, RCVL’s actual profit would be much lower. RCVL’s interest in Reliance Telecom, the GSM venture, is even lower at 35%. Therefore, it would still be a while before RCVL catches up with Bharti in profit terms.

A quasi hedge fund

Reliance Equity Fund is no normal equity diversified fund. The investment style it proposes to follow actually makes it look more like a hedge fund. Apart from buying stocks, like equity funds normally do, Reliance Equity Fund would use derivatives to hedge its portfolio, and also gain from short-selling opportunities.

Few equity funds use derivatives currently, and even when they do it’s only for hedging purposes. In that sense, Reliance’s new scheme is ground-breaking, since it offers investors the opportunity to profit from short-selling opportunities available in the market. The scheme’s fund manager Sunil Singhania explains, “With the Sensex at the 10000 levels, not all stocks can be expected to go up. Our existing equity schemes only invest in stocks that we feel will appreciate. Reliance Equity Fund will not only invest in stocks that we like, but also go short on stocks which we feel may go down.”

Currently, cash and derivatives arbitrage schemes short stocks in the derivatives market, but only to their extent of the buy position in the cash market. But new rules released by the Securities and Exchange Board of India (Sebi) late last year now allow mutual funds more flexibility with the use of derivatives, including short-selling.

This liberty to short stocks using the derivatives markets will be exercised for the first ever time by Reliance’s new scheme. At the same time, some restraint would be exercised in terms the total exposure to derivatives. The maximum exposure to derivatives products will be 100% of the value of equity stocks held, and that too, only if the price-earnings (PE) ratio of the Nifty is over 28 times trailing earnings. The Nifty has a PE of 18 times currently, and according to Reliance’s pre-arranged formula, the use of derivatives (for shorting and hedging) would be to the extent of 30-50% of the equity portfolio.

Also, according to Singhania, since a part of its portfolio would always be made up of short positions in the derivatives market, it would not get impacted as much as normal equity diversified funds when the markets fall. Yet, applying the same logic, if the markets were to continue rising, it’s likely that Reliance Equity Fund’s returns would lag that of normal equity diversified funds, since the short position in the derivatives market would lead to losses and pull down the returns made by the equity portfolio. Thus, although the new scheme is innovative and offers mutual fund investors new opportunities, it’s not for someone who simply wants to go long on the Indian equity market.