The last one year in the stock market has clearly belonged to Reliance Industries. The market cap of the stock over the last 1 year has crossed the Rs.500,000 crore mark and has overtaken TCS to become the most valuable company in India. The chart below tells its own story.
If one looks at the 1-year stock performance of RIL, it has been a clear outperformer compared to its peers as well as to markets overall. Consider the chart above. During the last 1 year, the stock of RIL is up by 56.18%, a phenomenal performance for a stock of that size. During the same period, the Nifty index is up by just about 16.1%. When you look at the peer group of Reliance Industries, the outperformance is still starker. Bharti has underperformed the Nifty giving a return of just 11.9% during the last one year whereas Idea has had negative returns of (-13.8%). So how exactly did this outperformance come about?
To be fair, RIL is not a telecom company but essentially a company that straddles the hydrocarbons value chain. However, the outperformance of the refining and the petchem sector was known all along. The real alpha for the RIL stock came after the launch of Reliance Jio in September last year. But, why is the market assigning such a positive valuation to the Jio business at a time when telecom companies are struggling to sustain growth and margins.
Using cash cows to finance the market cap drivers…
Like the large IT companies in India, RIL was generating more cash through its refining and petchem business that it could productively utilize. But, unlike the IT companies, RIL had planned to use up this cash pile to finance its foray into telecom. RIL was caught in a weird dilemma a few years back. The investments into the refining business had been completed and the cash flows were really streaming in. But the valuations piece was missing altogether. Despite healthy cash flows, RIL commanded sub-Nifty valuations. The reason was that the company really lacked a future growth and value engine. The problem with a company that has healthy cash flows and limited investment opportunities is that, sooner rather than later, the company is seen as a holding company and starts quoting at discounted valuations. The answer came in the form of the Reliance Jio foray. The RIL group has sunk close to Rs.200,000 crore ($30 billion) into the Jio venture and the cash flow trajectory is still hazy. However, in Jio they have a long term growth and valuation engine. While analysts and investors were initially sceptical, the concept of using cash cows to fund the future value proposition has really worked.
Owning the entire value chain…
Early on in the hydrocarbons business the RIL group learnt that the only way to remain relevant was to attain scale and the only way to sustain profits was to own the entire value chain. That is exactly what the RIL group did in the oil sector. They first created world class petrochemicals infrastructure in India. Then the company integrated backward into refining and marketing of oil, which is a key input for petchem. Finally, the company also has a major stake in extraction and prospecting through its stake in the KG Basin as well as in marquee oil properties worldwide.
So how exactly is Reliance Jio applying this principle to telecom? The company has already created a scalable LTE infrastructure across India with high-end 4G capabilities. That has been able to deliver high bandwidth very efficiently at low cost. Secondly, the company has identified the need for compelling content to drive customers to the Jio ecosystem. Acquisition of stakes in Network 18 and Balaji Telefilms is only one side of the story. The company is actually trying to replicate the scale of what Apple has achieved on the content space. The last piece in the jigsaw puzzle is the telecom hardware. Today, nearly 50 crore mobile phone owners are outside the data ambit since they do not have smart phones. Jio is now proposing to launch special LTE smart phones at zero cost and just entailing a refundable deposit of Rs.1500. That is likely to open up the demand for data services in a big way. After all, the core of philosophy of Jio has been that voice is a commodity and hence needs to be priced as such. It will be more a game of data in the telecom space! The focus has been on creating an unbeatable ecosystem by owning the complete client experience encompassing bandwidth, hardware, software and content.
What about the ROI of the Reliance Jio business?
Those who are still exerting themselves over the ROI of the Jio business are missing a very important point. The amount that RIL has sunk into the Jio business is around Rs.200,000 crore. But the market cap of RIL as a result of the Jio venture has gone up by nearly Rs.180,000 crore in the last 1 year. Effectively, 90% of the total investment that RIL has sunk into Jio has already been recouped by RIL shareholders in the form of value accretion. Not surprisingly, the shareholders are hardly complaining. When the cash flows from Jio actually begin to show up meaningfully, the impact on valuation will be much bigger. But what exactly will drive valuations from here for RIL?
We continue to see the petchem and refining business as stable cash cows for the Reliance Group. But value will come from two fronts. First is the cannibalization effect. In the last one year Jio has cannibalized a lot of value from companies like Bharti, Vodafone and Idea. That will continue due to the greater control over the ecosystem and the higher ARPUs that Reliance Jio will continue to enjoy. The second source of value will come from an ability to grow the data side of the telecom business exponentially in the next 10-15 years without compromising on profitability. That means a much better valuation proposition for the RIL group.
To cut a long story short, RIL’s telecom bet could be a true-blue game changer for the group. How competition actually reacts will be the second part of the story!