A financial trader reacts as he works at his computer screens. (Photographer: Ralph Orlowski/Bloomberg)

Dear Reliance Industries, Please Explain This Valuation Gap

The Rs 78,100-crore gap is puzzling. How did the valuation of Reliance Jio Infocomm Ltd.’s fibre and tower assets increase by that much even though some of that infrastructure is yet under development?

The numbers cropped up in a Reliance Industries Ltd. investor presentation. The country’s second largest company by market capitalisation has decided to demerge the tower and fibre infrastructure of its telecom arm — Reliance Jio. The assets will be transferred to two special purpose vehicles — Jio Digital Fibre Pvt. Ltd. and Reliance Jio Infratel Pvt. Ltd., which will be controlled by an Investment Infrastructure Trust or InvIT.

The company is yet to file the InvIT prospectus with market regulator Securities and Exchange Board of India. But the investor presentation states that Reliance Jio has invested close to Rs 1,25,200 crore in fibre and tower assets and currently values them at Rs 2,03,300 crore. This difference in valuation was settled by issuing preference shares worth Rs 78,100 crore to Reliance Industries.

Dear Reliance Industries, Please Explain This Valuation Gap

The valuation jump throws up three questions…

1. How did Reliance arrive at this new number?

It was based on studies done by an internationally reputed expert firm, said the company in its presentation. But it did not provide any details on who did the external valuation or how it arrived at this number. An email query from BloombergQuint seeking clarification remains unanswered.

2. Is such an increase in valuation an acceptable accounting practice?

Amarjit Chopra, former president of the Institute of Chartered Accountants of India, says that it is not a common practice to revalue the assets before selling but there is nothing wrong if it is done. But when it is done to transfer the asset to a related party, it should be considered with a pinch of salt, the veteran auditor added.

Gautam Nayak, partner at audit firm CNK & Associates LLP, says that revaluing an asset is a normal practice, because if anyone is selling or transferring an asset, it will be done at a fair value which could be higher or lower than the amount invested. As long as basis of considering the fair value of the assets is right, it should not be a problem, he said. For valuation purpose, one has to not only consider the value of the asset, but also the income that the asset will generate in future. The potential of the asset to generate income will have a major say in the fair value of the asset, Nayak added.

There are depreciation and tax implications, other accountants said, that would be clearer once more details are available.

3. Is the new valuation justified?

That’s a tough question to answer without the detailed valuation report. BloombergQuint’s calculations, using industry benchmarks, suggest the asset valuation may be on the higher side. For two reasons — some of its assets are still under development and will require additional capital investment, and the InvIT will find it tough to lure tenants other than Jio for these assets.

After all, there are currently more tower companies in India than telecom operators.

Also read: What Reliance Jio InvIT Offers Investors

Benchmark Valuations

According to the company, the special purpose vehicles will hold 11 lakh route km of fibre and 1.75 lakh towers in its portfolio. However of this, only 7 lakh route km of fibre is ready and some of the towers are under development. Currently, Reliance Jio is the only user for all the towers and 50 percent of fibre for the next 20 years.

Fibre Assets

It’s tough to establish benchmark valuation for Indian fibre assets in the absence of any similar deals and Reliance hasn’t provided any information yet. But industry analysts suggest the replacement cost of fibre is generally Rs 10 lakh per kilometer.

That works out to Rs 1,10,000 crore for the 11 lakh route km of fibre. Reliance has valued it at Rs 1,66,400 crore. To be clear, only 7 lakh route km of fibre is ready and the InvIT will have to incur additional capital expenditure to build the remaining asset. This could further increase the asset value on the balance sheet of the SPVs.

Dear Reliance Industries, Please Explain This Valuation Gap

Tower Assets

Recent transactions by Vodafone Idea Ltd. and Bharti Infratel Ltd.’s valuation serve as a benchmark for valuing tower infrastructure. In 2017, Vodafone India Ltd. and Idea Cellular Ltd. sold their tower assets to American Tower Corp at a valuation of Rs 37 to 40 lakh per tower based on tenancy ratio. Idea with a tenancy ratio of 1.8 times got Rs 40 lakh per tower.

Bharti Infratel’s market valuation suggests a derived valuation of Rs 49.7 lakh per tower at a tenancy ratio of 1.88.

Using the average of the three, the value of Reliance’s 1.75 lakh towers adds up to Rs 43,000 crore. A tad higher than the company’s own valuation of Rs 36,800. But remember, Reliance’s towers have a tenancy ratio of one. So the valuation ought to be lower, some analysts say.

Also, as all the tower assets are not built, the InvIT will have to incur additional expenditure which could further increase the asset value on the balance sheet.

Dear Reliance Industries, Please Explain This Valuation Gap

Waiting For The Prospectus

Both the SPVs are yet to file the valuation report with the registrar of companies and the Reliance is in the process of preparing the InvIT prospectus. That will provide more information on cashflows and revenue.

Reliance has said it will provide more details by June-end. Analysts will be watching for how the company explains this gap in valuation and the subsequent issue of preference shares to the parent company.