Behind the Jio investment rush – Livemint

That could either have meant that Jio Platforms would raise about $5.7 billion more, or sell another 10% stake. But as it turns out, the company has ended up selling an additional 12.4% stake already to global investors, and has raised $8 billion more. At the rate Jio Platforms is signing up investments—$1.3 billion per week in the past six weeks—it may well reach the $15-billion mark soon.

It’s almost as if the delay in the $15-billion deal with Saudi Aramco doesn’t matter, when it comes to RIL’s stated plan to reduce debt in its books. And to add, its $7-billion rights issue was oversubscribed 1.6 times—although with the staggered payment option only a fourth of these proceeds will be received this year. By and large, strong investor interest in Jio Platforms is rubbing off on RIL, where the traditional oil-linked businesses have taken a hit owing to covid-19. RIL shares have risen by about a third since it announced the Facebook investment, compared with a less than 10% increase in the Nifty 50 index during the same period.

So, what is driving investors by the droves to Jio Platforms? To start with, Jio ticks a number of boxes such as proven execution, a nearly debt-free capital structure and being on the right side of regulation. But the fact also remains that private equity funds are flush with cash. “Competition for assets remains high, a consequence of the superabundance of capital-seeking investment. Prequin estimates there is around $2.5 trillion in dry powder dedicated to private capital strategies,” PwC said in a report this February.

It has also helped that shares of technology companies such as Amazon and Facebook have risen since the coronavirus outbreak, in stark contrast to the drop in markets overall. Social distancing has meant increased usage of technology and digital solutions, which is driving investors towards tech companies.

RIL has tapped into this heightened interest for technology investments by positioning Jio as a digital platform company. Investors dream of a day when customers will talk, shop, bank, read, write, eat, watch and listen to digital content and book a holiday using a Jio app. The Facebook connection adds heft, since its vast resource of user data and preferences can potentially be used to target customers effectively.

“Investments by technology investors should help in positioning Jio as a tech major rather than just a telco,” analysts at CLSA said in a report on 22 May, after KKR announced a $1.5-billion investment in Jio Platforms. Of course, it’s one thing to be positioned as a tech major, and quite another to deliver on the promise through effective monetisation. With a $13.7-billion backing from investors, success may seem like a foregone conclusion, although as some analysts point out, questions remain.

Digital premium

The high competition for assets often results in an inflated acquisition price. Jio Platforms is being valued about 35-40% higher than Bharti Airtel Ltd on an EV/Ebitda basis. EV stands for enterprise value and Ebitda is earnings before interest, tax, depreciation and amortization.

While Airtel’s India business, excluding the value of its stake in Bharti Infratel Ltd, is valued at around 9.5 times estimated Ebitda for FY22, PE firms have ascribed Jio Platforms a value of about 13.5 times, points out an analyst at a multinational brokerage, requesting anonymity. Of course, this isn’t an apples-to-apples comparison, since Airtel is still viewed largely as a telco.

Almost as if to buttress its digital platform claim, Jio launched JioMart soon after the Facebook deal. The e-commerce venture, which used Facebook’s popular WhatsApp as the interface, has had some teething troubles, although investors seem enthused about the long-term prospects of the venture. Besides, Jio has already acquired a number of firms such as the music streaming company Saavn and education technology firm Embibe, raising hopes of the creation of a superapp.

Here is one line of thinking of how a superapp housed within WhatsApp and the partnership with Facebook could be a money-spinner.

“In a pilot phase, Jio’s grocery app ‘JioMart’ could be available inside WhatsApp. Although both companies are in no rush for monetization, overtime they could: charge a take-rate for every transaction on JioMart via WhatsApp. This could be expanded to non-grocery e-commerce; charge a pre-decided commission if users pay for Jio apps like Health-care and Ed-tech via WhatsApp; better collaboration on focused advertising between Facebook/Instagram and Reliance Retail brands; finally, RIL could help Facebook better monetize its marketplace with more feet-on-street,” analysts at Bank of America Merrill Lynch said in a note to clients.

There are often comparisons made of Jio being the Tencent of India, but the success of this strategy can’t be taken as a given. To start with, existing examples of superapps such as WeChat are network agnostic. An app tied to a particular telco results in conflict of interest and defeats the purpose of a supperapp, say analysts.

Besides, large companies such as Amazon haven’t been able to gain a foothold in the Chinese markets, whereas they already have a strong presence in India. “Is success here a given? We believe no, particularly when Amazon already has a strong presence in India, and Walmart, Alibaba, Tencent have made strategic investments,” Macquarie Capital’s analysts wrote on the prospects of the digital transformation Jio has been talking of.

It’s clear that the premium being given by the PE firms is to factor in the so-called optionality of controlling the digital lives of millions of Indians, or, in other words, being the gateway for their digital spending.

“How should this optionality be valued? Frankly, we do not know. We have allowed for a $10 billion optionality in our bull case. (But) inherently there is significant information asymmetry here,” analysts at Macquarie wrote in a note to clients.

Facebook and the PE firms who have collectively invested $13.7 billion in Jio Platforms would evidently have more information on its operating structure, compared with public investors in RIL. Of course, that’s par for the course. Also, from an RIL investor’s perspective, as long as value is getting captured by one of the many RIL arms—be it Jio Platforms or Reliance Retail Ltd—they don’t have much reason to complain.

But as far as understanding the difference in valuation of Jio Platforms goes, more clarity on its structure would have helped. For instance, a March quarter results presentation made by RIL suggests that e-commerce venture JioMart is housed in Reliance Retail, although it isn’t clear if Jio Platforms derives any commercial value because of its contribution to the venture.

Regulatory advantage

Jio’s e-commerce plans are a significant part of investor discussions lately. Recently, India rejected Walmart-owned Flipkart’s application to enter the food retail business. In the past, the matter of foreign ownership in the e-commerce business has been a regular bone of contention with the government.

While there are similar concerns with Amazon’s India operations, with Jio, these problems disappear because of its domestic identity. While this doesn’t mean that Amazon’s and Flipkart’s investments in the country are write-offs, it does certainly put Jio at an advantage as far as being on the right side of regulation goes. “Investors are willing to pay a premium for this aspect,” says an analyst at a domestic institutional firm.

While the eventual success of the digital platform can be debated, the fact remains that PE investors seem convinced. In a worst case scenario, for them, they may have only overpaid for the largest telco in one of the biggest markets by subscribers.

“It’s important to note that the telco piece itself comes without legacy issues that peers such as Airtel and Vodafone Idea suffer with, both in terms of operating costs and regulatory dues. Besides, it has nearly debt-free balance sheet. So, Jio ticks many boxes even before we reach the optionality of the superapp,” says an analyst at a firm hired to manage RIL’s rights issue.

In the December 2019 quarter, Jio had a 35.4% revenue market share, higher than Airtel’s 32.4% share and Vodafone Idea’s 26.2% share, according to analysts at SBICAP Securities Ltd. Given Vodafone’s woes, the analysts estimate a market share of 42% for Jio by the end of the current financial year.

Indebted

While Jio’s growth has been impressive, it was fuelled by leverage both at the telecom arm and the parent company. When Jio Platforms was created, most of the debt was shifted to the parent company’s books. Even so, the balance sheet of the digital company remains bloated and return ratios aren’t yet decent.

As far as the debt on the parent company’s books go, the Jio stake sales and the rights issue will bring considerable relief in the next year-and-a-half. But other pieces need to fall in place for the company to turn debt-free by March 2021. “RIL’s organic free cash flow (FCF) generation for FY21 looks as though it will be severely impacted, and if reported capex continues in the ₹60,000- ₹80,000 crore range, it would be FCF-negative again in FY21E,” analysts at JP Morgan said in a note last month.

RIL’s reported debt in end-March 2020 stood at around $21 billion, without accounting for other dues such as vendor payables and spectrum related debt, which accounted for another $21 billion, according to an analyst at a multinational brokerage. Further asset sales such as a stake sale in the fibre infrastructure business can help bridge the gap, especially if free cash flow ends up being negative. And if the Aramco deal ends up being completed, the extent of deleveraging would be substantial.

In any case, the Jio deals have significantly reduced worries on the debt front for analysts and credit rating agencies.

With the balance sheet now looking leaner, the RIL stock’s returns have outpaced the market in recent months. Since Jio launched operations in September 2016, the RIL stock has risen at an annual average rate of 36%, compared to a mere 3.3% rise in the Nifty 50 index.

A big question is if the over-eager PE investors can also expect similar returns for their massive investments in Jio Platforms. Much depends on how the superapp ambitions play out. “If investors want to only ride the expected growth in the Indian telecom story, in terms of tariff hikes etc., Bharti Airtel is a far better play,” says the analyst at the multinational brokerage.

In conclusion

While Jio has been successful in executing the telco piece of Jio, technology capabilities and, more so, the ability to monetize it, is yet to be displayed. As pointed earlier, success can’t be taken as a given.

For one, worthy competition still exists in many of the verticals Jio Platforms is targeting. Second, success can’t be taken as a given for all RIL projects, even going by past history. “RIL’s upstream oil and gas foray in 2008 is an example of aspirations not materializing even alongside a global major such as BP,” Macquarie’s analysts point out.

For now, RIL investors can rejoice that their company is making the most of the superabundance of private equity capital.