Tracing Jio's next leg of growth, after Facebook investment

 

In December and January the Ambani twins Isha and Akash were hard at work on a potential deal with Facebook. Over multiple trips to the US they negotiated the deal with Facebook executives, with Mukesh Ambani and Mark Zuckerberg coming in once it was almost ready to be signed. In late March the SARS Cov2 outbreak and a ban on international travel slowed things down. But nearly a month into the India lockdown Reliance Industries and Facebook Inc, in the last week of April, announced a $5.7 billion (₹43,574 crore) partnership with Facebook, buying 9.9 percent of Jio Platforms. For Isha who looked after the customer experience at the groups retail and telecom businesses, and Akash who was in charge of the technological aspects of both businesses, the deal marked a clear acceptance of Jio as a tech business.

It followed up on May 4 by announcing a ₹5655.75 crore deal with Silver Lake, a global technology investor, for a 1.1 percent stake in Jio Platforms at a 12.5 percent premium to the price Facebook paid.

Unlike its rivals, Jio never saw itself as just a telecom company. The subsidiary of flagship Reliance Industries was acutely aware that while telecom giants Verizon and Vodafone had spent billions laying out ‘dumb pipes’ to carry data, it was the tech majors Google, Netflix, Facebook and Amazon that had reaped the benefits. It was not a position Reliance’s Chairman Mukesh Ambani, who had spent an estimated ₹250,000 crore building Jio’s network, wanted to find himself in. Monetising the customer was top on his mind.

In analyst meets around 2016-17, the company had begun to push this narrative. They wanted Jio to be valued as a technology business, according to an analyst familiar with the briefings. At that time there was plenty of skepticism and the market was unwilling to see beyond how the company could sell anything more than cut-priced voice and data. Jio (as a part of Reliance Industries) was accorded the relatively low multiple that telecom companies trade at. “There was little appreciation for the platform that Jio said it planned to create,” the analyst says pointing out that even today the company has neither been able to significantly monetise the movies its customers can watch on the platform nor Jio Pay.

There was, however, a small group of investors who saw it differently. The world over platforms—Google, Amazon, Alibaba—have been able to monetise seemingly disparate businesses. These companies, listed in the US market, had seen their valuations soar and been responsible for a large part of the outperformance of the US market over the last decade. And unlike the first dot-com bubble, this time investors had picked a narrow set of stocks to ride the rally.

 

If Jio could place itself at the center of a technology platform story, Reliance Industries, which had spent a decade in the ₹400,000 crore market cap range, would rerate. Global investors also did not have much choice. Though India was a vast and untapped internet market, it presented no investible opportunities in the internet space except for the tiny, by global standards, $3.55billion (₹27,000 crore) market cap Info Edge that owns Naukri.com and has a stake in Zomato.

Two large funds, Fidelity Management and Research and the Capital Group, took an early call in 2017 and started accumulating Reliance Industries’ shares at about ₹700 a share. They hold 268 million (worth ₹37,520 crore) and 111 million (worth ₹15,500 crore) shares respectively making them among the largest shareholders in the company.

The deal between Jio Platforms and Facebook could be the first vindication of their early conviction. According to information available so far, the transaction aims to marry WhatsApp ubiquity with Reliance Retail’s on-the -ground presence to create a retail platform. India’s retail industry worth $792 billion (₹59,40,000 crore), according to CARE Ratings, has proven difficult for organised players who have a 12 percent share. If the Jio-Facebook combine manage this, it could put in place the building blocks to transform the company from a petrochemical and refining major to a new-age internet business with a large presence in telecom and retail. “So far Jio had received a valuation based purely on its telecom service provider business. This deal may now add more credence to Reliance’s fiber and digital service endeavour,” says Swarnendu Bhushan, research analyst at Motilal Oswal.

 

Contours of the deal
For both Reliance and Facebook, the handshake announced on April 22 was equally necessary.

In Menlo Park, California, the $534 billion market cap Facebook was facing growth challenges of its own. Its user growth in the western world had begun to plateau and even though CEO Mark Zuckerberg had spent time learning Mandarin and made several trips to China, the company found itself shut off from that market.

India, with its 400 million users, presented the next big growth opportunity even though at $3 per use they made a lot less for the company than the $41 an American user made. Facebook had been stymied by regulations that nixed its Free Basics plan and had been denied permission to launch WhatsApp Pay.

Reliance, on the other hand, had ₹291,000 crore of debt on its books and had committed to becoming a net debt free company by March 2021. A deal with Saudi Aramco to sell 20 percent of its refining and chemicals business for $15 billion had moved slowly. Jio, with its 388 million users and ₹21,000 crore in EBIDTA, provided an opportunity for both Reliance and Facebook to partner.

 

The deal gave Facebook a 9.9 percent stake in Jio Platforms, giving the company an enterprise value of ₹462,000 before the deal. Importantly, this meant that Facebook had bought into Jio at 21 times FY20  EBIDTA. Compare this to the 10-12 times EBIDTA that Bharti Airtel, its nearest rival, trades at and it becomes clear that Facebook sees a lot of potential in the Jio platform. “It also increases the sum of the parts valuation for Reliance Industries,” says Jal Irani, senior vice president, wholesale capital markets, Edelweiss Financial Services.

The deal also allows RIL to work on its deleveraging. Jio Platforms pays ₹28,000 crore to Reliance Industries while ₹15,000 crore goes to Jio with a new enterprise value of ₹467,000 crore. “The proposed transaction kick-starts the deleveraging exercise for RIL at a time when the large net debt has remained a key concern over the past few years and there were apprehensions of a delay/derailment in the Saudi Aramco transaction,” wrote Kotak Institutional Equities.

For RIL, the sum of the parts moves up to ₹1,620-1,770 per share based on FY22 estimated earnings, according to an analysis by several brokerages including Credit Suisse, Motilal Oswal and Kotak Institutional Equities with petrochemicals, refining and marketing accounting for an enterprise value of $59 billion, retail $42 billion and telecom $57 billion post the Facebook deal.

The Retail Edge
The deal announcement had a strong retail subtext to it. Facebook spoke about connecting India’s 60 million small businesses while Mukesh Ambani, through a four-minute video address, spoke about connecting India’s small kiranas to customers through the power of WhatsApp of which he said, “WhatsApp in particular has entered our people’s daily vocabulary.”

Organised retail in India has faced a scaling-up challenge. Over a decade after retailers started expanding in earnest, the largest, Reliance Retail, has 26 million square feet under operation. Finding real estate, hiring staff and entering into sourcing agreements is a time-consuming process. As a result, most retailers have adopted a cluster approach preferring to saturate a state or region before expanding. At the same time, kirana stores that offer credit, instant delivery and a reasonably wide assortment, have proved to be formidable competitors. Expanding a physical retail operation in India through stores can only happen in a linear manner.

Working with kiranas is an opportunity that organised retail is increasingly begin to tap. One such program is Metro Cash and Carry’s Smart Kirana. It works with 15,000 stores and supplies products to them. “We use data analytics to improve footfalls and increase conversions and sales,” says Arvind Mendiratta, managing director at Metro Cash and Carry India. Metro, which has a licence to sell only to businesses, gains through increased sales to kiranas.

A Jio-WhatsApp combination through JioMart aims to surpass the challenges of setting up stores allowing it to scale much faster. Here’s how it would work. Orders would be taken on WhatsApp, which has 400 million users in India, and sent on to the nearest kirana store. The store would be responsible for making the last-mile delivery. Pilots have begun in Thane, Navi Mumbai and Kalyan. “Globally, grocery ecommerce is not sustainable as the margins are wafer-thin. Add to that transportation costs and it becomes unviable. In this case, the additional costs don’t apply,” says Abneesh Roy, executive vice president, Edelweiss Securities.

If executed well, JioMart stands to gain traction. Retail, particularly fast-moving household items like groceries, vegetables and oils, remain low-margin items (between five and seven percent) and it’s unclear how the margin would be split between the kirana and JioMart. Reliance Retail has been silent on supplying stores through its wholesale business. For now, the model doesn’t envisage a fleet of delivery boots on the ground like Swiggy and Zomato leaving the stores to take care of the manpower (and costs) of last-mile delivery.

The most exciting aspect of the deal is the potential integration of WhatsApp’s payment platform, which is still awaiting regulatory clearance, with the ordering experience on JioMart. That would give access to household spending patterns and allow Jio to sell commission-based services like mutual funds and insurance. “In effect they would have the data a credit card company has access to and that is a very powerful resource. If executed well it could mean that a customer may not need to leave the Jio ecosystem,” says an analyst who declined to be named citing company policy. He also cautioned that unlike China, India lacks a superapp and WhatsApp is free to partner with Jio’s rivals. (Net neutrality rules also mean that telecom providers cannot prioritise traffic for any app or website over others.)

Valuing the new Reliance
On April 30, RIL announced plans for a rights issue— its first in 30 years. The company, which has so far grown through internal accruals and debt, plans to ask existing shareholders to subscribe to shares worth ₹53,125 crore at a 14 percent discount to its April 30 closing price. The money would allow Reliance Industries to get closer to its stated aim of a net debt free company by March 2021.

This also gives its balance sheet the flexibility to raise money for the next round of growth if needed. Reliance Industries approved the hiving off of the oil to chemical business into a separate division to pave the way for a potential deal with Saudi Aramco. Jio, valued at ₹462,000 crore, brings in an EBIDTA of ₹21,000 crore. An investment at 21 times EBIDTA would mean that the company aims to double EBIDTA in the next 12-18 months or risk a fall in valuation. At the 2019 AGM, Ambani had declared that Jio’s investment cycle is now over, suggesting that there was ample scope to increase revenue and profitability through increased tariffs, fiber to home, and Jio’s suite of apps.

As Jio and retail become the key drivers of growth the Reliance Industries stock has also started its rerating journey. In the six years since March 2013 Reliance Industries’ profits are up 89 percent to ₹39,588 crore. In the same period the stock is up 262 percent. It has also beaten the 74 percent gain in the Sensex in the same period.

The world over, investors have been patient with giving internet companies time to build businesses. A key attraction of these businesses is that little investment is needed for incremental growth and these companies are mostly able to fund themselves leaving higher earnings for shareholders or for reinvestment in the business. Reliance’s next phase of growth could be done with lower investment in fixed assets leaving a lot more on the table for its investors.