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MOSL: TATA COMMUNICATIONS (Buy)-Strong order funnel to drive growth-Expect earnings to start improving from 2QFY19

Tata Communications: Strong order funnel to drive growth; Expect earnings to start improving from 2QFY19

(TCOM IN, Mkt Cap USD4.8b, CMP INR591, TP INR730, 23% Upside, Buy)

 

We spoke with the management of Tata Communications. Our key takeaways:

• High investment in frontloading growth opex/capex had hurt Data EBITDA. The management now expects its healthy funnel of orders to help maintain 12% Data revenue growth over 2-3 years (against 8% in the last three years).
• Data EBITDA margin (85% EBITDA contribution) should improve from 17% to 23% over FY18-21, leading to 410bp expansion in overall EBITDA margin to 18% by FY20.
• Within the Data segment, Growth Services is likely to see 32% revenue growth and contribute 23% of overall EBITDA by FY21 (v/s 12% loss in FY18).
• The management maintained its capex guidance of USD250m-275m (11% of sales).

 Our view: Maintain Buy

• A key pull-back in the stock is towards the acquisition of TTSL’s (high margin) SME enterprise business, on which there is limited clarity towards the size and valuation. With estimated revenue/EBITDA of INR28b/INR10b, it could be acquired at INR70b on ~7x EV/EBITDA (current valuation).
• The acquisition of TTSL’s SME business could increase net debt from INR70b (net debt to EBITDA of 3.2x) to INR14b. Also, TCOM remains vulnerable to RJio’s aggression. However, the space offers huge growth opportunity.
• The stock quotes at 7x FY20E EV/EBITDA, at 25% discount to the three-year average one-year forward EV/EBITDA of 9.6x (primarily building land demerger value).
• We ascribe 9x/3x to (FY20) Data/Voice EBITDA of INR30.2b/INR2.7b, arriving at a TP of INR730 (23% upside from CMP). Besides, land demerger (in the next six months) offers additional upside of INR176.