April 25, 2023
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TATA COMMUNICATIONS Stock Research Report by ICICI Securities
Sector: Telecommunications Services
CMP Rs. 1231, Target Rs. 1510 (23% upside potential)
Target Period: 12 Months
TATA COMMUNICATIONS Stock Research Report: Confident on delivering sustainable growth
Tata Communications’ (TCom) Q4FY23 data revenue grew 2.2% QoQ / 11.2% YoY sustaining double-digit growth. However, data EBITDA margin dipped 240bps QoQ to 24% due to higher employee cost. Company has given strong directional guidance, which puts it in a significantly better position: 1) TCom will continue to invest in people, products and platforms as it sees multiple opportunities, which it doesn’t want to miss for under-investment; 2) capex requirement may rise for driving Digital Services to 50% of data revenue; 3) company will not compromise on RoCE at >25%, which implies strong revenue growth. TCom has seen significant improvement in its orderbook, particularly in large deals (TCV >US$1mn) and it remains confident of continuing to improve on it in FY24/FY25, to facilitate which it has upfronted investments. We believe strong revenue growth will eventually drive operating leverage and margin improvement.
TATA COMMUNICATIONS Stock Research Report: We have cut our EPS estimates by 8% each year for FY24E/FY25E as we factor-in higher costs while remaining conservative on revenue growth. We have also increased capex and accordingly cut our target price to Rs1,510 (unchanged P/E of 20x for FY25E; earlier: Rs1,640). Maintain BUY.
● Data revenue grew 11.2% YoY / 2.2% QoQ to Rs37bn: We are closely tracking net revenue (total revenue minus direct cost), which is more representative of the underlying performance for TCom. In Q4FY23, net revenue increased 8.8% YoY / 2.8% QoQ to Rs26bn. TCom remains positive on its near-term revenue growth prospects in the data business driven by new product launches, ramp-up in execution and value-addition from the international business. Company is investing for acceleration of growth in terms of expanding sales & marketing teams in India and the international market, and adding products in Digital Services.
● Digital Platform & Services revenue grew 15.9% YoY / 2.3% QoQ to Rs11bn. However, net revenue improved 13.7% YoY and 9.1% QoQ to Rs5.2bn. Collaboration revenue increased 1.7% YoY / declined 3.6% QoQ to Rs4bn, which has been hurt from global-SIP business under-performance on slippage by one customer. Collaboration and CPaaS is expected to grow on the back of rise in revenue from new-age products like Rapid, InstaCC and Digo, while G-SIP remains a drag. Cloud, hosting and security grew 38.6% YoY / 9.9% QoQ to Rs3.6bn. Next-gen connectivity and media revenues were up 10.3% (+4.6% QoQ) and 19.5% YoY (down 2.1% QoQ on seasonality), respectively. Incubation revenue surged 65.4% YoY (9.8% QoQ) to Rs1.3mn. Core connectivity net revenue was up 5.3% YoY / 1.6% QoQ to Rs19.8bn. Transformation business revenue rose 2.4% YoY to Rs3.4bn.
● TATA COMMUNICATIONS Stock Research Report: Orderbook addition healthy, particularly in large deals. TCom saw good growth in its orderbook during the quarter aided by rise in the project pipeline for Digital Services and Incubation (40% of orderbook). In FY23, the company’s orderbook addition reached an all-time high, and it remains confident of continuing to grow its sales funnel and orderbook in FY24.
● Data EBITDA margin at 24.0%, down 240bps QoQ. Data business EBITDA fell 8.8% YoY (7.0% QoQ) to Rs8.8bn. EBITDA margin was impacted from rise in operating costs driven by: 1) higher employee cost, which rose 8.6% QoQ and 30.1% YoY on 15% (>1,000) addition in employee count, and rise in employee cost due to higher attrition in H1FY23 (company believes this will normalise as it has filled the human resource gap and attrition has normalised); 2) network cost has increased by 1.4% QoQ and 6.4% YoY on higher energy cost and investment in new product developments, while other expenses decreased by 2.0% QoQ and 1.4% YoY. Company believes peak of cost inflation is behind, and investment henceforth will follow revenue growth.
TCom has maintained its EBITDA margin guidance at 23-25% for the consolidated business and it wishes to invest excess margin back into the business to drive faster revenue growth. We have factored the rise in cost in our assumptions while we remain conservative on our revenue estimates for TCom.
● TATA COMMUNICATIONS Stock Research Report: FCF conversion remains healthy. TCom’s capex was Rs5.3bn in Q4FY23, and Rs17bn for FY23 (9.6% of revenue), which is lower than the guidance of US$300mn for FY23 – due to supply chain issues and better payment terms. Net debt decreased by Rs5.6bn QoQ (Rs10bn YoY) to Rs57.1bn in FY23 on good FCF conversion.
● TATA COMMUNICATIONS Stock Research Report: Switch TV acquisition to complete soon. TCom anticipates approvals for the merger in Q1FY24 and expects to start integration immediately. It expects Switch TV to improve TCom’s position in the US market for media services.
● Other highlights. 1) Company has a sharp focus on execution of Digital Services business, which can drive revenue growth in double digits. This implies Digital Services revenue has to grow in excess of 20%. TCom has ambition increase Digital Service revenue (including Incubation) to 50% of data revenue; 2) the large deals (defined as TCV of >US$1mn) win has significantly improved, and the company expects it to grow in the coming years. Discussions with customers, both in India and international, are on positive trajectory; 3) Company did not share concerns highlighted by Indian IT companies on slowing spend on network or digital services. These spends help IT companies to improve productivity; and 4) Company is committed to invest in operating cost and capex, but remains confident of achieving >25% RoCE. This implies TCom is penning revenue growth upward of 14-15% over the next three years.
● Risks: 1) Slower than expected execution in Digital Services revenue, and 2) continued investment in costs keeping pressure on margins.
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