Morgan Stanley reiterates overweight rating on Tata Communication stock

By: | Updated: August 12, 2016 11:21 AM

Company defers results twice this season, but that shouldn’t affect its growth prospects

Spectrum auction, Spectrum auction news, Spectrum auction latest, Spectrum auction bidsWith the auctions out of the way, the winners will now lick their wounds. PTI

We believe Tata Communications (TCOM) has significant potential to benefit from growing data and cloud business. FY16e managed services Ebitda (earnings before interest, taxes, depreciation and amortisation) should grow 120% year-on-year, improving cash flows, Ebitda margin and ROCE (return on capital employed).

TCOM has deferred Q4FY15 results twice this quarter as the financial statements of one of its foreign subsidiaries are in the process of being finalised, and it has asked the stock exchanges for an extension of up to 60 days. This was indeed disappointing, raising several investor questions that we would like to address in this note.

When will we see Ebitda growth for core business? We expect the data story to play out in FY16. FY15 saw flat growth due to a slowdown in voice, which has now become less consequential. At the core, we estimate a FY15-17 Ebitda CAGR (compound annual growth rate) of 20%, with margins improving 250 basis points to 17.5% at QE (quarter ending) March-17. Core PAT should grow at a 300% CAGR in FY14-17, on a low base.

What will drive data growth? Managed services (35% of data revenue, 20% of data Ebitda) is a high growth segment that should see 25% y-o-y revenue growth and 95% y-o-y Ebitda growth over the next two years. Loss-making products (i.e., new products and banking services) generated -18% Ebitda margins (as of FY14) vs. established products at 21%. Reduction in the drag alone should have a multiplier effect, driving Ebitda margin of managed services from 3% in FY14 to 25% in FY17. New initiatives such as IZO (cloud platform) should add value in FY16, in our view. Break-even Ebitda at the banking business could be a key trigger for the stock.

Is there a corporate governance issue? We believe the management should have communicated the clear reasons for deferring the results twice this season. Investors are also seeking management clarity on the time-frame for Neotel demerger. We expect this deal to come through in FY16. Though the deal is not EV (enterprise value)/ Ebitda accretive, it should help TCOM reduce debt and focus on its core business. The company expects to receive the said financial statements within the next four-five weeks.

Why should we buy the stock? We believe improving fundamentals are not reflected in valuations. By our estimate, over FY14-17, ROCE will increase 600 bps to 12.4%, FCF (free cash flow) yield will grow -0.8% to 10.2% and net debt to Ebitda will decline from 3.5x to 1.8x . On FY16 EV/Ebitda, the stock trades at 6x, a 33% discount to global peers. Reiterate OW (overweight) on the stock.

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