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Tata Communications: Investments to accelerate revenue growth, ICICI Securities

Tata Communications’ (TCom) Q3FY23 data revenue grew 2.9% QoQ / 11.1% YoY. Company maintained good revenue growth momentum even in the seasonally weak quarter, which shows rising execution efforts. Digital services revenue grew by a healthy 17.2% YoY on recovery in Collaboration & CPaaS services, which increases visibility of double-digit growth (this would not be possible without Digital services revenue growing in excess of 20%). Company’s orderbook and sales funnel remain healthy with a favourable tilt towards Digital services. Company anticipates further acceleration with rise in feet-on-the-street in international markets and improvement in win-rates. Switch TV acquisition will aid in driving US regional sport production and distribution business, and also help in the global sport market where TCom has a strong positioning. Cost inflation has hurt near-term profitability; however, the company sees the peak of inflation to be behind and anticipates rise in revenue growth momentum as investments yield benefits. We have cut our EPS estimates by 2.4% / 16% for FY23E/FY24E as we factor-in higher costs while remaining conservative on revenue growth. We roll-forward our valuations to FY25E and according raise our target price to Rs1,640 (unchanged 20x P/E; earlier: Rs1,500). Maintain BUY.

· Data revenue rose 11.1% YoY / 2.9% QoQ to Rs36bn: We are closely tracking net revenue (total revenue minus direct cost), which is more representative of the underlying performance for TCom. In Q3FY23, net revenue was hit by higher direct costs due to acceleration in project execution, change in product mix and building capabilities. Hence, net revenue growth decelerated to 6.6% YoY / 1.5% QoQ to Rs25bn. TCom remains positive on its near-term revenue growth prospects in data business on the back of new product launches, ramp-up in execution and value-addition from international business.

· Digital Platform & Services revenue grew 17.2% YoY / 5.8% QoQ to Rs11bn. However, net revenue declined 1.0% YoY and 2.1% QoQ to Rs4.7bn. Collaboration revenue has increased by 8.9% YoY / 6.1% QoQ to Rs4bn, which we believe has lower conversion to net revenue. Nonetheless, Collaboration and CPaaS has shown growth after multiple quarters on 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 23.6% YoY / 9.0% QoQ to Rs3.2bn. Next-gen connectivity and media revenues were up 26.7% and 17.2%, YoY. Incubation revenue surged 125.9% YoY (0.8% QoQ) to Rs1.2mn. Core connectivity net revenue was up 4.7% YoY / 0.9% QoQ to Rs19.5bn. Transformation business revenue rose 6.4% YoY to Rs3.3bn.

  • Orderbook remains healthy. TCom saw good growth in its orderbook during the quarter aided by rise in the project pipeline for Digital Services and Incubation. Sales funnel for future orderbook was stable in Q2FY23, which has started growing again driven by rise in renewed sales strength (higher feet-on-the-street). Company has also witnessed marginal improvement in win-rates, but it sees headroom for further increase. Considering the order pipeline, TCom is confident of double-digit revenue growth.
  • Data EBITDA margin at 26.4%, down 240bps QoQ. Data business EBITDA fell 8.9% YoY (5.9% QoQ) to Rs9.5bn. EBITDA margin was impacted from rise in operating costs driven by: 1) higher employee cost which rose 5.8% QoQ and 25.5% YoY on 15% (>1,000) addition in employee count, and higher attrition. Company believes this will normalise as it has filled the human resource gap and attrition has normalised; 2) network cost has increased by 2.4% QoQ and 5.6% YoY on higher energy cost and investment in new product developments; and 3) other expenses increased by 5.3% QoQ and 9% YoY on reversal of covid benefits. Company believes peak of cost inflation is behind, and investment henceforth will follow revenue growth.
    Company 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.
  • FCF conversion remains healthy. TCom’s capex was Rs3.9bn in Q3FY23, which is lower than what one would expect from the guidance of US$300mn capex for FY23. Net debt has decreased by Rs1.3bn to Rs62.7bn in Q3FY23 on good FCF conversion.
  • Switch TV acquisition has multiple synergies. TCom anticipates multiple synergies from Switch TV acquisition for its media services business: 1) it adds to TCom’s production capabilities which it can cross-sell to existing global customers; 2) the acquisition gives strong positioning in the US regional sport market, and Switch has production facilities at a large number of locations which will act as an entry barrier; and 3) TCom’s global cloud-based delivery solutions will add value to Switch customers. Company anticipates Switch to be margin-dilutive initially, but should improve on realisation of synergy benefits.
  • 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%; 2) TCom’s GTM has shifted from selling Core Connectivity to more cost efficiency driven solutions business; 3) Collaboration should benefit from the launch of new products in CPaaS space, which is finding good traction among customers; SIP trunking dip has decelerated; 4) Company is in process of launching new products within Digital services, which should also aid revenue growth.
  • Risks: 1) Slower than expected execution in Digital services revenue; and 2) continued investment in costs keeping pressure on margins.

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