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Higher ROCE + more reinvestment in biz = Faster EBIT growth

Tata Communications (TCom) hosted its analyst day yesterday. Key takeaways include: 1) Company has increased its ROCE guidance to 25-30% from 20% earlier; 2) maintained double digit data revenue growth and tightened EBITDA margin range to 23-25%; and 3) plans to invest margins in new business and reinvest FCF into R&D, infrastructure and M&A. The company expects ROCE expansion despite reinvestment which implies much faster EBIT growth. TCom is seeing changing consumer behaviour with vendor consolidation and everything on internet has put the company in an advantageous position. We expect EBIT CAGR of 21.8% over FY21-25E, but we see an upside risk to our estimate. We have released a detailed note highlighting the changing telco enterprise landscape and how TCom may benefit from it (link). We maintain our target price of Rs1,461 and BUY rating.

Higher ROCE + more reinvestment in biz = Faster EBIT growth.

TCom has increased its ROCE guidance from >20% to 25-30% in medium term. This is despite keeping EBITDA margin in tight range of 23-25%. TCom had generated margin of 25% in FY21, but had covid related cost benefit, which are unsustainable (~100bps margin impact). The company plans to reinvest margins in seeding new opportunities and white space expansion to drive faster growth. It has maintained double digit data revenue growth. The company also plans to reinvest FCF in R&D, strengthening infrastructure and tactical M&A (for building product portfolio or technology). We are impressed with the company’s rising ROCE on expanded capital employed which implies it is looking at faster growth in EBIT.

Sales organisation gearing for changing buying behaviour.

Enterprise buying behaviour is shifting to 1) everything on cloud, multi or hybrid cloud; 2) vendor consolidation; 3) tailored services for large enterprises, 4) increased spend on digital security; and 5) industry vertical such as automotive, retail, consumer etc are remodelling consumer experience or enriching services. It has two sale engines to capitalise the changing behaviour – 1) sell to: geographical break-up and industry / tech vertical; and 2) sell with: alliance with global system integrators (GSIs). It has segmented customers and focus remains on driving sales from top 1,000 customers. It plans to cross sell or up sell services driving funnel addition and simultaneously improve win rates.

Connectivity services – next generation connectivity growing at CAGR of 14.5%.

Though globally core connectivity services including leased lines, internet services and VPN are declining at 1.9% pa, next generation services including IZO platform, managed LAN and bandwidth on demand are growing at healthy 14.5% CAGR. Unlike core connectivity service where TCom did not enjoy any advantage over peers, it sees a shift to internet-based WAN putting the company in an advantageous position with slightly better reach, packaged services and integrated WAN with SLAs. It expects to win higher market share in next generation connectivity market.

Collaboration and connected solutions.

TCom believes its collaboration services come with holistic solution including global SIP connectivity which puts the company in a better position. Unlike wholesale SIP market, UCaaS has good contribution of revenue from fixed fees. TCom also plans to launch CPaaS soon which is a cloud-based platform for omni-channel communications on the software layer which can be accessed via APIs along with developer integration. The company sees very few player in market which can provide both UCaaS and CPaaS services.

Cloud and security services.

Multi cloud adoption is rising on application modernisation to benefit from portability, modularity and high availability (micro services). Cloud shit is driving end point protection gaining importance to zero trust architecture. The company is focused on driving private cloud with creation of government community cloud, BFSI cloud, SAP Hana grid and edge cloud. India cloud and hosting services grew at 24% CAGR to US$6.8bn. Managed security services is growing at CAGR of 8.1% to US$15.5bn. It provides full stake of WAN services from network integrated SDWAN, overly SDWAN and app-oriented SDWAN (NetFoundary) where industry is growing at 64% CAGR to US$6bn.

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