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Plugging the gaps through inorganic route

Tata Communications (TCom) has agreed to acquire Kaleyra, a US-based omni- channel integrated CPaaS player for enterprise value of US$250mn (0.73x CY22 sales). This is likely to enhance TCom’s global position in CPaaS services (which is growing at 25% CAGR as per Juniper), and with The Switch acquisition, TCom’s position in the US may become stronger. Strong digital businesses in the US can assist TCom to cross sell other products, thereby, improving market share in core connectivity and Digital services. It aims to grow data revenue by 2x to Rs280bn by FY27. The loss-making acquisition may drag EBITDA margin down in the near term; however, TCom aims to reach 23-25% margin in the medium term. Its balance sheet remains healthy, and the acquisition is unlikely to deteriorate the position. We have not baked in the acquisition in our estimates, and with increasing revenue outlook, we increase our valuation multiple (PE) to 24x (from 22x) FY25E, and accordingly raise target price to Rs1,810 (from Rs1,665). Maintain BUY.

* TCom to acquire CPaaS platform player Kaleyra Inc. TCom has entered into a definitive agreement to acquire Kaleyra, Inc. (NYSE: KLR) for an enterprise value of US$250mn with cash payment of US$100mn, and net debt of US$150mn. It is paying US$7.25/sh while closing price for NYSE: KLR on Jun 27, ’23 was US$4.8, which implies a premium of 50%, and 80% premium to Jun 26, ‘23 stock price. Kaleyra had revenue of US$339mn in CY22, therefore, implying TTM EV/sales at 0.73x; however, the company had EBITDA loss of US$15mn (negative 4% EBITDA margin). TCom expects this transaction to complete in 6-9months, and take Kaleyra Inc private. Kaleyra is a global omni-channel integrated communication services provider with a set of proprietary platforms, offering targeted personalisation through messaging, video, push notifications, e-mail and voice-based services, and chatbots. This is the third acquisition by TCom wherein it is plugging the gaps in its digital platform & services (DPS) by acquiring – 1) Oasis Smart SIM Europe SAS (Oasis), embedded- SIM (eSIM) technology provider to augment MOVE / IOT business (link); 2) The Switch Enterprises to strengthen its (TCom) region-to-region media services in the largest US market (link); and 3) and now Kaleyra, a CPaaS player largely in US, Europe and Indian markets.

* Acquisition rationales – scale, geographical expansion and synergy benefits. TCom has highlighted certain strong objectives behind Kaleyra acquisition – 1) TCom has been a late entrant into the fast growing CPaaS market with the launch of Digo, which has received encouraging response in India and APAC region. Digo is also omni-channel communication service provider focused on large enterprises, and Kaleyra is also focused on large enterprises with very little overlap of customers and geographies. Kaleyra is strong in US and Europe, while Digo is focused at APAC; 2) Juniper Research anticipates CPaaS revenue will reach US$32bn by CY26, rising from US$10.2bn in CY22. Juniper Research also anticipates SMS to remain the most widely used channel for A2P messaging over the next five years despite the rise of rich media messaging and the popularity of OTT messaging applications. CPaaS revenue from SMS business messaging traffic is expected to reach US$24.3bn globally, rising from US$9.4bn in CY22; and 3) TCom anticipates synergy benefits wherein it expects to reach EBITDA breakeven soon and progress to achieve double-digit EBITDA margin. It has strong relationships with telecom operators, owns large telecom infrastructure and has combined SMS buying for Kaleyra and Digo.

* Our key expectations from Kaleyra acquisition. 1) TCom’s ability to improve product mix from SMS-heavy services to IP-based multi-channel communication. Kaleyra had earlier targeted to expand its non-SMS revenue at 20% (SMS is still 80%). We believe Rich Communication Services (RCS), and other types of IP communication services such as email, push notifications, video/audio/chat, and WhatsApp will continue increased adoption; 2) continue to grow market share. CPaaS' market in the near term is likely to be slow (<5% revenue growth) as guided by Kaleyra due to uncertainties in the US market from financial crisis, high inflation, consumption slowdown etc. Further, the business has seasonality with H2CY23 being strong. Kaleyra has guided for 20% EBITDA growth in CY23 and 3) better gross profit margin to >25% sustainably, and EBITDA margin in double digit (early to mid-teens). To watch out synergy benefits accretion from large infrastructure owned by TCom on margins.

* Update to CY23 Investor Day-2023. 1) Two loss making entity acquisitions – The Switch Enterprises and Kaleyra- can temporarily drag TCom’s EBITDA margin below its guidance level of 23-25%; company will aspire to maintain EBITDA margin at guided levels in the medium term; 2) it does not see much deterioration in leverage position and will remain under the guided levels of <2x EBITDA; and 3) despite inorganic acquisition, TCom will continue to accelerate growth in existing businesses to reach data revenue of Rs280bn by FY27.

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