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Recovery playing out slowly and steadily

* Tata Communications (TCOM)’s 1QFY22 revenue/EBITDA was up 1%/-3% on a QoQ basis. It reported an 8% EBITDA miss on lower data traffic, impacted by the lockdown and provisions towards a newly implemented 8% license fee on ISP data traffic revenues. This marked the third straight quarter of EBITDA decline.

* We revise down our EBITDA estimate by 4% for FY23 due to the stock’s lower than expected business performance, although we expect a 7%/8% revenue/EBITDA CAGR over FY21-FY23. Maintain Neutral.

EBITDA down 2.9% (8% miss); flat QoQ, adj for provisions

* Consolidated revenues were flattish at INR41b (up 1% QoQ; 2% miss), led by 5.5% growth in the Voice business, while Data revenue was flat. Usagebased revenues were impacted by the lockdowns affecting collaboration traffic in the Data segment.

* EBITDA declined 3% QoQ to INR9.9b (8% miss), primarily due to the impact of INR330m worth of provisions on account of an 8% license fee newly implemented by DoT on ISP revenues – the new license fee has also impacted Bharti’s Homes and Enterprise businesses (charges on pure Internet services, which were allowed as a deduction earlier). Subsequently, the EBITDA margin contracted 90bp to 24%. Normalized for the provision impact, EBITDA would have been flat QoQ at INR10.2b.

* TCOM’s PAT was in-line (-1% QoQ) at INR3b, whereas PAT adj for exceptional items stood at INR2.9b (down 3% QoQ; 7% miss)

* 1QFY22 capex stood at INR3.8b v/s INR3.7b in 4QFY21 and FY21 capex at INR14.2b.

* Net debt grew marginally to INR80b (v/s INR77.9b in 4QFY21). The management attributed this to annual employee bonus payouts in 1Q and higher working capital – which tends to be elevated at the start of the year.

Highlights from management commentary

* Funnel improves; targeting smaller deals: The deal funnel improved and is expected to drive revenue. However, it is seeing longer lead times in closing large transformation deals. Hence, it is focusing on smaller margin neutral deals to support growth.

* Recovery in place, albeit likely to be gradual: 25% of usage-based data revenue and IoT products are seeing slow traction due to the COVID impact, but witnessed a reversal in trends during the quarter.

* Capex guidance: Guidance stood at ~USD250m for FY22, driven by new orders, maintenance capex (2% of revenue), and strategic capex. It may spend higher to tap growth opportunities.  EBITDA margin: Guidance was maintained at 23–25% for the long term.

Valuation and view

* The recent rejig in business segments and focus on driving larger deals in the digitization-led business advocate healthy growth. Management commentary on deal wins and demand for networking solutions have also been bullish since the COVID outbreak. However, revenues for Data – the key growth driver – have been muted (down 2% YoY). This has dragged down overall EBITDA growth by 2%, even after adjusting for the newly implemented license cost.

* We see limited incremental margin improvement of 40–50bp over FY21–23E, against nearly ~800bp over the last two years. Therefore, deal wins and deal-torevenue conversions would be the key monitorables over FY22–23 for achieving double-digit earnings growth.

* We revise down our EBITDA estimate by 4% for FY23 on lower-than-expected business performance. We maintain a Neutral rating, with TP of INR1,555 (assigning 10x/3x to EBITDA for the Data/Voice business).

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