Neutral Tata Communications Ltd For Target Rs. 1,660 by Motilal Oswal Financial Services Ltd
Aims to deliver profitable growth; margin expansion goal remains a tall ask
* TCOM has deferred its ambition of doubling data revenue to INR280b by one year to FY28, which implies a 3-yr CAGR of ~13% (vs. ~19% CAGR target over FY23-27 earlier). We believe the revenue goal is more credible (vs. FY23), though a tad optimistic and higher than our estimate (~8.5% CAGR or INR250b by FY28).
* Management aims to increase the share of its digital portfolio to 65% (vs. ~47% currently), which implies acceleration in digital revenue CAGR to ~26% (vs. ~25% CAGR over FY21-25, including large acquisition). We build in ~12% CAGR in digital portfolio over FY25-28 with share rising to ~52%.
* Moreover, management has reiterated its guidance of returning to 23-25% EBITDA margins and 25%+ RoCE over the medium term through improvement in digital margins to double digits (~INR15b EBITDA contribution, vs. ~INR9b loss currently).
* We believe ramping up digital margins to double digits would remain a tall ask, given inherent low margins and a significant share of resale business in TCOM’s digital portfolio.
* After significant time correction (5% return since 2023 analyst meet), valuations are now reasonable. However, we maintain our Neutral rating on TCOM with an unchanged TP of INR1,660 as we await acceleration in revenue growth, along with margin improvement in digital portfolio, before turning more constructive.
Goal of doubling data revenue deferred by one year to FY28, still a tad optimistic
* TCOM management has deferred its ambition of doubling data revenue to INR280b by FY27 to FY28 now, which implies a 3-yr CAGR of ~13% (vs. ~19% CAGR over FY23-27 earlier).
* Further, management indicated that any potential acquisition is not baked into the INR280b data revenue ambition.
* We believe the revenue goal is more credible (vs. FY23), though a tad optimistic and higher than our estimate (~8.5% 3-yr CAGR to INR250b by FY28).
* Management is aiming to increase the share of digital in data revenue to ~65% (vs. ~47% currently), which implies i) ~26% 3-yr CAGR (vs. ~25% CAGR over FY21-25, including Kaleyra acquisition) in digital portfolio, and ii) potential decline in core-connectivity revenue, which would hurt overall profitability.
* However, we believe the ambition of improving the contribution from its digital portfolio to 65% is very optimistic without any further acquisitions. We build in a 3-yr CAGR of ~12%in digital revenue to reach ~INR128b or ~51% share by FY28.
* Moreover, management indicated that ~33% of the incremental revenue over FY25-28 would be contributed by strategic bets (such as AI Cloud, Kaleyra.ai etc.) and capability shifts.
Aims to reach EBITDA of INR15b (double-digit margins) in digital portfolio, remains a tall ask
* TCOM management reiterated its ambition of getting back to 23-25% EBITDA margins (vs. ~19% in FY25) and ~25%+ RoCE (vs. ~16% in FY25).
* The key to margin improvement would be improvement in the profitability of TCOM’s digital portfolio (vs. ~INR9b or ~10% operating loss in FY25).
* Management is aiming for EBITDA of ~INR15b or double-digit margin in the digital portfolio over the medium term (implies before FY28, given the goal of reaching ~INR150b+ digital revenue by FY28).
* TCOM’s digital portfolio comprises inherently lower-margin businesses, with significant revenue share coming from reselling products and services from large enterprises and telcos, which would typically not have much headroom for margin expansion.
* We believe the goal of reaching double-digit margins in the digital portfolio would remain a tall ask and could become tougher with any further margindilutive acquisitions.
Strategy to go ‘deeper with fewer’ delivering results
* TCOM continues to focus on going deeper with fewer clients and added 16 new accounts to its USD1m+ clients (MDC) to reach 290 in FY25.
* TCOM’s revenue growth from USD1-10m accounts was ~1.3x and higher ~2.1x growth from USD10m+ accounts.
* Management indicated that a new logo takes ~18 months to become MDC and each MDC has the potential to grow to USD10-50m.
* Further, its digital portfolio already accounts for 50%+ of revenue for 53% (~155) MDCs, with 70% of USD5m+ customers opting for 3+ of TCOM’s fabrics.
* Management aims to sharpen its focus on top accounts and is targeting 80% of MDCs to have 3+ fabrics, which results in higher share of customer wallet.
Valuation and view
* We currently model a ~12% CAGR in digital revenue over FY25-28 and expect digital to account for ~51% of TCOM’s data revenue by FY28 (vs. ~48% in 4QFY25). An acceleration in digital revenue remains key for re-rating.
* Our earnings estimates are unchanged. We believe TCOM would still fall short of its ambition of reaching INR280b in data revenue in FY28 without further acquisitions. Overall, we build in a ~9% data revenue CAGR over FY25-28, with data revenue reaching INR250b by FY28.
* We continue to believe management’s expectation of returning to 23-25% EBITDA range over the medium term remains a tall ask and build in a more gradual margin expansion to ~22% by FY28.
* We ascribe 9x Jun’27E EV/EBITDA to TCOM’s data business and 5X EV/EBITDA to voice and other businesses. We ascribe an INR30b (or INR104/share) valuation to TCOM’s 26% stake in STT data centers. Our SoTP-based TP remains unchanged at INR1,660.
* After significant time correction (5% return since 2023 analyst meet), the stock currently trades at reasonable 11.3x one-year forward EV/EBITDA (~10% premium to LT average).
* We reiterate our Neutral rating as we await acceleration in data revenue, along with margin expansion, before we turn more constructive.
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