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Subdued results on weak core-connectivity growth

* Tata Communications (TCOM) reported weak results with consolidated EBITDA declining 1% QoQ (5% miss) and margins contracting 60bp QoQ to 19.4%. The reported revenue/EBITDA were boosted by INR865m prior period revenue recognition.

* Reported data revenue grew 3% QoQ (inline) with a modest 2.5% QoQ growth in core-connectivity and ~4% QoQ growth in digital portfolio, driven by 34% QoQ growth in Incubation. DPS revenue grew modest ~1.5% QoQ.

* TCOM management indicated that the order book was up 25% YoY in 2Q on account of large deal wins with OTTs and hyper-scalers as well as the highest order booking in five years in international business. The funnel continues to remain robust, though funnel additions have been subdued. Management has maintained its ambition of doubling data revenue by FY27 and bringing EBITDA margins back to 23-25% over the medium term.

* Our FY25-26E revenue is broadly unchanged as we build in ~11% data revenue CAGR over FY24-27, with data revenue reaching INR240b by FY27 (vs. TCOM’s ambition of INR280b). We believe TCOM’s ambition of doubling data revenue by FY27 remains a tall ask without further acquisitions.

* We lower FY25-26 EBITDA by 3-4% as we lower our margin assumptions by ~90bp on account of a slower ramp-up in profitability in the digital portfolio. With the rising share of inherently lower margin businesses in TCOM’s mix, we believe that margin expansion to 23-25% by FY27 would be difficult. We lower our SoTP based TP to INR1,790 (implying a 1% downside). The stock trades at ~20% premium to its LT average EV/EBITDA. We remain Neutral on the stock.

EBITDA down 1% QoQ (5% miss) on weaker growth in core-connectivity

* Consol revenue was up modest ~2% QoQ to INR 57.7b (inline). TCOM recognized INR0.87b as other operating income pertaining to reversals from the prior period.

* Data revenue at INR48b (inline) grew 3% QoQ, with core-connectivity growing 2.5% QoQ (3% YoY), while digital portfolio grew ~4% QoQ on account of 34% QoQ growth in Incubation. DPS grew modest ~1.5% QoQ.

* Consol EBITDA declined 1% QoQ to INR 11.2b (5% miss) due to lower growth in the higher margin core-connectivity segment.

* Consol adjusted EBITDA margin contracted 60bp QoQ to 19.4% (110bp miss) as the data margin came in 90bp below our estimate at 18.2% (down 110bp QoQ, -460bp YoY).

* Reported Consol PAT at INR2.3b declined 32% QoQ (+3% YoY, 26% miss). The company had exceptional gain of INR0.4b pertaining to gain on assets held for sale.

* Adjusted for the same, PAT after minority declined 25% QoQ (-17% YoY) to INR1.8b (40% miss) on account of lower EBITDA, other income, and higher interest cost.

* Net debt increased by further INR8.8b QoQ to INR105b on account of higher working capital (up INR13.5b in 1HFY25).

* Committed capex inched up to INR5.8b (vs. INR4.9b in 1Q), while cash capex was ~18% lower QoQ at INR4.5b

* Reported RoCE (annualized) declined further to 16.4% vs. 17.5% in 1Q.

* For 1H, TCOM’s EBITDA was up ~10% YoY and on our estimates, the ask rate of 2H is ~11% YoY EBITDA growth.

Key takeaways from the management interaction

* Order book: Management indicated that the order book was up 25% YoY, reflecting broad-based improvements across segments, including few large deal wins (commencement from 2HFY26). Further, order booking in international business was the highest in five years. Management indicated that win rates have improved, but the conversion cycle remains elongated due to slower decision-making.

* Funnel: The funnel remains robust, though the pace of funnel additions remains subdued.

* Doubling of data revenue: Management indicated that adverse macroeconomic factors were not considered in its guidance of doubling data revenue to INR280b by FY27. However, it continues to pursue its ambition of doubling data revenue by FY27.

* Margins: TCOM management noted that several costs were front-ended and margins for FY25 are likely to remain in the 20% range. It continues to aim for improving margins to 23-25% range by FY27.

* Strategies to monetize non-core assets: TCOM is looking to sell a land parcel to STT Datacenter for INR7.5b-INR8b and has filed for shareholders’ approval as the transaction is with a related party (TCOM has 26% stake in STT).

Valuation and view

* Our FY25-26E revenue remains broadly unchanged as we build in ~11% data revenue CAGR over FY24-27, with data revenue reaching INR240b by FY27 (vs. TCOM’s ambition of INR280b). We believe TCOM’s ambition of doubling data revenue by FY27 remains a tall ask without further acquisitions.

* We lower FY25-26 EBITDA by 3-4% as we lower our margin assumptions by ~90bp on account of a slower ramp-up in profitability in the digital portfolio. With a rising share of inherently lower margin businesses in TCOM’s mix, we believe that margin expansion to 23-25% by FY27 would be difficult.

* We ascribe 10X EV/EBITDA to TCOM’s data business and 5X EV/EBITDA to voice and other businesses. We ascribe INR26b (or INR92/share) valuation to TCOM’s 26% stake in STT Datacenters. We lower our SoTP based TP to INR1,790 (implying a 1% downside) on EBITDA cut and higher net debt. The stock trades at ~20% premium to its LT average EV/EBITDA. We remain Neutral on the stock.

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