Tata Communications’ (TCom) Q1FY24 data and digital services revenue (organic) grew 14.2% and 28% YoY, respectively, which is significant acceleration vs consensus estimates. It believes the growth is likely to sustain, and remains committed to achieving INR 280bn revenue by FY27E in data services. Though underlying data EBITDA margin has improved 60bps QoQ, reported EBITDA margin has been impacted by acquisition-related costs. We continue to like TCom’s determination to become a strong digital services player, which we believe may drive significant value creation. However, EBITDA margin can remain sub-optimal for 1-2 years due to merger of loss-making entities The Switch and Kaleyra. TCom remains committed on turnaround of these businesses, and potential synergy benefits to services offering. Maintain BUY.
Data revenue (organic) grew 14.2% YoY / 4% QoQ
Including The Switch Enterprises acquisition, data revenue rose 17.1% YoY / 6.6% QoQ to INR 39bn in Q1FY24. Data net revenue increased 4.6% QoQ / 12% YoY to INR 27bn. TCom has clarified that it had no one-off gains in revenue, and orderbook remains healthy. It is benefiting from ramp up in new products, including DIGO, Global Rapid, InstaCC and IZO variant, which is helping it accelerate revenue growth. It is also aided by significant sales force addition done in the past 12 months. Cloud adoption remains strong, which is also driving increased requirement network transformation. Core connectivity benefited from strong demand in APAC region.
Digital services revenue (organic) grew 28.1% YoY / 8.5% QoQ
Including The Switch Enterprises, revenue rose 37.5% YoY / 16.5% QoQ to INR 14bn. Net revenue improved 31.8% YoY and 15.5% QoQ to INR 6.9bn. Collaboration revenue increased 19.4% YoY / 13.5% QoQ to INR 4.4bn, which has benefited from strong traction in its CPaaS platform. Cloud, hosting and security grew 24% YoY / down 2.2% QoQ to INR 3.5bn. Next-gen connectivity was up 46.3% (+15.1% QoQ) to INR 2.2bn. Media services revenue (organic) grew 39.8% YoY (36.3% QoQ), and including The Switch merger, revenue was up 2.1x to INR 2.9bn. Incubation revenue grew 27.2% YoY (down 15.5% QoQ) to INR 1.1bn. Core connectivity net revenue was up 6.5% YoY / 1.4% QoQ to INR 20bn. Transformation business revenue rose 7.3% YoY to INR 3.4bn.
Data EBITDA margin at 23.7%, down 30bps QoQ, but on underlying basis has improved 60bps
Data business EBITDA fell 4.3% YoY (+5.3% QoQ) to INR 9.3bn. EBITDA margin was impacted by rise in operating costs driven by: 1) Higher employee cost, which rose 4.4% QoQ and 29.4% YoY on >1,000 addition in employee count, and rise in employee cost due to higher attrition; 2) network cost has increased by 2.1% QoQ and 7.4% YoY on investment in new product developments, while other expenses rose 15% QoQ and 18.6% YoY on integration cost for The Switch merger, and some cost-related acquisition announcement of Kaleyra.
TCom has maintained its EBITDA margin guidance at 23-25% for consolidated business in medium term; however, integration of The Switch, and Kaleyra may be EBITDA dilutive, dragging the consolidated EBITDA margin below the guidance for 1-2years. TCom expects scale and synergy benefits to help drive margin improvement for these businesses over the next few years.
FCF conversion remains healthy
TCom’s capex was INR 4.3bn in Q1FY24 (9.1% of revenue); it maintains capex guidance of USD 300mn for FY24. Net debt increased by INR 3bn QoQ to INR 60bn due to payment of INR 4.8bn for The Switch acquisition, seasonality impact on working capital and annual bonus payout.
The Switch acquisition started contributing to revenue
The Switch financials have been integrated wef May 1, ’23, and it contributed INR 970mn to revenue (under media segment), and INR 460mn net revenue. However, it has dragged EBITDA and PBT by INR 100mn and INR 216mn in Q1FY24, respectively. TCom has already started releasing the benefits of strong production capabilities from The Switch, and has started penetrating the European market. Its media business has expanded capabilities on edge-delivery.
We have aligned revenue recognition in line with company reporting, where real estate revenue is included in top line (earlier in ‘other income’). We have also updated our model for FY23 annual report. Our EPS estimates have increased by 7.3% for FY24E and 2.1% for FY25E. Accordingly, our target price has increased to INR 1,850 (INR 1,810), valuing the company at 24x FY25E EPS (unchanged). Maintain BUY.
Slower-than-expected execution in digital services revenue, and 2) continued investment in costs keeping pressure on margins.