Tata Communications’ (TCom) Q2FY23 data revenue grew 4.6% QoQ / 11.2% YoY and showed significant acceleration though lower net revenue growth took away some lustre. Net revenue growth was hit due to various factors including the high base of Q1FY23, project execution cost, and low-margin new projects (showcase projects). Management is confident of orderbook build-up and sales funnel, and it hinted at easing supply chain issue. Therefore, data revenue growth outlook has turned brighter in our view and is likely to significantly accelerate. We believe net revenue growth will likely follow total revenue growth unlike this quarter. Lower EBITDA margin guidance of 23-25% is on intention to invest for growth, and absolute EBITDA expectation to improve eventually. Digital Services product portfolio is getting stronger, and Incubation had consistent growth in past few quarters which was lacking previously. Despite our optimism on growth, we are retaining EPS estimates with an upward bias as we wish to track consistency in performance. Our target price is unchanged at Rs1,500 (20x FY24E EPS). Maintain BUY.
- Data revenue rose 11.2% YoY / 4.6% QoQ to Rs35bn: We are closely tracking net revenue (total revenue minus direct cost), which is more representative of the underlying performance for TCom. In Q2FY23, net revenue was hit by higher direct cost due to acceleration in project execution, one-off in the previous quarter and lower-margin projects to showcase capabilities. Hence, net revenue growth decelerated to 9.6% YoY / 2.6% QoQ to Rs24.7bn. TCom remains positive on its near-term growth prospects in data business on the back of supply chain issue stabilising; it is maintaining inventory of hardware, and value addition from international business.
- Digital Platform & Services revenue grew 16.6% YoY / 6.2% QoQ to Rs10bn. However, net revenue grew slower at 9.3% YoY and was down 0.6% QoQ to Rs4.8bn. This was due to dip in Collaboration revenue, which was up only 1.1% YoY / 2.9% QoQ to Rs3.8bn. Cloud, hosting and security grew 21.9% YoY / 5.8% QoQ to Rs3bn. Next-gen connectivity and media revenue was up 31.7% and 40.1%, YoY. Incubation revenue rose by a strong 2.8x YoY (36% QoQ) to Rs1.2mn. Core connectivity net revenue was up 6.7% YoY / 2.4% QoQ to Rs19.3bn. Transformation business revenue dipped 3.9% YoY to Rs3.2bn.
- Orderbook remains healthy. TCom saw good growth in its orderbook during the quarter aided by rise in the project pipeline for Digital Services and Incubation. The quality of orderbook has also improved with more large-project deals. However, supply-chain disruption in equipment supply is hurting project execution and revenue booking, but it is expected to ease soon. Sales funnel for future orderbook is stable and the company said deal-win rate is healthy.
- Data EBITDA margin at 28.8%, down 20bps QoQ. Data business EBITDA fell 4.1% YoY (+3.8% QoQ) to Rs10bn. Core Connectivity EBITDA margin improved by 410bps QoQ, 70bps YoY, to 46.6%, but Digital Platform & Services dipped to EBITDA loss due to higher investment in marketing, and direct cost on project execution. Company has maintained its lower EBITDA margin guidance of 23-25% for the consolidated business and it wishes to invest margin back into the business to drive revenue growth. Though EBITDA margin was at the higher end of the guidance in Q2FY23, the company has plans to invest in the business, hence cost may come back-ended.
- FCF conversion remains healthy. TCom’s capex was Rs4.2bn in Q2FY23, which is lower compared to annual guidance of US$300mn capex for FY23. Net debt has increased by Rs2.7bn to Rs64bn in Q2FY23 on dividend payment of Rs6bn during the quarter.
- Other highlights. 1) Collaboration should benefit from the launch of new products in CPaaS space, which is finding good traction among customers; and SIP trunking dip has decelerated; 2) TCom won large deals in IZO FIN Cloud and Security SOC from two large organisation, NPCI and RBI REBIT; 3) company expects to maintain revenue growth of 25-30% in Digital Services excluding Collaboration; and 4) we notice company is launching many variants of new products based on solutions demanded by the user industries, and evolution of product portfolio is impressive particularly in Cloud, Security, Next Gen Connectivity and UCaaS (including CPaaS).