Land, operational factors triggers for Tata Communications

Land sales and improvement in return ratios would lead to re-rating

The Tata Communications stock is up four per cent over the last couple of trading sessions on the back of brokerage upgrades and moves to monetise surplus land. The government, which has a 26 per cent stake in the company, has reportedly approved the demerger and is approaching the National Company Law Tribunal (NCLT) for approval.

The surplus land of 740 acres was part of the erstwhile VSNL. The Tatas had purchased 45 per cent stake in VSNL in 2002. 
 

While the timeline for execution is unclear, analysts at Morgan Stanley believe the deal would benefit Tata Communications’ minority shareholders. They peg the value of the land at Rs 189 a share, which is expected to act as a catalyst for the stock.

Potential beneficiaries of the land sale, according to them, would be the government (51 per cent), minority holders who sold their stake to Tata via open offer in 2002 (25 per cent), and existing minority shareholders (24 per cent). 
 

On the operational front, improving data margins and higher return ratios after the recent restructuring are the key triggers. Rumit Dugar of BOB Capital Markets says recovery in return on capital employed (ROCE) will drive a re-rating of the stock. The company’s shift towards infrastructure-bundled telecom service is expected to expand the addressable market and enhances growth and returns prospects, he adds. He expects ROCE to improve from five per cent in FY17 to 13 per cent in FY20, given lower and better capital allocation and operating profit contribution from growth in the services segment. 
 

The company has been, over the past couple of years, getting out of higher capex and lower returns businesses. This led to the sale of its data centre business (74 per cent stake) and its operations (Neotel) in South Africa in FY17. The only low-return business in its portfolio, currently, is the payments service (white-label ATMs). The company is looking at exiting this as well. From being a business that leases out infrastructure, the company has been bundling services with investments in the cloud, networks and Internet of Things (IoT).

While these are delivering higher growth of 25 per cent, it is incurring losses at the operating profit level, as the business is scaling up. Once the business makes money at the operating level, overall operating margins should move from the current 13.7 per cent to over 17 per cent in FY20, Dugar said. 
 

Including the value of the land, the stock is trading at a reasonable eight times its estimated FY19 enterprise value to operating profit.