Worth taking a call

SPECIAL REPORT

IT service providers specialising in the telecom domain are poised to leapfrog thanks to the explosive growth in the telecom sector.

India's telecom sector is the third largest network after China and the US. However, with just 19 people out of every 100 in the country owning a phone, there is tremendous potential for Indian telecom operators (telcos) to grow, at least for the coming few years.

The sector is set to explode with telecom operators eyeing rural penetration (the current rural tele-density is a pathetic 1.9 per cent), and waiting to introduce 3G (third generation) services in a bid to increase the dipping average realisation per user (ARPUs).

Moreover, analysts estimate the capital expenditure of Indian telecom operators to be in the region of $20 billion over the next 3-4 years.

These measures offer a host of opportunities to players who offer information technology (IT) services to telecom operators.

The companies featured below are doing precisely this. And the strategy is paying dividends. While IT stocks in general have been registering 40-60 per cent growth in net profit rates year-on-year (y-o-y), these firms have been registering anywhere between 75 and 200 per cent growth rates. 
 

HOW THEY FARED
Financials (consolidated) Rs crore	Net Sales		Operating Profit		Net Profit		EPS (Rs)	P/E (x)
	FY07	Growth (%)	FY07	Growth (%)	FY07	Growth (%)	FY07	FY07
Tech Mahindra	2936.70	136.32	649.60	115.17	612.60	160.24	50.54	29.05
Subex Azure	340.90	87.90	80.06	50.74	67.57	78.43	19.41	30.82
GTL **	1156.29	54.25	144.06	2.83	97.18	38.97	9.97	22.81
Sasken Comm	477.13	54.85	80.62	71.97	44.27	93.15	15.53	32.00
Spanco*	429.74	114.74	67.15	60.57	34.81	100.40	16.86	15.17
Tanla Solutions	221.84	251.96	117.87	234.95	92.79	206.74	18.56	21.82
* Standalone ** Unaudited

However, since a majority of these companies derive a major share of their revenues from outside India, particularly the UK, they remain exposed to the risks of rupee appreciation versus the UK Pound Sterling (4.8 per cent from March 31-June 30) and euro (5.8 per cent from March 31-June 30).

These are, however, better off than most other IT service providers who have a larger portion of their revenues coming from the US, as the rupee appreciation against the dollar has been relatively higher at eight per cent.

Tech Mahindra
BT holds the key
Tech Mahindra's recent $1 billion five-year deal with British Telecom makes the stock attractive.

ENAM Securities analyst says the first year "would entail investments and transition pains (thus lower margins)" while revenues would scale up from the second year onwards.

They expect higher revenue and PAT accretion from FY09 onwards. Strategically, the analyst argues, the deal will enable the company leverage additional wins from BT and other players too.

For the FY07, the consolidated net profit, excluding exceptional and prior period items, stood at Rs 612.6 crore "� an increase of 160 per cent over the previous financial year.

Its consolidated revenue grew by 136 per cent and stood at Rs 2,937 crore. Analysts expect the revenues to rise around 60 per cent in FY08 to touch Rs 4,650 crore and the earnings per share to touch Rs 65.5.

The headcount of the company was up by 88 per cent and totalled 19,749. The utilisation percentage including trainees was at 67 per cent.

The company "� estimated to have a 9 per cent share in telecom vertical exports "� derived 18 per cent, 73 per cent and 9 cent of its revenues from the US, Europe and rest of the world respectively, and the number of clients increased to 83 in FY07 from 62 in FY 2005-06.

The company's top client (British Telecom) contributed 67 per cent to the revenue. The top five clients contributed 83 per cent whereas the top 10 generated 89 per cent to the revenue. The top client concentration is also perceived as a risk to the company's fortunes.

Tech Mahindra has been expanding its services portfolio in growth areas like BPOs and remote infrastructure management.

The company also entered into a joint venture with Motorola known as CanvasM to deliver targeted solutions in the form of value-added services (VAS).

And recently, it announced a strategic alliance with Sun Microsystems to provide systems and software for internet protocol television (IPTV) services to customers in India and the Asia-Pacific markets. 
 

IT SPEND BY TELECOM SERVICE PROVIDERS
($ bn)	2005	2006	2007	2008E	2009E	CAGR (%)
North America	9.0	9.4	9.9	10.4	10.5	3.9
Latin America	2.3	2.6	2.8	3.0	3.1	7.3
Western Europe	9.7	10.3	10.8	11.2	11.3	3.8
Eastern Europe	1.2	1.4	1.5	1.7	1.7	9.6
China-India	2.4	2.8	3.3	3.7	3.8	12.3
Asia-Pacific	4.5	5.0	5.3	5.7	5.8	6.4
MEA	1.4	1.7	1.9	2.1	2.2	11.3
Total	30.6	33.1	35.6	37.7	38.4	5.8

GTL
Networking pays
GTL is a Rs 1,160 crore (consolidated) leading network services provider that has alliances with original equipment manufacturers (OEMs) like Alcatel, Nortel, Nokia, Oracle and Motorola to provide solutions to local carriers.

This helps GTL to get bulk orders. The management expects to rollout 200,000 towers over the next 2-3 years.

Around 75 per cent of the company's business comes from India. It is now focusing on international markets and wants to increase the share to around 50 per cent.

Last October, GTL acquired Genesis Consultancy in an all-cash deal of $9 million (around Rs 40 crore) to help it expand its footprint into European markets and foray into the 3G services space.

GTL expects Rs 100 crore to be added to the revenue by Genesis in FY08. The company has earmarked Rs 1,000 crore for acquisitions and has made non-binding offers to companies with operations in the US, Europe, Middle East and Asia-Pacific regions. It has already raised Rs 682 crore through external commmercial borrowings.

Around 65 per cent of the company's business comes from network deployment which has the lowest margins among all segments of the network services' chain. GTL, therefore, is now concentrating on increasing its share in the network operations and maintenance and professional services business.

Around 6 per cent of the company's revenues comes from its largest customer; 46 per cent from the top 5 customers; 56 per cent from its top 10 customers. Around 78 per cent of GTL's revenues come from the telecom vertical. During the quarter ended March 2007, turnkey projects formed the greater part of the company's revenue.

Its operating profit for the third quarter was Rs 55.65 crore as against Rs 36.62 crore for the corresponding period in the previous year or y-o-y growth 52 per cent. 
 

TELECOM REVENUES
($ bn)	TSP	OEM
2005	1,201	308
2009	1,665	348
IT/ R&D SPENDS
2005	31	37*
2009	38	42*
* assuming ~12% of topline spend towards R&D and IT services Source: Company RHP, ENAM Research.

Sasken
It's all about research
Sasken Communication Technologies offers a hybrid model of services and products, and works with network OEMs, semiconductor vendors, terminal devices OEMs and operators.

For the full year ended March 2007, Sasken posted a consolidated profit after tax of Rs 44.3 crore, an increase of 93 per cent as compared to previous fiscal. The consolidated revenue of the company for the full year at Rs 477 crore, grew by 55 per cent y-o-y. The consolidated earning per share went up 73 per cent to Rs 15.75 as against Rs 9.08 in FY06.

Offshoring of research and development (R&D) work to India is expected to grow from $3.1 billion in 2005 to $6.6 billion in 2010 at a CAGR of 16 per cent. Sasken is a direct beneficiary of this global trend. Citigroup rates Sasken as a Buy with Medium Risk.

They expect Sasken's services business to record a 42 per cent CAGR over FY06-09. The acquisition of Botnia has helped in accelerating growth. Rajiv Mody, chairman & CEO, Sasken said the company would continue to focus strongly on the product business.

"Going forward, we should see Design-Wins (phone launches) happen on the multimedia subsystem product with various customers, including a global tier-1 customer, in the first quarter."

Analysts expect a ramp-up and a turnaround in the products business in the current financial year.

This is despite the fact that the share of the product business, which the company had been showcasing of late, has just contributed a minuscule 4.6 per cent to the total revenue of Rs 477 crore. Citigroup forecasts a 52 per cent CAGR in revenues over FY06-09 and see the business turning around from losses to a 30 per cent-plus margin in FY09.

The company has filed for more than 40 IPRs till date. Royalty revenues are expected to drive the product revenue growth in FY08. Analysts expect the company to generate around Rs 34-35 crore out of annual license fees and customisation fees in FY08 as against Rs 24.5 crore in FY06.

The company has 84 active clients. Revenue contribution from the top five customers stood at 73.6 per cent and from top 10 customers at 86.3 per cent.

Sasken's total employee strength in March 2007 stood at 3,611. The company improved the revenue share from Europe to 43 per cent although the share of North America to the consolidated revenue of the company dropped to 29 per cent, from 35 per cent in the FY06.

India and APAC contributed 22 per cent and 6 per cent to the company's consolidated revenue for the year. Sasken is now seeking to become a service provider to telecom operators, and is exploring the possibility of acquiring a company in this space.

Spanco
Integrating businesses
Spanco is a networking and systems integration player in India. From providing telecom integration services (over 90 per cent of its business), it is now extending its expertise to the Business Process Outsourcing (BPO) sector too.

The company's revenues for FY07 increased by 197 per cent to touch Rs 403 crore (excluding Sparsh) with a 282 per cent increase in the revenues from the telecom integration business. Its standalone net profit increased by 107 per cent to Rs 34.8 crore (not comparable).

Spanco's telecom integration division caters to the networking and networking infrastructure requirements of its target customers/segments. It assumes a turnkey responsibility in the supply of the requisite products and services under the PDIM (Plan Design Implement-Manage) model.

It recently bagged a 10-year contract to set up, operate and maintain call centres for the Indian Railways. The contract is expected to bring in revenues of Rs 800-900 crore for Spanco over this period.

Analysts expect a nearly 80 per cent jump in revenues in financial year 2007-08. BRICS Securities estimates revenues of Rs 778 crore and net profit of Rs 67.3 crore for FY08 "� translating into a fully diluted earnings of Rs 28.6 per share. Emkay analysts expect the revenues for the current year to increase 81 per cent to Rs 777.2 crore.

Subex-Azure
Betting on products
The company ended the year registering a 78 per cent growth in net profit for the entire fiscal to touch Rs 67.57 crore.

The revenue grew by 87.9 per cent to reach Rs 340.9 crore. The product revenue grew by 96 per cent to Rs 228.76 crore. While products contributed 67 per cent of the revenue, services accounted for the balance 33 per cent.

While 37 per cent of the revenue came from Europe and West Asia, another 36 per cent was contributed by the Americas. The APAC region accounted for 27 per cent of the revenue. And just last month, the promoters of Subex increased their stake in the company.

The product line witnessed a nearly 85 per cent growth during the fourth quarter ended March 2007. With the company acquiring Toronto-based Syndesis, the guidance for FY08 has been revised.

The company has projected Rs 615 crore of product revenue (an 80 per cent jump) and Rs 155 crore of net profit. The firm is a leading player in the fraud management and revenue assurance space and is estimated to have a 25 per cent market share. The addressable market is around Rs 1,600 crore and growing at 20 per cent CAGR.

Tanla Solutions
Signals growth
Tanla Solutions, a telecommunications software products and services provider, registered a total income of Rs 221.84 crore as against Rs 63.12 crore in FY06, registering a growth of 252 per cent.

The company's net profit of Rs 92.79 crore for FY07 is higher by 207 per cent when compared with the profit of Rs 30.25 crore in the previous year. Its earnings per share stood at Rs 18.56 during FY07. The consolidated results include Tanla Solutions (UK), a wholly-owned subsidiary, and Tanla Mobile, a wholly-owned subsidiary of Tanla Solutions (UK).

Tanla Solutions is a provider of integrated telecom infrastructure solutions and products. The company commenced business in the telecom products space, specialising in telecom signalling solutions.

In this area, Tanla has developed products such as SMS Centre, High Density Media Servers, Voice Mail Servers and Caller Ring Back Tone Servers.

In 2005, Tanla entered the aggregation business (now accounting for 71 per cent of its revenues) in the UK through Mobizar (now known as Tanla Mobsile), offering a range of SMS, MMS, WAP and 3G services.

Aggregators work on a revenue-sharing model. The company also provides Offshore Development Services, through which it provides technical expertise to some of its signalling solutions and aggregator customers, mainly content developers and mobile virtual network operators (MVNOs).

All the three businesses have high margins ranging between 35-90 per cent and enables Tanla to offer end-to-end telecom solutions. The company has strong business ties with Vodafone, O2, T-Mobile, Virgin, Orange and 3 (Hutchison). It plans to expand its geographic presence by entering newer markets.