Tejas Networks: Strong growth prospects, premium valuations

Prices could have been more attractive, due to weak financials

Tejas Networks, India’s second-largest telecom networking product maker, will be banking on the robust growth prospects of the $600-million Indian optical networking sector to power its revenues. The Indian market, which contributes 63 per cent of its revenues, is expected to grow at an annual rate of 14 per cent to hit $869 million by 2020. 

The triggers for the higher growth rate is the exponential rise in data consumption and government initiatives to increase broadband access in the country. Given that less than 20 per cent of cell phone sites in India are connected by fibre and as data demand growth requires faster and broader capacity, telcos would need to make investments to “fiberise” their networks, fuelling growth for the company. 

Some of the growth in higher telecom spends by private and government players has been captured by Tejas and is reflected in its revenues which have shown an annual growth of 27.5 per cent over the FY14-17 period. This growth, however, has largely come in FY16 and FY17, while revenues in the FY13-15 period were flat. The company indicated there would be some lumpiness of revenues but it would follow an upward trend as has been the case over the past couple of years. 

The other issue is the higher working capital cycle. Given the supplies to larger service providers and concentrated client base (the top 5 account for 60 per cent of revenues), the firm’s bargaining power is low. Some of this is reflected in the working capital cycle of 166 days, though it has come down from 274 days in FY15. About 70 per cent of the issue proceeds would be used for working capital requirements.

While the company spends about 8.3 per cent on R&D, it has to continuously upgrade its product features both to accommodate client requirements as well as to keep an edge over competition. The company had to take a one-time write-off of ~30 crore in FY17, which led to net profit getting reduced by that amount. Higher R&D spends will be critical if it were to match competitors, led by large global companies Huawei, Alcatel-Lucent, Ciena and ZTE. Huawei’s market share at 36 per cent is more than twice that of Tejas.

Given lack of pricing power, higher volumes is the only trigger to improve revenues. Improvement in revenues and operating leverage was responsible for the company improving its operating profit margins from 17.7 per cent in FY15 to 19.6 per cent in FY17. The roll-out of the government programmes and private sector expansion will be key in ensuring higher volumes for Tejas. While the growth prospects are strong, given pricing and other challenges it should have priced its offering at better than the 24x it is asking on FY17 adjusted net profit and diluted equity base. Investors with a higher risk appetite can consider the issue with a longer-term holding period.