A low-cost expansion strategy coupled with a changing business mix will help Tulip Telecom register consistent growth numbers.
The stock of enterprise data communications company, Tulip Telecom has run up substantially last week gaining almost 25 per cent and is trading at Rs 678. The market seems to be enthused by a decent September quarter performance and plans of the company to cater to new segments of the enterprise data market.
The company, which is primarily known for its expertise in offering wireless last mile data connectivity to corporates, is planning to augment this by laying fibre optic cable within cities. The company's Rs 100 crore expansion in major cities to be completed by the end of the current calendar year, will help it to increase the size of the enterprise data market it can cater to from Rs 1,000 crore currently to Rs 6,000 crore in the current fiscal.
Beyond wireless
Of the five segments which comprise the enterprise data market, Tulip Telecom caters to just one – the Rs 2,000 virtual private network (VPN) segment. A VPN allows corporates to transmit data across locations in a cost effective manner. The other enterprise segments are domestic and international leased business, corporate internet and VSAT.
Tulip is a market leader in the VPN market with a 28 per cent market share, but has only 6 per cent share in the overall enterprise data market. This, however, is likely to change as the expansion will not only help the company to strengthen its hold on the VPN, but will also bring it into play in other enterprise segments.
Challenges ahead
While an increase in the addressable market size is a positive, it will place the Rs 1,200 crore Tulip Telecom bang in the middle of a competitive landscape that includes four of India's largest enterprise data communication providers---Tata Communications (VSNL), Reliance Communications, Bharti Airtel and BSNL. While most telcos have their own fibre network within and between cities, Tulip Telecom leases its intercity network from players such Gail and Railtel. It is focussing on a low-cost strategy of developing infrastructure within cities.
Despite increased competition, the company believes that its infrastructure (provides connectivity in 1,300 cities and towns) and a significant presence in the last mile corporate connectivity space helps it to influence decision- making in areas that supplement its VPN business---managed services (data centres), internet and network integration projects.
Price war?
Analysts believe that the presence of large number of players will commoditise the market and benefit entrenched players with deep pockets. The company, however, says that it is the intercity bandwidth that is likely to see a price war while last mile connectivity (within the city) where it has advantages offers significant scope for revenue generation as well as enhancement of margins. The second area of concern for the company is the entry of telcos into the wireless corporate data connectivity space (its major source of revenue currently) by bidding for spectrum on the Wimax platform.
While a wireless corporate network has advantages such as quicker and inexpensive rollout, it has niche applications and is more suited for low bandwidth applications and remote location connection. A fibre network not only dramatically alters the list of services that can be offered such as domestic and international long distance connectivity as well as the high-speed internet, but has major cost benefits for corporates over the long term. With the fibre rollout, the company believes that the ratio of revenues (70 per cent) will tilt towards fibre, while those for the wireless network will come down to 30 per cent.
| WIRED PROFITS | |||
| Rs cr | FY08 | FY09E | FY10E |
| Net sales | 1,218.98 | 1,523.73 | 1,904.66 |
| Operating profit | 245.64 | 319.98 | 399.98 |
| Net profit | 187.11 | 198.08 | 285.70 |
| P/E (x) | 12.34 | 11.66 | 8.11 |
| E: Estimates | |||
Gradual climb
Despite being a new entrant and a smaller player, the company maintains that it will be able to keep its margins due to a prudent strategy of building its business based on customer requirements rather than get into a large capex programme upfront as is the case with most telcos. This could also help it in the current times when credit is hard to come by.
On the impact of the economic slowdown, the management believes that while corporate capex is coming down, opex-based business is quite robust with organisations implementing packages such ERP, CRM and video conferencing to reduce travel costs. In addition to the Rs 100 crore fibre investment in India's ten largest cities, the company plans to expand its presence to smaller towns and villages on the wireless network over the next two years at a cost of Rs 600 crore.
These expansions are to be funded from internal accruals (annual cash profit of over Rs 200 crore) and cash and bank balances of about Rs 450 crore (as on September 2008). Likewise, these funds could also be used to bid for wireless spectrum or a foray into the submarine cable business.
Investment rationale
After the expansion, the company should be able to grow revenues by 25-30 per cent due to a presence in the larger corporate market. But, for FY09, the growth could be a bit subdued, especially the net profit; the company has incurred a forex loss of Rs 10 crore in Q2, while employee costs have risen by 120 per cent to Rs 34.23 crore in first half. The latter is consequent to hiring of senior personnel for the foray into newer lines of business, which should pay well going ahead.
For H1, revenues were up by 51.6 per cent y-o-y to Rs 717 crore, while net profit grew by 46.5 per cent to Rs 96.1 crore. Notably, despite these, the company was able to sustain operating margins at 21 per cent by ramping up its customer base to over 1,000 and increasing the number connections therein by over 20,000 in the quarter.
The company believes that by focussing more on the data connectivity chunk of enterprise communications (OPM - 35 per cent) than the network integration (OPM-under 10 per cent), margins should actually improve.
It will also keep away from standalone network integration projects like the Rs 95 crore order it won recently from the Madhya Pradesh government. Going ahead, the company plans to take up new network integration orders as a part of an overall data connectivity package ensuring better margins.
Notwithstanding the sharp increase in prices, the stock is available at a PE of 8.1 times its FY10 EPS estimates of Rs 83.8. The EPS estimates are on fully diluted equity, assuming investors of the $150 million FCCB issue made in August 2007 (conversion price of Rs 1,137; due in 2012) opt for conversion into equity. The stock should fetch about 25 per cent over the next eighteen months.
