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The Tata Communications (Tata Comm) stock was up eight per cent to Rs 202.50 on news that the company was in exclusive talks with Vodacom for sale of Neotel, its South African subsidiary. While the company did not disclose the amount involved in the sale, analysts estimate it in the $500-$590 million range.
Analysts say a deal will be beneficial given that it will help Tata Comm pare down its consolidated debt of Rs 12,000 crore as well as improve profits. Neotel, which accounts for 11 per cent of consolidated revenues, was a loss-making entity and has a debt to the tune of Rs 3,000 crore.
While so far analysts were not ascribing any sum-of- the-parts value to Neotel given losses (Neotel's contribution to each Tata Comm share in fact is a negative value ranging from Rs 15 to Rs 30), its sale could add anywhere between Rs 33 and Rs 85. Say Rohit Chordia and Shyam M of Kotak Institutional Equities Research, "Even at zero equity value the transaction would mean a value accretion of Rs 33 a share to Tata Communications' sum of the parts valuation. Every additional $100 million in deal equity value is worth Rs 15 a share for Tata Comm." If the equity value of the deal is taken at $500 million, analysts believe that the deal could increase Tata Comm's fair value by Rs 85-100 a share.
Tata Communications has so far invested $400 million in equity investments for its 67 per cent stake in Neotel. The company had in FY13 increased its stake by 2.5 per cent and brought it to the current level by paying $14.9 million, thus pegging the equity value of Neotel at $596 million.
In addition to the deal which is a positive, the stock could further re-rate given reduction in capex, improvement in business performance and further asset sales. Ebitda margins, which were under 12 per cent in FY13, have improved to 14.5 per cent in the June quarter and are estimated to be 15 per cent for the September quarter aided by rupee depreciation and lower costs. CIMB analysts say while the sale could be a significant re-rating catalyst, other positives are reduction in capex intensity and further deleveraging in its core business as well as potential demerger of surplus land.
At the current price, the stock trades at 5.5 times its FY15 Enterprise Value/Ebitda. Most analysts have a buy or outperform rating on the stock with a target price of Rs 250-330.
Tata Comm has been struggling to post a profit for some years now given the falling international call rates and consequently weak performance of its voice business, which is the largest segment contributing to 50 per cent of consolidated revenues. High capex and leverage (net debt to ebidta at over five times) have not helped. Things could change going ahead as both capex moderates and data business (which accounts for about 39 per cent revenues) provides the growth boost.
Analysts at Religare estimate the company will post 10 per cent annual revenue growth in FY13-15 with higher growth from the data business offsetting the slower growth of the voice segment. Growth in the data services business is likely to come from managed services and Tata Communications Payment Solutions, which among other services runs the network of white label or independent automated teller machines. On the capex front, the company has indicated in a recent investor call that its capex and debt levels have peaked and are starting to reduce now. The company has guided for an annual capex of $300 million a year going forward or about 10 per cent of sales as against 15.5 per cent in FY12.
High business growth, especially on the data side, coupled with lower capex and interest costs should help the loss-making company post net profits in FY15. And, analysts are watching the performance on the operational side keenly. "The Street will look at performance going ahead especially on margins which have been erratic (11-14 per cent). While peak capex is behind the company and cash flows should improve, consistent growth in revenues will also be a key monitorable," says an analyst with a foreign brokerage.
Vodacom, which is 65 per cent owned by Vodafone, is among the leading wireless services providers in South African market. Kotak's analysts say Neotel, the second-largest wireline operator in South Africa, has assets including national core fibre (around 15,000 route-km), metro fibre (roughly 8,000 km in Johannesburg, Cape Town, and Durban), capacity in five subsea cable systems, and wireless spectrum (five MHz in 1,800MHz band, 12 MHz in 800MHz band, and 28 MHz in 3.5GHz band - all paired). They believe Neotel has not commercially deployed its wireless spectrum; this is where a transaction can happen at a value significantly higher than the going-concern value they have been ascribing thus far.
