Tata Comm's fresh priorities to raise returns

Change in business focus and lower capex are positives; these will boost the company's stock valuations

The Tata Communications stock has gained 24 per cent over the last month, with half of the gains coming over the last week on clearance from South African competition commission on Neotel sale and brokerage upgrades. The stock hit a 52-week high of Rs 649.5 on Monday, gaining as much as six per cent.

Analysts believe the company, after its Neotel (fixed line telco in South Africa) and data centre sale, would have a leaner balance sheet and lower capital expenditure (capex) needs. This, coupled with a renewed focus on enterprise data vertical, should yield higher return ratios. The company had sold 67 per cent stake in Neotel to Liquid Telecom for an enterprise value (EV) of $460 million and 74 per cent stake in data centre business to ST Telemedia for an EV of $634 million. Both deals, announced five months ago, are expected to close in the current financial year.

  Analysts say that the funds employed in non-core areas of data centre and Neotel as well as payment solution or ATM business (the first two have been sold) will come down. The company may eventually sell the payment solutions business, which is generating sub-optimal return on capital employed. Of the FY16 capex, about 30 per cent was on these three businesses. Return on capital employed, which was in single digits over the recent financial years and 10.8 per cent in Q1FY17, is on track to enter mid-teens by FY19, belying investor concerns on weakness on exit of data centre business, say analysts at Religare Institutional Research. Data centre margin at 32 per cent is higher than the overall data segment margin of 22 per cent. Analysts say that data margins have consistently improved even if one were to exclude the data centre business.

The company is restructuring its operations, with revenue, customer, and services mix shifting towards data, enterprises, and managed services, respectively. From 50 per cent in FY13, data now accounts for over 60 per cent of revenues, while data contribution to Ebitda is 84 per cent now from 65 per cent three years ago. Ebitda is earnings before interest, tax, depreciation, and amortisation. From a service provider and carrier, the company has moved to being an enterprise-focused company (managed services). Finally, managed services' share of the services pie (the other is network services) has increased to 38 per cent from 29 per cent earlier.

Current valuations are not reflecting the higher return ratios that the entity can generate. From the current price, the stock, which trades at only over six times its FY18 EV/Ebitda, can generate about 15-20 per cent returns.