Near-term pressure for Tata Comm’s data biz

While sale of surplus land ends that uncertainty, execution in the core business has to improve if stock is to be re-rated

The monetisation of Tata Communications' surplus land is finally taking off, after the board of directors approved its transfer to a separate company, Hemisphere Properties. Minority shareholders will get a share in the new entity for every one held in Tata Communications (Tata Comm). The government owns 51 per cent, while minority shareholders of Tata Comm and the erstwhile VSNL have 25 per cent and 20 per cent, respectively; Tata Sons has four per cent.

Going ahead, the newly demerged entity, whose land holdings are valued at ~9,400 crore, will be listed. About 60 per cent of the 740 acres is in Delhi. Analysts at ICICI Securities say the listed entity could operate as a real estate company and, therefore, the net asset value after development could be much higher. They peg the value of the land at ~263 a share. Most analysts had estimated ~180-220 prior to the announcement and the higher value attributed had led to the stock gaining about two per cent in trade on Thursday.

The spinoff of the assets will also improve the capital structure, as the restriction in raising funds through the equity route will be removed. The next trigger, say analysts, could be sale of 26 per cent stake by the government to a strategic investor.

With the surplus land demerger finally completed, investors will now focus on execution in the core business. The growth in data revenues, 66 per cent of the total, will be key. The segment underperformed in the September quarter, impacted by consolidation in the telecom sector (RCom shutting down its second generation tech services and Aircel in consolidation mode) and sale of mobility services (Tata Tele) to Bharti Airtel.

Analysts believe the data services business, which disappointed in the quarter with growth of 1.7 per cent over a year, will recover in FY19. This, says Maybank’s Kim Eng, will be driven by continuing momentum in growth services, larger contracts for innovation services (internet of things, crossborder mobility), client mining (higher number of products sold per client) and new client wins.

Growth services (a fourth of the data segment) is growing at 35 per cent yearly as compared to 2025 per cent in earlier quarters, with higher business from cloud, streaming and video connect services. The innovation services business is yet to contribute in a major way to revenue, though the management expects this to rise over the coming quarters. The company expects the growth services business to achieve operating profit break-even by the end of FY18 and margins to hit mid single-digits in a year.

While the management has not indicated a timeline, acquisition of the enterprise business of Tata Teleservices at reasonable valuations will help expand the market share. Given the higher churn in traditional services, investment in digital transformation programmes and higher personnel costs in the September quarter, analysts have cut their FY18 revenue and operating profit numbers by three to seven per cent.

While growth in the data business could see an uptick in FY19, voice services (a third of revenue) will continue to see only single-digit growth, due to pricing pressure. Voice segment revenues were down 20 per cent in the September quarter and its margins, too, at seven per cent are less than half of the data segment.

Analysts at ICICI Securities see near-term uncertainty from impact of the Tata Tele wireless divestment on Tata Comm’s earnings, shutting of operations by some challenger telecom companies and possible acquisition of Tata Tele's enterprise business. They also expect the gearing levels (net debt to operating profit at 3.4 times) to increase to about 3.7 times if the deal comes through. Total net debt is $1.2 billion (~7,700 crore). While some brokerages have increased their target price for the stock, improved traction in revenues from the data segment and margin trajectory will be key if it is to be re-rated. At the current price, the stock is trading at 35 times its FY19 earnings estimate.