Riding the airwaves

Niren Shah / Mumbai March 17, 2008
The Indian information technology and software space has lost its charm over the past one year due to the rising rupee as well as the imminent US slowdown, which is likely to result into cuts in IT-budgets of multinationals around the world.
 
This means slower revenue and profit growth for most software majors across the board. More so, discretionary IT expenditure would be the first to be chopped off by the clients abroad.
 
On the other hand, generic service providers catering to sectors like banking and financial services or insurance, with services which are somewhat indispensable too would face margin pressures due to lack of growth in the underlying sector, the loss of pricing power and the need to increase offshoring. One therefore wonders whether software services companies could be trusted or not for investing.
 
It is however, not yet the moment to despair, since there are other avenues in the technology space, which offer steady demand growth, and high margins. These are companies which provide specialised services to telecommunications companies. They thrive on the specific intellectual property they own, because of which they win their clientele and dominate the marketplace that they operate in. These factors act as significant entry barriers.
 
Considering only the Indian telecom space, the numbers that pop out are enormous. As on January 2008, there were over 237.9 million wireless subscribers with a 60 per cent y-o-y growth. Despite slower growth, the wired line subscriber base is increasing steadily from the present 273 million.
 
In other developing markets, the scenario is not very different. For the developed counterparts, even though the subscriber base may not be growing significantly, telecom majors are increasingly cross-selling value-added services (VAS).
 
We have handpicked companies offering software services and equipment to telecommunications players, which are indispensable in nature, thus making the technology spend non-discretionary. Since the demand for these services is directly proportionate to the growth in telecom subscriber base and the usage of various services, the good prospects for the telecom industry will augur well for these companies too.
 
Thus there is also potential for upward revision in valuations of these technology companies, which are almost half that of telecom majors.
 
Apart from the companies we recommend, frontrunners like Subex and Sasken Communication also are part of the game, but the recent turnout of negative events keeps them out of the outperformers' league. For these two companies, investors may want to wait and watch for positive signals over the coming fiscal. Read on, for more.
 
Gemini Communications
 
Gemini Communications provides network integration and technology infrastructure management services to telecommunications operators, with operations across India, Taiwan and Europe. It provides last mile wireless telecom infrastructure, broadband wireless and Wimax solutions to telecom companies and internet service providers.
 
Besides, it also has some offerings in the radio frequency identification (RFID) equipment and software for supply chain management. It also provides turnkey project consultancy to corporates for telecom and network infrastructure roll out.
 
At the end of Q3 FY08, Gemini had a pending order book of Rs 260 crore, of which it plans to carry Rs 160-170 crore to FY09. Recently, it invested Rs 80 crore in capacity expansion for radio frequency and Wimax services. The company has a track record of maintaining operating profit margins at 25 per cent, and expects to sustain this.
 
With an estimated 17 per cent revenue growth, net profit growth of over 70 per cent, capital expenditure cycle nearly done and economies of scale kicking in, the numbers for FY09 appear decent. Add in the cheap valuations of 7 times estimated FY09 earnings, and it becomes an attractive package. 
 
GROWTH PICKS
  Market Cap
(Rs crore)
CMP (Rs)
As on Mar 14
3-yr CAGR
(%)**
Revenues
 (Rs crore)
OPM (%) EPS (Rs)
FY09E
P/E (x)
FY09E
Revenues PAT FY08E FY09E FY08E FY09E
Gemini Communications 266.8 150.0 41.3 169.9 240.0 335.0 26.0 24.0 22.0 6.6
Kavveri Telecom 223.4 224.3 65.5 187.0 150.0 170.0 16.5 17.0 18.0 12.7
Megasoft* 358.8 79.8 33.8 240.1 300.0 480.0 30.0 32.0 27.0 3.2
Onmobile Global 2937.7 517.3 99.0 100.8 235.0 350.0 47.0 45.1 13.0 39.8
Tanla Solutions 2872.3 550.2 126.0 166.6 450.0 630.0 45.0 43.0 45.0 13.1
Tulip IT Services 2819.1 956.9 45.2 147.1 1200.0 1600.0 21.0 23.0 74.0 12.6
* year-ending December ** Between FY04-07
 
Kavveri Telecom Products
 
Another niche company, Kavveri Telecom Products makes antennas and radio frequency equipment for wireless telecom operators, defence and space applications. The company has been adding to its product and intellectual property portfolio organically as well as inorganically.
 
Last year, the company made two acquisitions in Canada – DCI Digital Communications and Til-Tek – adding telecommunication filters and specialised antennas to its product portfolio, and the third one was an acquisition of technology, intellectual property rights (IPRs) and patents from Sigma Wireless, an Irish design and manufacturing company for cellular and telecommunication antennas.
 
This January, Kavveri acquired US-based Spotwave Wireless, which entitles the company with intellectual property, new products and an established client-base. Besides, it plans to invest Rs 13 crore in its own research and development, which will aid in adding newer products to its kitty. Kavveri boasts an impressive clientele including the likes of Alcatel-Lucent, Bharti, BSNL, Ericsson, Nokia, RComm, Tata Tele and Vodafone.
 
Thanks to the massive investments by mobile players, Kavveri has grown at 66 per cent a year over the past three years. Profitability too has been on a rise – operating profit margin went up from 11 per cent in FY06 to 16 per cent in FY07. Net profit margin has doubled to 14 per cent. Going forward, the margins are likely to improve further as the company adds new IPRs and capacity, resulting in better realisations and economies of scale.
 
At Rs 242, valued at 13 times one-year forward earnings, the stock may appear tad expensive compared to the other picks featured here, but appears reasonable given the growth profile.
 
Megasoft
 
Megasoft provides software solutions to telecom and information technology companies via its two divisions. Xius, its telecom division, provides advanced roaming, billing support, call traffic management and network integration software products. BlueAlly offers application development and software consulting services to other businesses, on the lines of any other software business.
 
Although both the businesses contribute equally to the top line, the management expects the telecom business to register a whopping 90 per cent y-o-y growth in the coming fiscal, while the customised software business will continue to grow at the usual 20 per cent y-o-y.
 
Megasoft has made a number of acquisitions in the past, the latest being the US-based Boston Communications Group, last year. This acquisition brings in a number of marquee clients in the telecom space, and will increase the contribution to the company's top line from the telecom business to 70 per cent going forward.
 
Megasoft's standalone financials took a dip in the last few quarters due to rupee appreciation. However, the consolidated profitability is high with operating margins in excess of 30 per cent, and net margins close to 20 per cent, helped by higher growth in the telecom business.
 
Although the company may lose some of its profits in taxes as the software technology park benefits end in FY09, it is expected to improve efficiencies and bring in benefits of scale, to neutralise the impact to some extent. With an estimated CY09 earning per share of Rs 27, the stock is cheap at less than 4 times.
 
OnMobile Global
 
The recently listed OnMobile Global did invoke some investor interest as it continues to trade at a premium to its already expensive IPO price. OnMobile boasts of a 95 per cent share of the Indian telecom value-added-services market. It functions as a content aggregator, provides software application services and delivery platforms for various value-added services that telecom operators offer to their users.
 
Examples of its services include providing ring-back tones, voicemails and missed call alerts, voice–based short messaging services, interactive information and entertainment solutions on mobile phones such as alerts and updates, and mobile commerce solutions like mobile ticketing and bill payments.
 
So far, the company has shown impressive growth, doubling its top line every year, and is high on profitability with operating margins in excess of 45 per cent consistently. However, the company may end up losing its foothold in the market as the VAS revenues for telecom operators increase (from the present share of less than 10 per cent of their top lines) as competition steps up.
 
On the flipside, the quest of telecom operators to gain VAS capabilities in-house may make the company an attractive takeover target, which appears to be the only reason justifying the high valuations that the company commands on the bourses. Overall, at 40 times its estimated FY09 earnings, OnMobile appears expensive, but steep declines could be considered as potential buying opportunities. Those holding the stock may want to book profits.
 
Tanla Solutions
 
A fast growing telecom content aggregator focused on the UK market, Tanla Solutions' stock price has nearly doubled over the past year. Tanla boasts of a robust clientele in the UK, strong content sourcing relationships as well as an end-to-end portfolio of services, including route optimisation, voice mail, short messaging and roaming services, besides other value-added services.
 
In a matured market like the UK, where VAS revenues are as high as 20 per cent of telecom operators' total revenues, Tanla commands a market share of around 5 per cent in these services.
 
Going forward, as the penetration of 3G and data services increases, the company stands to make hay. Besides, it is now looking to enter the US market too, via acquisitions for which it has raised Rs 42 crore last year, which takes its total cash chest to Rs 400 crore. A foray into the Indian markets could prove an icing on the cake.
 
A high margin business, similar to Onmobile, Tanla is valued at a much lower price-earnings multiple of 14 times, in comparison. One of the reasons for lower valuations could be the delay in its US acquisition plans.
 
Further, an acquisition of a VAS player in the US is expected to be expensive, which may be factored in, in Tanla's valuation. However, such an acquisition could act as a potential trigger owing to the top line growth it will bring in, as much as any progress toward gaining foothold in the Indian markets.
 
Tulip IT Services
 
From being a network integration business, Tulip IT Services has grown into a last-mile wireless data connectivity provider to telecom operators between the local exchanges and subscribers. The company has built 800 city wireless networks so far, and holds a dominant 40 per cent market share in its niche. With the added emphasis on creating rural broadband internet infrastructure and installing state wide area networks (SWANs) highlighted in the Budget this year, Tulip is likely to be the key beneficiary.
 
Owing to consistent demand for infrastructure for internet connectivity both in the public and private domains, Tulip is expected to maintain a consistent top line growth of over 45 per cent y-o-y, while its profitability is likely to grow faster as the business gains scale. At about 13 times estimated FY09 earnings, Tulip's valuations appear reasonable, with some upside left as the volume of business is expected to grow.