We initiate coverage on Tulip Telecom (TTSL) with an Overweight rating
and Dec-11 price target of Rs215 (21% annualized upside potential). We
believe that concerns about competition from traditional telecom operators
and, more importantly, from the entry of new (BWA) players have driven a derating
from 10x a year ago to the current 7x. These concerns are overdone, in
our view, and we expect continued margin improvement, new government
project wins, and showcasing of resilience vs. competition, i.e. sticky clients
(government segment and increasing suite of services,) to help support the
share price. The company expects to record cash-flow break-even this year,
which we believe is achievable without aggressive assumptions.
• Expanding addressable base; margin support: We believe TTSL is well
placed for growth driven by a 5x increase of its addressable markets, change
in mix toward high-margin business, and decreasing capex intensity. We
forecast 20% revenue growth in FY11/12 and note that ~70% of TTSL’s
revenue is recurring. We note that a business mix shift alone could lift its
margins by ~2pp, while technology shifts could lend further support. We
estimate a 2.2pp margin expansion over two years.
• TTSL is better protected from the competition than is currently
reflected, in our view, because: (1) we don’t expect BWA winners to
actively target the enterprise market; (2) an immature TD-LTE technology
allows TTSL a one-to-two-year window; (3) new BWA spectrum winners
are a threat only to TTSL’s wireless business (targeted 30% contribution in
two years vs. 75% currently); and (4) TTSL’s 13% stake in the Qualcomm
BWA joint venture offers it a hedge in the key Mumbai and Delhi markets.
• Our Dec-11 price target of Rs215 implies an annualized upside potential of
21%. TTSL trades at a 7.9x one-year forward P/E (7.0x FY12E EPS), a 22%
discount to its three-year average P/E, and at a 5.4x one-year forward
EV/EBITDA (4.8x FY12E), a 30% discount. We believe that the current
valuation and relative underperformance reflect market concerns about
increasing competition. A key risk to our PT is earlier/deeper enterprise
competition from BWA service providers.
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