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SUBEX AZURE LIMITED (SUBEX)
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.88
FY12E P/E: 6.7X
Subex's operating performance for 3QFY11 was a mixed bag. Product
revenues were flat on a QoQ basis and came in below expectations. EBIDTA
margins for products division at 32.7% were above expectations. Interest
cost was higher on a sequential basis, which was surprising. The order intake
for the quarter was 39% higher QoQ at Rs.27mn, we believe and
reflected the management optimism on achieving higher revenue growth.
While Subex indicated higher confidence in the macro scene larger peers in
the industry have indicated still sluggish outlook for the telecom vertical.
We need to watch the future pipeline and order book conversions before we
become more optimistic on the future prospects of Subex. The financial
performance of Subex has also been very erratic in the past. Subex's
employee costs continue to fall, surprisingly. We expect revenues to grow
QoQ, leading to higher margins as costs remain under tight control. We
have also assumed full conversion of the restructured FCCBs and preferential
allotment to promoters of 4mn shares. However, we are surprised at the
decision to dilute equity further at these valuations to repay debt and have
not considered the same in our workings. Our FY11 earnings estimates
stand at Rs.8.8 per share and FY12E at Rs.9.3 per share. We maintain
ACCUMULATE with a PT of Rs.88 (Rs.91) based on FY12E earnings. We have
assumed FCCBs to be converted into shares (conversion price about Rs.80,
which may increase liquidity in the stock). Uncertainty over the same may
keep the stock range bound. Better visibility and comfort on the future
performance can make us more bullish on the stock.
Product revenues
n Product revenues were flat QoQ during the quarter. This was below our estimates.
n We believe that, revenues remained flat because of the seasonality in the business.
n License revenues grew by about 13% QoQ, in our estimates and formed about
55% of product revenues.
n However, customization and managed services likely de-grow on a QoQ basis,
which was surprising. Support services contributed about 26% to the revenues
and remained flat QoQ.
n The contribution of managed services fell to about 14% v/s 17% QoQ.
n We had said that, we need to see sustained rise in annuity revenues, which can
reduce the volatility in revenues of the company.
Improving macro
n Subex has maintained that, there is a revival in sentiment among clients. The
management indicated increase in number of contracts being placed by clients.
n It also indicated that, they were looking at costs and hence, vendors are forced
to provide better value or immediate cost reduction benefits to customers.
n While Subex is optimistic on the prospects of the industry, most of the larger
players have indicated still sluggish prospects.
n We understand that, Subex's experience might be different because its products
help increase revenues while attacking operating costs.
n However, we would remain cautious because of the concentrated nature of the
market (few players dominate the same) and the lumpy nature of revenues.
Order bookings and order pipeline
n In terms of order bookings and pipeline, the order intake was at about $27mn,
which was higher than the $19mn reported for the previous quarter.
n Thus, order flows have witnessed a sizeable jump. We need to watch out for
sustainability of this in the future quarters.
n An important aspect of the order flows, according to the management, is that,
large managed services contracts are being won by the company. These are
expected to provide stability to overall revenues, going ahead.
n Annuity revenues now form about 45% of Subex's revenues.
n We will watch this figure closely over the next few quarters.
n The company had a qualified pipeline of $413mn ($385mn).
n Subex had normally enjoyed a conversion rate of 40%. However, it now expects
the same to be about 20%, indicating real challenges and increased competition.
In the previous fiscal, the conversion rate was at 18%.
n The existing order pipeline, new lines of revenues like managed services and the
company's premier positioning in the area of operations are expected to lead to
revenue growth in the next few quarters.
n However, the critical factor is whether the company is able to convert this order
book into revenues and the pipeline into orders.
Margins
n The company had EBIDTA margins of about 32.7% in the products business as
compared to 29.8% in the previous quarter.
n The margins were higher because of the higher revenues and a slight reduction
in employee costs.
n Subex's employee expenses have seen a reduction over the past several quarters,
which is surprising. The management had indicated a couple of quarters
back that, employee expenses would stabilize at those levels.
n A likely shift from on-site to off-shore has resulted in this decline. According to
the management, about 750 employees are off-shore.
n The company had Rs.36mn of operational other income as compared to Rs.12mn
in the previous quarter.
Conversion / restructuring of FCCBs, Preferential placement
n Subex had restructured about $141mn of FCCBs (out of a total of $180mn). The
company has issued new FCCBs of $98.7mn against the cancellation of these
older FCCBs. The new FCCBs carry a coupon of 5% and are convertible into
shares at a price of Rs.80 per share (Rs.656 per share earlier).
n The company has already reduced its liability partly, we have assumed the conversion
of FCCBs to happen over the fiscal.
n Of the restructured FCCBs, about $55.8mn worth of FCCBs are outstanding.
n The company is holding an EGM in February to consider the allotment of about
5.1mn shares on preferential basis at Rs.81 per share, to M/s KBC Aldini Capital
Mauritius Ltd.
n According to the management, the funds will be utilized to repay bank debts
(non-FCCB debts), which are currently at Rs.1.49bn. The company has likely obligations
to repay the same.
n We are surprised by the fact that, the company has neither opted to re-structure
the debt nor replace the debt, but has agreed to dilute the equity at these valuations.
n We also note that, till recently, management had been indicating high degree of
comfort in repaying all its obligations without further dilution.
n We have assumed the dilution due to FCCB conversion to Rs.979.6mn as against
the current Rs.651.8mn.
n The increased liquidity may keep the price range bound in the near term.
We make changes to our FY11 and FY12 estimates.
n We expect Subex to report revenues of Rs.5bn in FY11 and Rs.5.67bn in FY12E.
n Product revenues are expected to be at Rs.4.34bn and Rs.5.04bn, respectively.
n EBIDTA margins are expected to improve to about 27.2% in FY11 and further to
28.8% in FY12E, on the back of higher product revenues and cost control initiatives.
n We arrive at a PAT of Rs.861mn for FY11E and Rs.1bn in FY12E, leading to an
EPS of Rs.8.8 for FY11E and Rs.10.2 for FY12E, on the enhanced equity (pre
preferential allotment).
n We have neither considered the MTM gains / losses on the FCCBs nor the other
forex gains / losses in line with the company policy, which treats them as extraordinary
items.
Risks
n A delayed recovery in major user economies may impact our projections.
n A sharp acceleration in rupee from the current levels may impact our earnings
estimates for the company.
n Delays in receipt and execution of orders may make earnings volatile in future
quarters while likely impacting the overall revenue and profit growth of the company.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
SUBEX AZURE LIMITED (SUBEX)
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.88
FY12E P/E: 6.7X
Subex's operating performance for 3QFY11 was a mixed bag. Product
revenues were flat on a QoQ basis and came in below expectations. EBIDTA
margins for products division at 32.7% were above expectations. Interest
cost was higher on a sequential basis, which was surprising. The order intake
for the quarter was 39% higher QoQ at Rs.27mn, we believe and
reflected the management optimism on achieving higher revenue growth.
While Subex indicated higher confidence in the macro scene larger peers in
the industry have indicated still sluggish outlook for the telecom vertical.
We need to watch the future pipeline and order book conversions before we
become more optimistic on the future prospects of Subex. The financial
performance of Subex has also been very erratic in the past. Subex's
employee costs continue to fall, surprisingly. We expect revenues to grow
QoQ, leading to higher margins as costs remain under tight control. We
have also assumed full conversion of the restructured FCCBs and preferential
allotment to promoters of 4mn shares. However, we are surprised at the
decision to dilute equity further at these valuations to repay debt and have
not considered the same in our workings. Our FY11 earnings estimates
stand at Rs.8.8 per share and FY12E at Rs.9.3 per share. We maintain
ACCUMULATE with a PT of Rs.88 (Rs.91) based on FY12E earnings. We have
assumed FCCBs to be converted into shares (conversion price about Rs.80,
which may increase liquidity in the stock). Uncertainty over the same may
keep the stock range bound. Better visibility and comfort on the future
performance can make us more bullish on the stock.
Product revenues
n Product revenues were flat QoQ during the quarter. This was below our estimates.
n We believe that, revenues remained flat because of the seasonality in the business.
n License revenues grew by about 13% QoQ, in our estimates and formed about
55% of product revenues.
n However, customization and managed services likely de-grow on a QoQ basis,
which was surprising. Support services contributed about 26% to the revenues
and remained flat QoQ.
n The contribution of managed services fell to about 14% v/s 17% QoQ.
n We had said that, we need to see sustained rise in annuity revenues, which can
reduce the volatility in revenues of the company.
Improving macro
n Subex has maintained that, there is a revival in sentiment among clients. The
management indicated increase in number of contracts being placed by clients.
n It also indicated that, they were looking at costs and hence, vendors are forced
to provide better value or immediate cost reduction benefits to customers.
n While Subex is optimistic on the prospects of the industry, most of the larger
players have indicated still sluggish prospects.
n We understand that, Subex's experience might be different because its products
help increase revenues while attacking operating costs.
n However, we would remain cautious because of the concentrated nature of the
market (few players dominate the same) and the lumpy nature of revenues.
Order bookings and order pipeline
n In terms of order bookings and pipeline, the order intake was at about $27mn,
which was higher than the $19mn reported for the previous quarter.
n Thus, order flows have witnessed a sizeable jump. We need to watch out for
sustainability of this in the future quarters.
n An important aspect of the order flows, according to the management, is that,
large managed services contracts are being won by the company. These are
expected to provide stability to overall revenues, going ahead.
n Annuity revenues now form about 45% of Subex's revenues.
n We will watch this figure closely over the next few quarters.
n The company had a qualified pipeline of $413mn ($385mn).
n Subex had normally enjoyed a conversion rate of 40%. However, it now expects
the same to be about 20%, indicating real challenges and increased competition.
In the previous fiscal, the conversion rate was at 18%.
n The existing order pipeline, new lines of revenues like managed services and the
company's premier positioning in the area of operations are expected to lead to
revenue growth in the next few quarters.
n However, the critical factor is whether the company is able to convert this order
book into revenues and the pipeline into orders.
Margins
n The company had EBIDTA margins of about 32.7% in the products business as
compared to 29.8% in the previous quarter.
n The margins were higher because of the higher revenues and a slight reduction
in employee costs.
n Subex's employee expenses have seen a reduction over the past several quarters,
which is surprising. The management had indicated a couple of quarters
back that, employee expenses would stabilize at those levels.
n A likely shift from on-site to off-shore has resulted in this decline. According to
the management, about 750 employees are off-shore.
n The company had Rs.36mn of operational other income as compared to Rs.12mn
in the previous quarter.
Conversion / restructuring of FCCBs, Preferential placement
n Subex had restructured about $141mn of FCCBs (out of a total of $180mn). The
company has issued new FCCBs of $98.7mn against the cancellation of these
older FCCBs. The new FCCBs carry a coupon of 5% and are convertible into
shares at a price of Rs.80 per share (Rs.656 per share earlier).
n The company has already reduced its liability partly, we have assumed the conversion
of FCCBs to happen over the fiscal.
n Of the restructured FCCBs, about $55.8mn worth of FCCBs are outstanding.
n The company is holding an EGM in February to consider the allotment of about
5.1mn shares on preferential basis at Rs.81 per share, to M/s KBC Aldini Capital
Mauritius Ltd.
n According to the management, the funds will be utilized to repay bank debts
(non-FCCB debts), which are currently at Rs.1.49bn. The company has likely obligations
to repay the same.
n We are surprised by the fact that, the company has neither opted to re-structure
the debt nor replace the debt, but has agreed to dilute the equity at these valuations.
n We also note that, till recently, management had been indicating high degree of
comfort in repaying all its obligations without further dilution.
n We have assumed the dilution due to FCCB conversion to Rs.979.6mn as against
the current Rs.651.8mn.
n The increased liquidity may keep the price range bound in the near term.
We make changes to our FY11 and FY12 estimates.
n We expect Subex to report revenues of Rs.5bn in FY11 and Rs.5.67bn in FY12E.
n Product revenues are expected to be at Rs.4.34bn and Rs.5.04bn, respectively.
n EBIDTA margins are expected to improve to about 27.2% in FY11 and further to
28.8% in FY12E, on the back of higher product revenues and cost control initiatives.
n We arrive at a PAT of Rs.861mn for FY11E and Rs.1bn in FY12E, leading to an
EPS of Rs.8.8 for FY11E and Rs.10.2 for FY12E, on the enhanced equity (pre
preferential allotment).
n We have neither considered the MTM gains / losses on the FCCBs nor the other
forex gains / losses in line with the company policy, which treats them as extraordinary
items.
Risks
n A delayed recovery in major user economies may impact our projections.
n A sharp acceleration in rupee from the current levels may impact our earnings
estimates for the company.
n Delays in receipt and execution of orders may make earnings volatile in future
quarters while likely impacting the overall revenue and profit growth of the company.
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