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SUBEX AZURE LIMITED (SUBEX)
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.82
FY12E P/E: 6.9X
Subex's operating performance for 4QFY11 was lower than our
expectations. Product revenues fell by about 7% on a sequential basis.
EBIDTA margins for products division at 31.9% were below expectations.
This was despite the sequential fall in employee expenses from Rs.654mn to
Rs.605mn. The consistent fall in employee expenses continues to surprise us.
The order in-take for the quarter was marginally higher at $.28.3mn ($27mn
QoQ), we believe. Subex has indicated higher confidence in the macro
scene. 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. 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 KBC Aldini Capital
Mauritius of 4mn shares. Our FY12E earnings stand at Rs.9.6 per share. We
maintain ACCUMULATE with a PT of Rs.82 (Rs.88) 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 fell on a sequential basis, v/s our expectation of a sequential
growth. This was below our estimates.
n In fact, over the four quarters of FY11, revenues have not increased. In 1QFY11,
product revenues were Rs.1.01bn and in 4QFY11, they were 1.02bn.
n For FY11, product revenues rose by 9% QoQ. Annuity revenues contributed
about 28% of the overall revenues. Managed services formed about 14% of
FY11 revenues.
n 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 $28mn,
which was higher than the $27mn reported for the previous quarter.
n Thus, order flows have witnessed a rise. 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 formed about 42% of Subex's FY11 revenues. We will watch
this figure closely over the next few quarters.
n The company had a qualified pipeline of $418mn ($413mn).
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 company has an order book of $60mn to be executed in FY12. This is as
against $49mn at the end of the previous fiscal.
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 31.9% in the products business as
compared to 32.7% in the previous quarter.
n The margins were lower because of the lower revenues and they fell despite the
reduction in employee costs. Employee costs fell by about 7% on a sequential
basis.
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 The company had Rs.11mn of operational other income as compared to Rs.36mn
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 FY12.
n The company held its 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.693.1mn.
n The increased liquidity may keep the price range bound in the near term.
We make changes to our FY12 estimates.
n We expect Subex to report revenues of Rs.5.47bn in FY12E. Product revenues
are expected to be at Rs.4.86bn.
n EBIDTA margins are expected to improve to about 28.5% in FY12E, on the back
of higher product revenues and cost control initiatives.
n We arrive at a PAT of Rs.938mn in FY12E, leading to an EPS of Rs.9.6 for FY12E,
on the enhanced equity.
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.82
FY12E P/E: 6.9X
Subex's operating performance for 4QFY11 was lower than our
expectations. Product revenues fell by about 7% on a sequential basis.
EBIDTA margins for products division at 31.9% were below expectations.
This was despite the sequential fall in employee expenses from Rs.654mn to
Rs.605mn. The consistent fall in employee expenses continues to surprise us.
The order in-take for the quarter was marginally higher at $.28.3mn ($27mn
QoQ), we believe. Subex has indicated higher confidence in the macro
scene. 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. 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 KBC Aldini Capital
Mauritius of 4mn shares. Our FY12E earnings stand at Rs.9.6 per share. We
maintain ACCUMULATE with a PT of Rs.82 (Rs.88) 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 fell on a sequential basis, v/s our expectation of a sequential
growth. This was below our estimates.
n In fact, over the four quarters of FY11, revenues have not increased. In 1QFY11,
product revenues were Rs.1.01bn and in 4QFY11, they were 1.02bn.
n For FY11, product revenues rose by 9% QoQ. Annuity revenues contributed
about 28% of the overall revenues. Managed services formed about 14% of
FY11 revenues.
n 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 $28mn,
which was higher than the $27mn reported for the previous quarter.
n Thus, order flows have witnessed a rise. 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 formed about 42% of Subex's FY11 revenues. We will watch
this figure closely over the next few quarters.
n The company had a qualified pipeline of $418mn ($413mn).
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 company has an order book of $60mn to be executed in FY12. This is as
against $49mn at the end of the previous fiscal.
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 31.9% in the products business as
compared to 32.7% in the previous quarter.
n The margins were lower because of the lower revenues and they fell despite the
reduction in employee costs. Employee costs fell by about 7% on a sequential
basis.
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 The company had Rs.11mn of operational other income as compared to Rs.36mn
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 FY12.
n The company held its 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.693.1mn.
n The increased liquidity may keep the price range bound in the near term.
We make changes to our FY12 estimates.
n We expect Subex to report revenues of Rs.5.47bn in FY12E. Product revenues
are expected to be at Rs.4.86bn.
n EBIDTA margins are expected to improve to about 28.5% in FY12E, on the back
of higher product revenues and cost control initiatives.
n We arrive at a PAT of Rs.938mn in FY12E, leading to an EPS of Rs.9.6 for FY12E,
on the enhanced equity.
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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