Deals should keep Tata Comm debt in check

The focus will now turn to growth of its high-margin data business

After many false starts, Tata Communications would be hoping that its 6.55 billion South African Rand (about Rs 2,900 crore) deal to sell Neotel, its South African subsidiary, to Liquid Telecom (majority owned by Econet Wireless Global) sticks. The company had been in talks with Vodacom to sell Neotel for about two years. However, the deal, pegged at 7 billion Rand (around Rs 3,130 crore), fell through because of regulatory and legal challenges.

In addition, the company has recently said it will sell 74 per cent stake in its data centre business in India and 100 per cent in Singapore. This should fetch it about $460 million (Rs 3,187 crore). If a majority of the proceeds goes towards debt reduction, it would help bring down current debt levels of $1.4 billion (about Rs 10,000 crore). Analysts had pegged net debt to Ebitda (earnings before interest, taxes, depreciation and amortisation) levels for financial year 2016-17 (FY17) to move up to 3.3 times, but this should now come down below two times.

While Neotel had reported a 22 per cent year-on-year fall in revenues in the quarter ended March, data business growth has been a healthy 23 per cent, coupled with margin expansion. This is why selling the data centre business (part of data business) will impact its financials with estimates pegging it about 10 per cent of operating profits. The move to sell the data centre business is in line with the trend of other international companies exiting this segment to improve return ratios, according to analysts at Bank of America Merrill Lynch. Data services account for 55 per cent of consolidated revenues (Rs 20,605 crore in FY16) and about 84 per cent of operating profit, and is expected to grow at 20 per cent rates. Importantly, the management is working towards improving operating profit margin of 23 per cent in the data business to 30 per cent over the longer term.

These should help offset the pressure in the voice business (38 per cent of revenues), where volumes have been declining over the past few quarters and current profit margins are around five per cent.

The Tata Communications stock has gone up 23 per cent over the past three months on hopes of lower debt, higher data growth and improvement in margins. With the deals, the stock could re-rate further if there are signs of stability in growth, cash flows and return ratios improve.