Pickup in digital margins could help Tata Communications stock rerate

In a recent analyst meet, Tata Communications reiterated it had a data revenue target of ₹28,000 crore but postponed the timeline, with a delay of a few quarters, to FY28 from an earlier guidance of achieving it in FY27. Given revenue of ₹19,500 crore in FY25, this implies a compounded annual growth rate (CAGR) of 26 per cent during FY25-FY28. Guidance includes consolidated earnings before interest, taxes, depreciation, and amortisation (Ebitda) margin of 23-25 per cent by FY27 and consolidated pre-tax RoCE (return on capital employed) of above 25 per cent and a net debt to Ebitda ratio of below 2x.

 

The management clarified that these assumptions could change if there’s any acquisition related impact. Management also shared that 1/3rd of incremental data revenue during FY25-FY28 would be driven by capability shift and strategic bets. The digital portfolio will contribute over 65 per cent to data revenue (47 per cent currently), and 80 per cent of its “million-dollar” customers will use three or more “fabrics” (out of its five fabrics). This implies acceleration in digital revenue CAGR to 26 per cent vs 25 per cent CAGR over FY21-FY25, including large acquisition. 

 

Core connectivity maintained high profitability (FY25 Ebitda margin: 43.6 per cent), but the digital platform business is margin-negative. Tata Communications said the digital portfolio Ebitda margin has bottomed out (Ebitda was negative ₹890 crore in FY25 with Ebitda margin of negative 9.7 per cent) and expects margin improvement to positive double digits implying Ebitda of ₹1,500 – ₹2,300 crore in the next few years. The Ebitda margin will achieve breakeven and improve to 4-6 per cent and then achieve double digit margin. But there’s no exact timeline for this margin guidance. 

 

The company aims to maintain leadership in India and start making inroads into international markets. Tata Communications (TCOM) will also continue its strategy of asset monetisation in non-core businesses while maintaining its 26 per cent stake in STT’s India data centre business. It has re-aligned its corporate structure in overseas subsidiaries (TCOM UK and TCOM Netherlands) to make it easier for overseas M&A. Management is looking at land parcels to monetise though there’s no timeline. Tata Communications will participate in any capital raise done by STT to maintain stake.

 

Analysts calculate that data revenue of ₹27,300 crore in FY28 is possible, given growth in digital portfolio due to megatrends like cloud, AI, IoT etc. The overall Ebitda margin may improve from 20 per cent in FY25 to 23.5 per cent by FY28. One risk is weak global macro leading to deferment in discretionary spends and another would be adverse AGR rulings. Also, the rebound in digital margins to double digits may be optimistic within the timeline of FY28, given inherently low margins and significant revenue share from reselling products and services from other enterprises where there is no room for margin expansions.

 

Tata Communications strategy will be to go deeper with fewer clients. It added 16 new accounts to its million-dollar list to reach 290 such clients in FY25. The revenue growth from $1 million-$10 million accounts was 1.3x and there was a higher 2.1x growth from $10 million+ accounts. Tata Communications will sharpen focus on top accounts and is targeting 80 per cent of million-dollar clients to have 3-plus fabrics.

 

The fabrics facilitate exchange of data, information and intelligence across diverse digital systems and applications. Tata Communications has five fabric areas (network, cloud, interaction, IoT, security), with 70 per cent of new large deals involving three or more fabrics.

 

A pick up in digital margins and revenue generation would be key for a rerating. The stock has not moved much in the last three fiscals.

 

According to Bloomberg, four of the six analysts polled in June are bullish, while one each is bearish and neutral. Their average one-year target price is ₹1,847.67, compared to Wednesday’s closing price of ₹1,715 on the BSE.