Tata communications Ltd: A Treasure Under Sea-2nd Part. Also Covered: Cybertech Systems

Tata communications Ltd (TCL) was recommended at 400 (Click here for earlier study). It touched 780 but last day declined 10% to 640. Market has given thumbed down to its Mar-17 quarter results in which it has posted a loss of 209 cr. But it is appearing bad only on the surface as the results are impacted by issues like one time provision of 872 cr, one of cable repair expenses, demonetization effect and low revenue after sale of data center business etc. Now is the season for mangoes in India. But mangoes are sweet only if left for proper ripening. But if we consume them raw and after finding them bitter may discard the tree cheaply. Friday’s fall was just like throwing away raw mangoes when the need was to wait for the maturation. And I have picked up more of TCL at 640 (Avg cost is 400) and will be buying more at every fall.

TCL is in massive reconstruction phase…big strategic planning is underway. It has made big investments in making the capacities which are huge even by global standards. Like its Subsea cable network of 500000 KM (200000 km is underground) is the largest globally owned by a single owner. TCL owns this large network independently while other big networks are owned by consortium of global companies like Airtel and Reliance. This large network provides TCL strong pricing and better cost control. TCL is reshuffling its product and services portfolio to bring in better synergy, focusing on its core area of communication solutions and more sweating of its assets. I remember it had grand plans for Data center business few years back but this year it sold off majority of the data center business to cut the high debt. So decisions making and changes are happening fast here.

TCL is transforming its Commodity business into Value added services

In last 5-6 years it has transformed itself from commodity business of wholesale of voice and data services to a new age communication technology company providing high valued enterprise solutions to global giants like Formula one. In its earlier Avatar the company mainly offered wholesale cable capacity or bandwidth to carriers like telecom or Mobile service operators (like Airtel, Idea etc.) who then pack their voice and data services on it and sell it to general public and businesses. With largest sea fibre network in the world it is going to see huge growth in managed service business. It is already a force to reckon in the field of Cloud and IOT. It has already started its IOT services in Bangalore and Mumbai. 

After the sale of majority stake in its Data center and Neotel business, its debt is down by some 5000 cr (Need to recheck) which will further raise the margins. This quarter Interest cost is down to 78 cr from 100 cr which will come down further. Last day, one analyst was comparing TCL with other Telecom stocks and saying that the fall was expected in line with the other telecom stocks. But TCL is very different from them…most of all it is in B2B business which surprisingly is a better model in telecom due to low competition (Due to client stickiness as business houses don’t change their service provider frequently), lesser regulations (No TRAI), low capex (No high spectrum costs). 

Moreover business houses are yet to fully embrace the communication revolution in their businesses although at personal and individual level communication storm has penetrated deeply. But businesses are realizing the power of lightening communication in a world of scarcity of resource and cost pressures amid cut throat competition. So any disruptive technology solving this for organizations is a big revolution in itself. Like use of IOT (Internet of things) in power management can save big money (Some have reported around 15% cost savings which are huge by any standards), sensor fitted big machines talk and communicate the state of operation and any danger (like overheating). Machines communicate if there is a repair required which if prevented before breakdown can save high repair costs and production losses. Shipping lines can better utilize their sensor equipped containers as they know their position real time.

So IT systems were the most significant industrial revolution (of course after Electricity) and machine to machine communication will be the even bigger as it will result into much higher degree of control over business process.

I feel that opportunities are much bigger in B2B than personal mobility sector. Personal mobile phones are made to consume data (Low creativity/productivity scope) but things like IOT and Bundled services by TCL offers huge benefits to business houses. In recent deal with US media giant Vice Media, TCL will provide them complete solution starting from high speed data capture, transfer, storage, security, cloud, processing capabilities; all of which are accessible across different geographies as if they were in the same location. IOT can bring in big cost savings and better use of costly resources.

Like for F1 racing, Tata provides extremely high speeds of 1 Gbps at all tracks to handle all of the data needs. Cars fitted with 150 censers transmit large volumes of data in real time to data centre located inside the race course (which may be in US) and also send the same to their Europe headquarter in real time. HQ and guys in the stadium can tell a driver to take a particular angled turn to save one-tenth of a second and that one-tenth can be the difference between winning and losing!!!

Emerging markets like India to drive the huge growth in data consumption benefitting TCL More

99% of the global internet traffic is routed via subsea cables. Subsea cables are being used for long and dated back to 1854 when first inter-sea cable was installed for telegraphic service. At present, Antarctica is the only continent which is not connected via physical subsea cables mainly due to tough terrain and commercial issues. Satellite internet is being used there but due to low bandwidth and latency issues the research stations produce more data than what can be transmitted via satellite internet. Satellite internet is just 1% although for some applications like Shipping/Air Travel satellite internet is the best option along with the hinterland where laying cable is very difficult involving huge capital investment as compared to low number of prospective customers. Furthermore, with submarine cables data is guaranteed to go from A to B, whilst with satellites a strong weather phenomenon could cause disruption to data transmissions. 

Laying subsea cable is very costly and time consuming. But in spite of the huge growth in Data consumption worldwide which has been doubled in last 2-3 years and still growing at breath neck speed, still the utilization levels of international subsea cable are at old levels. This is due to advancement in technology which has enabled more data transmission (from 10 GBps to 100 GBps) via same cables implying ample capacity worldwide to meet the future high demand for data. They have developed optical fibre cables which can transmit data at 99.7% of the speed of light!!! Also there is huge capacity unused in “dark cables” worldwide. Dark cables are subsea cable networks which are not being used currently but will be switched on to cater to the future high demand.

Emerging markets like India will be at the forefront in the growth of data consumption. TCL have cable landing stations in Mumbai, Kochi and Chennai. These are the places which connect India to international subsea cables network. Tata Communications is the only Tier-1 global telecommunications company in India. Tier-1 companies are those having large global network of cables connecting places across the globe; these networks serve as the backbone of the global internet. TCL has huge bandwidth available at these landing stations and around 50% cables are “dark cables” and I think with huge growth of data consumption in India TCL is going to gain big as its capacity utilization levels will increase. As India is connected to world via port cities hence cost of internet to Northern cities is more and there is high latency (Means slow internet speed). But now a cable is being established from Bangladesh to Agartala which will cater to Northern Indian markets.

TCL to become a force in IOT

TCL is investing big for the growth of IOT in India. It is working on the execution of Low powered Wide area network (LPWAN) based on LoRa IOT technology which has shown great results. Actually things are different in IOT. In IOT machines (or devices) are supposed to communicate with other devices and send small bits of data over long ranges which is quite opposite to the conventional 3G/4G technology which are suited for sending large volume of data. But data generation is low in IOT although it may be continuous or at specific breaks so current networks 3G/4G will not suit for IOT as they consume high power (The reason your smartphone battery is always out before lunch). So IOT will require different set of networking solutions and hardware (sensor etc.). LoRa operates in 900 Mhz band which is suitable for transmission of data over long ranges, low power consumption. Traditional long-range wireless networks are not designed for low data rate devices that run on either no battery or a small size battery which are the main features of IOT networks. So LPWANs are designed for IOT where data transfer rates are not the prime motive, but range, battery life and cost are. Tata’s LoRa based LPWAN’s has shown much better results enabling communication in deep water or 50 meters underground making this technology better suited for metro stations and car parks where GSM and Wi-Fi are not suitable.

So design of the IOT application will be the key as each application has different power requirements like door lock system doesn’t require frequent power supply as it doesn’t need to relay data over distance continuously. It needs to send data periodically or at some predefined trigger like forced entry. So if it can be designed in a way to switch on “Sleep” mode in it then this can save a lot of power. This switch thing can be brought in by including some type of “Microcontroller” in the application design which will put the application in sleep mode or low power mode as per pre-defined set of events or triggers. Similarly for applications where data transmission rate is high like wearable devices for medical purposes then in order to ensure the continuous power supply energy harvesting solutions like solar power systems can be embedded into the application.

So these are still early days for IOT development and I am keeping a keen eye on this sector picking up some stocks which I feel are doing substantial work in this field like KPIT technologies, Schneider electric infrastructure. I have also picked up Cybertech systems and Software Ltd which is doing a great job in the Geo-spatial field and so many municipalities like Bangalore and Nagpur are using its geospatial product Geo-Civic for better controlling their revenue and city development. 

Tata Communications has been working closely with Semtech Corporation, a semiconductor company, to build the world’s largest IOT machine-to-machine network. The company is keen to contribute to India’s smart cities programme with this technology. I am sure that TCL will be one of the leaders in this space.

Demerger of Land Bank: A big catalyst

Also the most interesting part of the story is 740 acre land bank owned by the Company which was not the part of the deal when Tatas bought VSNL from govt. There is a quite bit of confusion in the market about the impact of solution land deal dispute as some are concluding that benefit of the land deal will accrue to TCL. Although the reality is something else. There was a dispute regarding payment of Stamp duty (around 500 cr) and capital gain on transfer of Land pursuant to the demerger of land holdings from VSNL. Actually NDA government didn’t want to sell the huge land holdings of VSNL; they only wanted to dis-invest the voice service business. So they designed their offer in that way only. As per the offer after the divestment land holdings was to be demerged into a separate company and shareholding pattern of the new demerged entity should be the mirror of shareholding pattern of VSNL prior to divestment. Hemisphere Properties India Ltd (HPIL) was the company that would hold the surplus land after the demerger

Prior to divestment of VSNL, Govt of India was having 51% share, 25% was with ADR ( VSNL was listed in New York Stock Exchange), 4% with Tata group and 20% with other shareholders. But after the divestment of 25% share by Govt to Tata, Tatas further bought 20% via open offer from existing shareholders. With their early 4% share, shareholding of Tata group became around 50%.

But in order to bring the shareholding of new demerged entity to be the mirror image of pre-divestment levels; deal required Tatas to transfer their 25% share (which they bought in divestment) in new demerged entity to Govt of India and 20% to old shareholders the shares of whom were bought by Tatas in open offer. So this was a complex set of thing. The main reason behind this complex deal was the fear of NDA government that if they try to sell the land before divestment then existing shareholders might object to it as they might take it as nationalisation of the VSNL.

But soon after the disinvestment, things became more complex. After the divestment the dispute arose as to who would pay the Stamp duty charges and capital gain tax on transfer of land. Actually the demerger of land holding from TCL (Resultant Company after the divestment) was tax free as per existing tax laws as shareholding of demerged entity was going to be same as of TCL. But it was going to be changed as per the earlier deal wherein Tatas were required to transfer around 45% share to Govt and old shareholders so effectively this demerger was a sale transaction and capital gain was required to be paid on this. Board of TCL refused to pay stamp duty and CGT as Tata wasn’t going to get anything from the demerger or sale of land. Tatas were right in their refusal but government didn’t take any decision for almost 14 years even when the benefit was going to accrue to them only. Tata blamed that they had to incur maintenance cost of the land every year although there was no activity on the land. Tatas even proposed to buy the land at a fair value which was also declined by the Govt. Due to this indecision by the Govt, Tatas were not able to raise or infuse further equity for growth instead they had to pile up expensive debt for all these years.

Finally the issue was settled by passing of Taxation laws (Amendment) bill in 2016 as per which Government exempted such type of transactions from capital gain tax. As per the bill, In case a public sector company is divided and as a result of the demerger the land or an asset comes to the government, this transaction is exempted (from capital gains tax) by putting in an explanation in The Income Tax Act. So the path is clear for Government to demerge the land holdings into another company. Most of the value will accrue to Government and Minority shareholders (Like us)….and the value of land (Around 10000 cr) per share is around 170-200!!! 

Thus, the major beneficiary of the proceeds of the sale of land now would be government, which has 51% stake in HPIL. Minority shareholders and ADR holders will get around 45%, while around 4% will go to the Tata group.

So although TCL won’t get much from the demerger (only 4%) but the most significant gain will be in the form of its ability to raise further capital for expansion. As due to this hangover and indecision on the part of Government, TCL was not able to raise more equity for their expansion plans as Government didn’t allow dilution of their stake in the company (26%) as they were not sure how this would impact their rights to the land holdings. Also, other investors might also have preferred the solution of this case before committing any investments into TCL. So TCL had to go for the debt route to raise capital for their expansion. I think this move will provide further re-rating as I am sure equity infusion will be done at much higher valuation due to inherent strength of TCL and lesser need for capital for growing the asset base. For me this is one of the most significant events in the time line of TCL.

The demand for data is only going to be got bigger and bigger. So there is no doubt that TCL is in a sunrise sector and it is doing most of the things right now. So I feel that things are only going to be better from hereon.

Good buy at CMP of 640 and even better buy at every fall.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post)