Tejas Networks Ltd – IPO Note

-Report by Foram Ajani

TEJAS NETWORKS IPO NOTE

Tejas Networks is an optical and data networking products company, they design, develop and sell high-performance and cost-competitive products to telecommunications service providers, internet service providers, utility companies, defence companies and government entities (collectively, “Communication Service Providers”).

It is set to hit the Street on June 14. This is the second time the company is planning an IPO, after abandoning its previous attempt at a public offering in 2008-09.

Offer Details

  • The total funds to be raised: ~~ Rs 776 crore
  • Fresh Issue: Rs 450 crore
  • Offer for Sale: Offer for sale up to 12,711,605 shares (around Rs.326 crore)
  • Opening issue date: Jun 14, 2017
  • Closing issue date: Jun 16, 2017
  • Issue price range: Rs 250 – Rs 257 per Equity Share
  • Face Value per share: Rs 10 per equity share
  • Lot size: 55 shares and in multiple of 55 shares there-of
  • Minimum Order Quantity: 55 Shares
  • No of Shares on Offer: 1.75-1.8 Cr
  • QIB (%): 75%
  • Non-Institutional (%): 15%
  • Retail (%): 10%
  • Listing At: BSE, NSE
  • Issue Type: Book Built Issue IPO

Investors selling shares in the IPO include Cascade Capital Management Mauritius, India Industrial Growth Fund (Frontline Strategy), Intel Capital and Sandstone Capital. The CEO Sanjay Nayak and CTO Kumar N Sivarajan are also selling their shares. Other investors in the company include the likes of Goldman Sachs, Mayfield and Samena Capital.

 

Objects of the Offer
  • Capital expenditure towards payment of salaries and wages of research and development team
  • Working capital requirement
  • General corporate purposes
  • To receive the benefits of listing of the Equity Shares on the Stock Exchanges

 

Schedule of Implementation and Deployment of Net Proceeds

Particulars Amount to be funded from the Net Proceeds (in Rs. Cr) Estimated utilization of Net Proceeds in FY18 (in Rs. Cr)
Capital expenditure towards payment of salaries and wages of our research and development team 45 45
Working capital requirement 303 303
General Corporate Purposes*

*To be finalized on the determination of the offer price. The amount shall not exceed 25% of the Gross Proceeds of the Fresh Issue

Industry Analysis

India is currently the world’s second-largest telecommunications market and has registered strong growth in the past decade and half. The Indian mobile economy is growing rapidly and will contribute substantially to India’s Gross Domestic Product (GDP)

The Indian telecom sector is expected to generate four million direct and indirect jobs over the next five years. The employment opportunities are expected to be created due to combination of government’s efforts to increase penetration in rural areas and the rapid increase in smartphone sales and rising internet usage.

Total global telecommunications access network traffic is expected to grow at a 25% compound annual growth rate (“CAGR”) for the period from 2015 to 2020. In absolute terms, access traffic volumes are expected to grow from around 340,000 petabytes (“PB”) in 2015 to just over 1 million PB in 2020.

Cellular traffic will be the primary contributor to this growth, which is expected to grow at a CAGR of 47.9% for the period from 2015 to 2020, which is equivalent to the total cellular traffic growing by seven times over this period.

Leadership in the Fast Growing Indian Optical Equipment Market

Source: Company Presentation

Growth drivers in Indian telecommunications equipment market

  • Increased use of smart phones and mobile data usage– Ovum expects total mobile broadband subscriptions in India to cross one billion by 2021
  • Fiberisation of backhaul network– in India, less than 20% sites are fiberized compared to 70-80% sites in a developed country
  • Government Initiatives– Some of the key government initiatives generally affecting the Indian telecommunications industry are Digital India, National Optical Fibre Network (Bharatnet), Make in India, National Knowledge Network and Smart Cities. The key government initiatives promoting domestic manufacturing in the telecommunications industry in India are the Preferential Market Access Policy, Modified Special Incentive Package Scheme, Merchandise Exports from India Scheme, Defence Procurement Policy, Support for International Patent Protection in Electronics and Information Technology, Electronic System Design and Manufacturing (ESDM) promotion policies of various Indian states such as the Karnataka ESDM Policy 2013, anti-dumping duties on synchronous digital hierarchy transmission equipment, customs duty on products not covered by the Information Technology Agreement enforced by the World Trade Organisation and the Indian Telegraph Right of Way Rules, 2016

About the company

Tejas Networks Ltd (Tejas) is an optical and data networking products company with customers in over 60 countries. It designs, develops and sells software enabled networking equipment products to telecommunications service providers, internet service providers, utility companies, defence companies and government entities.

The company has has 15% market share in the Indian optical networking equipment market. The company is the second largest and only Indian company present in top 10 in India in a segment that is dominated by global giants like Huawei, Nokia, ECI Telecom, ZTE, etc. Tejas has filed 333 patent applications, with 203 filings in India, 89 filings in the United States and 6 filings in Europe, out of which 56 patents have been granted and it has also filed 35 patent applications under the Patent Cooperation Treaty.

Source: Company Presentation

Strengths

  • Its end-to-end portfolio of optical networking products positions them well to take advantage of the expected industry growth
  • Leadership in the fast growing Indian optical equipment market
  • Track record and culture of innovation leading to product and technology leadership
  • Software-defined hardware with ease of use
  • Cost and capital efficient business model
  • Long standing customer relationships with strong repeat business
  • Benefit from increasing government spend in broadband infrastructure
  • The only India-based optical transport systems company that is TL9000 certified
  • High entry barrier against domestic competition

Risk Factors

  • Client concentration: A significant portion of its revenue is generated from limited number of large customers. If the company is unable to maintain relationship with such customers, financial condition will be adversely affected.
  • Technology risk: It faces steep competition from global giants which operate on far larger scale, and are equally serious about innovation and R&D. In this area, the R&D, which is the company’s strong area, may hurt its financial position in terms of future write-offs.
  • Reliance on limited number of third party suppliers and electronics manufacturing services companies for the key components and products
  • Legal Proceedings: The Company has 40 tax litigations against it wherein total amount involved is Rs 158.2 crore, any adverse developments related to which could materially and adversely affect our business, reputation and cash flows.

Financial Analysis

Sharp growth in last two years due to expanding presence in developed markets through OEM relationships:

  • Tejas Networks has 88% of its revenue from repeat business while 58% of its revenue comes from top 5 customers. Operating revenues has grown at 24.2% CAGR in FY13-17 to Rs 878.2 crore.
  • Currently, India is the largest geographic segment (in terms of revenue i.e. around 65% of the revenues in FY17) and the company is banking on growth opportunities arising out of the Digital India and the Make-in-India programmes of the Government of India.
  • The growth in revenue from operations is driven by:
  1. Increase in optical spend by Indian telecommunication companies
  2. Increase in spending by the government of India coupled with PMA policy for government projects
  3. Replicating the India success in other similar emerging markets
  4. Expanding presence in developed markets through OEM relationships

Source: Company Presentation

EBITDA margins stable in the range of 17-19%

  • EBITDA has grown at 40.9% CAGR over FY13-17 to Rs 174.2 crore.
  • The company has lower operating costs due to India-advantage in R&D as well as SG&A costs since salary costs are a large portion of the operating costs
  • The EBITDA margin remained consistent around 20% in the past 4 years, indicating the efficient operation of the company.
  • Except for cost of material consumed, which is linked to revenues, majority of the operating costs are almost fixed leading to operating cost leverage.

Bottom-line impacted due to written off accumulated costs  

  • In the past, Tejas Networks has incurred losses on account of write-offs associated with strategic acquisitions and investments. In FY13, it wrote-off goodwill amounting to Rs 10.2 crore and intellectual property amounting to Rs 38.6 crore, which contributed to our restated loss for the year.
  • Considering various factors such as technological obsolescence, that require revision in the existing products, it has written off accumulated costs relating to past salaries of the wireless product development team, amounting to Rs 30.5 crore in FY17.

ROE & ROCE

Authors Note

The company might get the first mover’s advantage since there is no listed peer under this sector. Also the company is set to benefit immensely under Government’s Digital India/Make-in-India campaign.

On the valuation front, the company at higher price band is available at a P/E of 37x on a post issue basis, based on FY17 earnings, while after considering Extra Ordinary items of Rs 30.5 crore adjustments works out to P/E multiple of around 25x on EPS of Rs 10.5.

The company has a stretched out working capital cycle, given the nature of industry as well as the clientele it serves. The company’s cash conversion cycle is at 143 days in FY17 as against 274 days in FY15; however it’s still a high working capital requirement that would be under stress. Keeping in mind the low profit margin and ROE under 10% post IPO and high valuations of based on P/E, the stock appears unappealing.