Tanla Solutions Ltd. Institutional Equity Research. Buy Current Price: Rs252 Target price: Rs500

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1 Institutional Equity Research Key data 19 June 2008 Sector Telecom Market Cap Rs25bn/US$0.5bn 52 Wk H/L (Rs) 425/192 BSE Avg. daily vol.(6m) 113,694 BSE Code NSE Code TANLA Bloomberg TANSIN Reuters TNSL.BO Sensex 15,422 Nifty 4,582 Shareholding pattern (%) 31-Dec Mar-08 FIIs, NRI, Adr/GDR MFs and institutions Promoters Others Absolute returns (%) 1mth 3mth 12mth Tanla Solutions (12.3) (1.0) 29.1 Sensex (11.5) Tanla Solutions Ltd Company update Buy Current Price: Rs252 Target price: Rs500 Tanla Solutions Ltd recently acquired an 85% stake in Openbit for USD 18.6mn. The deal, funded by internal accruals, is valued at EV/Sales of 1.0X FY07 sales. The acquisition will be EPS accretive in the first year of operations. The base business is expected to remain strong over the next few years. We forecast earnings CAGR of 33% for FY08-11E. We maintain our Buy rating. Openbit acquisition will be EPS accretive in the first year of operations: In CY07, Openbit reported revenues of $15.88 mn and EBITDA of $0.79 mn (approx 5%). Openbit License Manager was embedded on 10mn plus handsets in CY07, and the management is targeting 70 mn handsets by CY08. TSL plans to capitalize on the rapidly growing worldwide demand for smart and feature rich phones. Openbit s revenues derived from license management would be the fastest growing. Further, Tanla will also target to obtain synergies from the connectivity related revenue that Openbit currently passes on to competitor billing partners such as Sybase, Netsize, etc., for payment related revenue share transactions. The acquisition will be 11% EPS accretive in the first year of operations. Base business continues to remain strong: In FY08, Tanla expanded geographically beyond the traditional UK market and generated ~15% revenue from Ireland, Singapore and Dubai. The margins from its aggregation business increased by 300 bps due to processing of high revenue generating rich media content, though the blended EBITDA margin came down by 200 bps due to a change in the revenue mix and higher SG&A expenses. Over FY08-11, we forecast TSL to report a CAGR of 53% in revenue and 33% in net profit. Margin pressure to continue and trend downwards: Over FY08-11, we forecast EBITDA and PAT margins to trend downwards with a low margin contribution from Openbit s acquisition, change in the revenue mix with increasing share of aggregation business, and higher SG&A cost with international expansion from 5 countries in FY08 to 40 countries in FY09. However, EBITDA margins above 35% and PAT margin of 23% characterize the strong business case model for TSL. Valuation and recommendation: With strong revenue and earnings growth on the back of Openbit s acquisition and geographical expansion, we have revised upwards our revenue and earnings forecast. We maintain our Buy call and revise our target price upwards from Rs450 to Rs500 by valuing it at 17.0X FY10 earnings. Currently, TSL trades at 10.8X and 8.3X times FY09E and FY10E earnings respectively. Himanshu Shah Shah.himanshu@religare.in Figure 1: Financials Year to March FY06 FY07 FY08 FY09E FY10E FY11E Net Revenues 630 2,218 4,598 8,427 12,209 16,426 EBIDTA 354 1,105 2,153 3,362 4,560 5,824 PAT adj ,631 2,337 3,060 3,844 EPS adj (Rs) EPS diluted (Rs) EPS growth (%) P/E (x) Dividend yield (%) RoE (%) RoCE (%) Price/BV (x) EV/EBIDTA (x) EV/Sales (x) Source: Religare Institutional Equity Research,

2 Openbit can provide upto 11% earnings upside in FY09 Openbit s is a software company that derives its revenue from the sale of its product Openbit License Manager (LM). License Manager is a client server solution that integrates on-device payment and digital rights management. The Client provides third party applications (ISVs independent software vendors) with API's to validate if the user has acquired the license for use and, if not, prompts the user to accept the license fee to be charged in his credit card or phone bill. The Server is provided by Openbit as fully hosted 24/7 service with links to billing partners. The license manager is usually pre-installed in Smartphone, but if not then, applications such as Symantec anti virus software, with which Openbit has forged associations, will prompt the user to download the Openbit LM. Thereafter, Openbit client on the handset will throw-up license obtainment / renewal options, and also enable payment over i. WAP based credit card; ii. Inclusion in the phone bill; iii. Premium SMS. Figure 2: Openbit s revenue streams mainly from set-up fee and revenue share Revenue stream Nature of transaction Revenue flow / Clientele Revenue per transaction Set-up fee Openbit tool-kit and account One time revenue - OEM / ISV Avg 0.3$ per kit set-up Professional $ per hour (85 Bespoke requirements Adhoc revenue ISV services Euro) Monthly fee Support and server hosting Monthly revenue ISV $ per platform (3000 Euro) License purchase Revenue share License sales / renewal over End user pays telecom on phone operator/cc gateway bill or premium SMS or credit Operator/CC gateway pays Below card charge Openbit Openbit pays ISV / Aggregator End user license fee Delivery and maintenance of end user license presentation Transaction revenue adds to top-line, set-up revenue to bottom-line and margins Transaction revenue: In FY07, Openbit had revenue of $15.9 mn, of which $13 mn came from 600K transactions of license sale / renewal over phone or credit card charge. With a gross margin of 12%, Openbit earned $1.6 mn. In Operator billing transaction, the share of the operator varies from 20% to 60% depending upon the geography (UK 20%, Spain 60%, average 40%). Operator transactions are generally low value transaction with less than 10. In case of credit card payments, the retention ratio is high as the operator retains no part of this revenue. Credit card transactions are generally greater than 10. Of the Openbit s revenue share, 88% is passed on to the ISVs / Aggregators as their portion of revenue. TSL connectivity to help improve the margin Further, Tanla will also target to obtain synergies from connectivity related revenue that Openbit currently passes on to the competitor billing partner such as Sybase, Netsize etc. By setting up its own connectivity, TSL management expects that the gross margin can be scaled up to 20-22%. Set-up revenue: Openbit earned revenue of $3 mn from installation of License Manager on 10mn plus handsets ($0.3 per phone) in FY07, and its management targets to scale it up to 70 mn by FY08. There is a very minimal cost associated with these. Openbit LM currently supports rich formats Smartphone s and Symbian OS for which it has a tie-up with Nokia. In FY08, Openbit plans to expand its License Manager client to additional platforms of Windows mobile, MIDP Java, Blackberry etc and to include feature rich phones beyond Smartphone s, shipments of which are expected to increase considerably over the coming years. 2

3 Increased installed base of LM and end customer transactions could add upto 20% in bottom-line by FY08. Figure 3: Earnings forecast of Openbit Description FY07* FY08 FY09E Installed based of phone Incremental installations Licence per H/s (US$) License revenue (US$ mn) Transaction count (000's) 600 1,200 3,000 Revenue per transaction (US $) Gross Revenue (US $ mn) Gross margin % 12% 18% 20% Gross margin (US $ mn) Total margin (US $ mn) Other cost (US $) PBT (US $) % PAT (US $) Base business PAT Earnings upside 11% 20% presentation, *year ending December We forecast a fall in LM revenue as volume picks up and Openbit starts providing volume discounts. We have also factored in the increase in the revenue share margin with the synergy from Tanla s connectivity. Openbit tie-up with 90 operators in 30 countries to provide boost to TSL international expansion plan. Base business to remain strong: Geographically, UK contributed 85% to the TSL s revenue where the company was able to increase its market share from 3% to 5%. For FY08-09, the management expects to increase its market share to 8% in the UK market with addressable market size of US$1,650 mn. TSL management has an ambitious plan to expand geographically by expanding it footprints from five countries in FY08 to 40 countries with direct connectivity in 28 countries. Openbit has established agreements to cover subscriber billing in 90 operator networks across 30 countries and with major credit card companies worldwide that allows convenient payment of mobile content and payment processing in over 150 countries. These would give instant fillip to Tanla s global expansion plan by leveraging on the billing agreements with operator networks and by cross selling of complementing tools for content management etc. Going forward, we shall see the revenue contribution in percentage terms decline for the UK market with the addition of new geographies, thereby diversifying the risk exposure for the company. TSL has identified for itself the markets to expand, size of the market, top priority markets, products / services to launch and time frame with respect to each of the markets and products. Among the additional geographies to be added, the company has identified 10 countries as priority list with high revenue potential and an addressable market size of $6.6 bn (China, USA, Russia, Brazil, Germany etc). Figure 4: Targeted operator connectivity Total no of countries New countries Connectivity by Revenues from 6 3 Q1-09 Jul Q2-09 Oct Q3-09 Jan Q4-09 Apr 09 3

4 Figure 5: TSL s expansion plan Description FY08 FY09E Countries 6 40 Short codes Operators Products, services and features Employees Development centre 2 4 Certification 2 9 Revenue and Earnings Forecast: With the acquisition of Openbit, TSL s management targets to have an annual growth rate of 100% in top-line or Rs9 bn. However, we have taken a conservative estimate and estimate the earnings growth to be 83%. Further, with international expansion, we expect the operating cost to increase significantly, especially the SG & A cost. We estimate the EBITDA margin to trend downwards with a change in the revenue mix, low margin contribution from Openbit, and increasing cost of operations. Excluding Openbit, we forecast the base business revenue and EBITDA to grow by 38% and 31% respectively over FY With Openbit, we forecast the overall business revenue, EBITDA and earnings to grow by 53%, 39% and 33% respectively over FY Figure 6: Segment-wise revenue mix In Rs mn FY07 FY08 FY09E FY10E FY11E Products Aggregator 1,574 3,532 5,448 7,470 9,820 Offshore ,170 1,521 Existing business 2,218 4,597 6,894 9,311 12,079 Openbit - - 1,533 2,898 4,347 Total revenue 2,218 4,597 8,427 12,209 16,426 Figure 7: Segment wise Revenue Contribution In % FY07 FY08 FY09E FY10E FY11E Products Aggregator Offshore Existing business revenue contribution Openbit Overall revenue contribution Figure 8: Segment wise EDITDA mix In Rs mn FY07 FY08 FY09E FY10E FY11E Products Aggregator 575 1,360 2,016 2,652 3,535 Offshore Existing business EBITDA 1,105 2,153 3,035 3,890 4,812 Openbit Overall EBITDA 1,105 2,153 3,364 4,558 5,804 4

5 Figure 9: Segment wise EBITDA margin In % FY07 FY08 FY09E FY10E FY11E Change in the revenue mix, increasing cost to bring down the overall EBITDA margin. Products Aggregator Offshore Existing business EBITDA margin Openbit Overall EBITDA margin presentation We are revising our revenue and earnings estimate upward for FY09 and FY10 to incorporate Openbit acquisition and to factor in margins revision in base business due to change in cost structure. Figure 10: Table for earnings revision Earlier estimates Revised estimates Upgrade/(downgrade) (%) FY09E FY10E FY09E FY10E FY09E FY10E Net Sales 6,882 9,273 8,427 12, EBITDA 3,097 3,895 3,362 4, EBITDA margin (%) (417 bps) (385 bps) PBT 2,828 3,496 3,080 4, Adj PAT 2,204 2,725 2,337 3, Adj PAT margin (%) (430 bps) (398 bps) Adj EPS (Rs) presentation Valuations and recommendations With global expansion and strong revenue and earnings growth, we maintain our positive outlook on the stock. We are revising our target price upward from Rs 450 to Rs 500. However, we are revising downwards our PE multiple from 20X to 17X FY10E earnings to factor in the execution risks from international expansion. 5

6 Stock performance TSL Absolute Perf. From Jan 07 Sensex Tanla Solutions Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Relative Perf. From Jan 07 Sensex Tanla Solutions Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Relative Perf. From Apr 07 to Mar 08 Sensex Tanla Solutions Apr-07 Jun-07 Sep-07 Dec-07 Mar-08 Relative Perf. From Apr 08 Sensex Tanla Solutions Apr 16-Apr 1-May 16-May 31-May 15-Jun Source: Bloomberg, Religare Institutional Equity Research 6

7 12 month forward rolling band charts TSL P/E Band 500 (Rs) x 16x x 10x P/BV Band 450 (Rs) x 3.5x 3x 2.5x EV/EBITDA Band EV/Sales Band 40,000 35,000 11x 45,000 40, x 30,000 9x 35, x 25,000 20,000 7x 30,000 25, x 15,000 5x 20, x 10,000 15,000 5,000 10,000 Mkt cap/sales Band 50,000 45,000 40,000 6x 5x 35,000 30,000 25,000 4x 3x 20,000 15,000 10,000 Source: Bloomberg, Religare Institutional Equity Research 7

8 Financials Income statement Y/E, 31st March FY07 FY08 FY09E FY10E FY11E Net sales 2,218 4,598 8,427 12,209 16,426 EBITDA 1,105 2,153 3,362 4,560 5,824 EBITDA margin (%) Depreciation EBIT 1,025 1,918 2,917 3,920 5,019 Other income Interest Exp/(Inc) (74) (174) (163) (230) (248) PBT (operating) 1,098 2,093 3,080 4,150 5,267 PBT margin (%) Extra ord (inc)/exp Taxes ,090 1,423 Minority interest PAT( Reported) 928 1,631 2,337 3,060 3,844 Less: Extra ordinary income / Others Adj PAT 928 1,631 2,337 3,060 3,844 Adj PAT margin (%) Quarterly Financials Y/E, 31st March Q4FY07 Q1FY08 Q2FY08 Q3FY08 Q4FY08 Net sales ,073 1,193 1,436 Changes (%) EBITDA Changes (%) Margin (%) PAT PAT adj Change (%) 47.8 (2.3) Margin (%) EPS adj (Rs) EPS dil (Rs) Ratios Y/E, 31st March FY07 FY08E FY09E FY10E FY11E Growth Net sales (%) EBITDA (%) PAT adjusted (%) EPS adjusted (%) EPS diluted (%) Valuations P/E (x) P/BV (x) EV/EBITDA (x) EV/Sales (x) Profitability EBITDA margin (%) Adj PAT margin (%) RoE (%) RoCE (%) RoIC (%) B/S ratios Inventory days Creditor days Debtor days Working Capital days Net debt/equity * ROIC is calculated on post tax basis. Balance sheet Y/E, 31st March FY07 FY08E FY09E FY10E FY11E Liabilities Equity share capital Total Res. & Surplus 5,362 6,993 9,332 12,392 16,233 Total Shareholders' fund 5,462 7,093 9,432 12,492 16,333 Convertible Debt Others Debt Total Loans Deferred tax liability (net) Total liabilities 5,484 7,115 9,454 12,514 16,355 Assets Net fixed assets & others 481 1,794 2,797 3,405 3,648 Capital WIP & others Total non-current assets 722 2,035 3,439 4,047 4,290 Total investments non current Current assets Inventories Sundry debtors 790 1,351 2,655 3,847 5,175 Cash & cash equivalents 3,911 3,827 3,667 5,123 7,614 Cash 1,260 2,887 3,167 4,623 7,114 Liquid investments 2, Other current assets Total current assets 4,854 5,430 6,784 9,639 13,689 Total current liabilities ,048 1,452 Total provisions Net current assets 4,570 4,936 5,920 8,420 12,066 Misc. expenditure Total assets 5,484 7,115 9,454 12,515 16,356 Cash flow Y/E, 31st March FY07 FY08E FY09E FY10E FY11E Cash from operations PAT 928 1,631 2,339 3,061 3,841 Dep & amortization Working capital changes (530) (450) (1,144) (1,045) (1,155) Others Net cash from operations 478 1,416 1,640 2,656 3,491 Cash from investments Capital expenditure (626) (1,500) (1,800) (1,200) (1,000) Sale/purchase of inv & others (2,651) 1, Net cash from investments (3,277) 211 (1,360) (1,200) (1,000) Cash from financing Issue of shares & share premi. 3, Dividend paid Debt change Net cash from finanacing 3, Net change in cash 1,079 1, ,456 2,491 Per share data Y/E, 31st March FY07 FY08E FY09E FY10E FY11E EPS diluted - wtd EPS consl and diluted CEPS Book value Dividend O/s shs.-actual (mn) O/s shs.-diluted (mn) O/s shs wtd / diluted (mn)

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