Tejas Networks Ltd. IPO Review. Price band ICICI Securities Ltd Retail Equity Research. Investment Rationale. June 9, 2017.

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1 IPO Review Rating matrix Rating : Unrated Issue Details Issue Opens Issue Closes 14-Jun Jun-17 Issue Size ( Crore) Fresh Issue ( crore) 450 Offer for Sale ( crore) Price Band ( ) No of Shares on Offer (crore) QIB (%) 75% Non-Institutional (%) 15% Retail (%) 10% Minimum lot size (No. of shares) 55 Objects of the issue Objects of the Issue a) Capital expenditure towards payment of salaries and wages of R&D team ( 45.3 crore) b) Working capital requirement ( 303 crore) c) General corporate purposes d) Offer for sale Shareholding Pattern Pre-Issue Amount crore Post-Issue Promoter & promoter group 0.0% 0.0% Public 100.0% 100.0% Financial Summary Crore FY14 FY15 FY16 FY17 Net Sales EBITDA EBITDA Margin (%) PAT 2.8 (17.9) Valuation Summary (at upper price band: 257) (x) FY14 FY15 FY16 FY17 P/E NM NM EV/EBITDA P/BV RoCE RoNW 0.9 (5.4) Research Analyst Bhupendra Tiwary bhupendra.tiwary@icicisecurities.com Sneha Agarwal sneha.agarwal@icicisecurities.com June 9, 2017 Tejas Networks (Tejas) is an optical and data networking products company with customers in over 60 countries. The company designs, develops and sells software enabled networking equipment products to telecommunications service providers, internet service providers, utility companies, defence companies and government entities. Tejas 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 operating revenues and EBITDA have grown at 24.2% and 40.9% CAGR over FY13-17 to crore and crore, respectively. It is coming with a fresh issue of 450 crore ( crore shares) and offer for sale (OFS) of ~ crore. Investment Rationale Leading Indian player in optical networking equipment market Tejas 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, which is dominated by global giants like Huawei, Nokia, ECI Telecom, ZTE, etc. The key clientele for Tejas includes BBNL, BSNL, PGCIL & RailTel among Indian PSUs. Similarly, it also serves private telcos like Airtel, Idea and Aircel among others. The company has a sticky clientele base and generated 88% of FY17 revenues from repeat business. In terms of contribution of top five customers, ~58% of revenues were contributed by them in FY17. Currently, India is the largest geographic segment (in terms of revenue - ~65% of revenues in FY17). The company is banking on growth opportunities arising out of Digital India and the Make-in-India programmes of the Indian Government along with demand from the private telcos as they expand their 4G network. Strong revenue and margins expansion in last four years Tejas operating revenues and EBITDA has grown at a 24.2% and 40.9% CAGR respectively over FY13-17 to crore and crore respectively. Given the sharp growth in topline, the company has benefited from the operating leverage and the margins have expanded from 12% in FY13 to 19.8% in FY17. Key risks and concerns Client concentration risk: 58% of its revenue (FY17) is generated from top five customers who exercise substantial negotiating leverage. The loss of one or more of significant clients could have an adverse effect on the business Technology risk: The company s future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address technological changes outstanding litigation pursuant to the grant of compulsory licenses Competition risk: The networking equipment market is highly competitive, rapidly evolving and is characterised by large MNCs who have a bigger bandwidth Priced at FY17 PE multiple of 36.4x on higher band Tejas Networks Ltd Price band At the IPO price band of , the stock is available at a multiple of x FY16 EPS.

2 Exhibit 1: Tejas product offering for telecom network Company Background Tejas Networks is an India-based optical & data networking products company with customers in over 60 countries. The company designs, develops & sells high-performance and cost-competitive products to telecommunications service providers, internet service providers, utility companies, defence companies and government entities (collectively, communication service providers). Products are used to build high-speed communication networks that carry voice, data & video traffic from fixed line, mobile & broadband networks over optical fibre. The products utilise programmable software-defined hardware architecture with a common software code-base that delivers an app-like ease of development and upgrades of new features and technology standards. Currently, India is the largest geographic segment (in terms of revenue - ~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 company has also entered into OEM agreements with Ciena, NEC and RAD, pursuant to which they can sell their products under their respective brand names to their customers. The current product portfolio targets access (i.e., the outer perimeter of a telecommunications network that connects to end consumers), metro (i.e. networks that aggregate and distribute traffic collected from access networks within a large city or region) and long-haul (i.e. networks that interconnect metro networks using high bandwidth transmission) networks. The hardware is modular and the software-defined architecture allows the company to remotely upgrade its hardware with new capabilities and features. This enables the customers to adopt a pay asyou-grow approach (i.e., purchase the products/services incrementally as needed) while adopting new services, and also enables them to extend the life of installed systems through regular feature upgrades without having to invest in new hardware purchases. The software-defined hardware architecture also enables the company to deploy the same products across multiple hardware platforms in multiple geographies by making country specific adaptations, thus allowing it to save costs and realise economies of scale. Source: DRHP, Roadshow Presentation ICICIdirect.com Research Page 2

3 The key clientele for Tejas includes BBNL, BSNL, PGCIL & RailTel among Indian PSUs. Similarly, it also serves private telcos such as Airtel, Idea and Aircel among others. It also has an international clientele base in the form of OEMs such as Ciena, NEC and Sacofa (direct). Exhibit 2: Clientele Source: DRHP, Roadshow Presentation ICICIdirect.com Research The company has a sticky clientele base and generated 88% of the FY17 revenues from repeat business. In terms of contribution of top five customers, ~58% of revenues were contributed by them in FY17. Exhibit 3: Top five clients and their contribution FY15 FY16 FY17 Bharti, Bharti, BBNL BSNL BSNL BSNL Ciena Ciena Ciena Railtel Sacofa Sacofa Tata Communication Tata Communication Tata Communication Contributed 55.7% of revenues Contributed 67.4% of revenues Contributed 58.2% of revenues Exhibit 4: Domestic and international revenues Domestic 57% FY15 Revenues Break-up Internatio nal 43% FY16 Revenues Break-up Domestic 72% Internatio nal 28% FY17 Revenues Break-up Domestic 65% Internatio nal 35% Page 3

4 Financials As mentioned above, Tejas earns ~65% of its revenues from the domestic market. Operating revenues and EBITDA have grown at 24.2% and 40.9% CAGR, respectively, in FY13-17 to crore and crore, respectively. Given the sharp growth in topline, the company has benefited from the operating leverage while margins have expanded from 12% in FY13 to 19.8% in FY17. Exhibit 5: Revenue and EBITDA trajectory ( crore) 1, FY13 FY14 FY15 FY16 FY (%) Total Revenue EBITDA EBITDA Margin (RHS) Exhibit 6: PAT and PAT margins trend ( crore) (20) (40) (60) (80) (100) FY13 FY14 FY15 FY16 FY17 (17.9) (79.0) (5.0) (10.0) (15.0) (20.0) (25.0) (%) PAT PAT Margin (RHS) The company, however, has an elongated working capital cycle given the nature of the industry as well as the clientele that it serves. The company net working capital ex cash at ~235 days (debtor days of ~149 days and inventory of ~76 days) indicates that cash generation despite higher profitability in the business would be under stress. Page 4

5 Industry Overview In India, investment in optical networking infrastructure has grown in recent years, including growth in data centre construction. According to Ovum, Indian telecommunications operators allocated an estimated 7.2% of their entire capital expenditure in 2015 for the development of optical networking infrastructure. Ovum estimates the Indian optical networking market revenue at ~US$ 594 million in 2016 and expects it to grow to US$869 million in Exhibit 7: India optical equipment industry India Optical Equipment Capital Expenditure USD Mn Tejas has 15% market share in the Indian optical networking equipment market. The company is the second largest and only Indian company present in Top 10 in India in a segment, which is dominated by global giants like Huawei, Nokia, ECI Telecom, ZTE, etc. Exhibit 8: Market share India Optical Networking market share 2Q2015 to 1Q2016 (US$ 0.6 billion) Fiberhome 3% ZTE 5% Ciena 9% Others 10% Huawei 36% ECI Telecom 10% Nokia 12% Tejas 15% Growth drivers in optical networking segment globally The optical networking market has grown in three fundamental ways: geographic extension, capacity expansion and interconnection among communication service providers (CSPs) & others. Network investment has continued despite uneven macroeconomic and geopolitical conditions. The global optical network market is projected to grow at a 4.1% CAGR, in India has exhibited strong growth prospects due Page 5

6 to renewed mobile network growth and data centre construction. India's optical networking market is expected to grow at a 14.2% CAGR, from 2014 to China, with growth been driven by Smart Cities, FTTx, mobile and long-haul DCI, is projected to grow at 5.7% CAGR, from 2014 to The Asia and Oceania region, driven by growth in India and China, is projected to grow at 5.2% CAGR, in North America's optical networking market is projected to grow at 3.0% CAGR, from 2014 to 2020 based on a renewed focus on high-performance business services, cloud adoption and DCI. 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 and the total mobile broadband penetration to reach 75.47% of the country s population by Fiberisation of backhaul network According to Deloitte, in India, less than 20% sites are fiberised compared to 70-80% sites in a developed country. The Department of Telecommunications (DoT), Government of India, has introduced Indian Telegraph Right of Way Rules, 2016 (the RoW Rules) to speed up the approval process for over ground (mobile towers) and underground optical fibre infrastructure. 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, CPO, 100G, greater-than 100G, OTN and ROADM technologies driving product segment growth From a product perspective, CPO, 100G, greater-than 100G, OTN and ROADM technologies are key growth drivers for optical networking products. According to Ovum, each of CPO, 100G, OTN and ROADM product segments have are growing at a CAGR 7.8%, 9.2%, 14.6% and 11.1%, respectively, from 2014 to Page 6

7 Objects of issue The offer consists of a fresh issue and an offer for sale (OFS) by existing shareholders with the total issue size ranging from crore to crore. Through the fresh issue of crore shares, the company intends to raise 450 crore at a price band of Objects of fresh issue: The details of the proceeds of the fresh issue are summarised below: a) Capital expenditure towards payment of salaries and wages of research and development team ( 45.3 crore) b) Working capital requirement ( 303 crore) c) General corporate purposes (remaining) Offer for sale: Selling shareholders will be entitled to the proceeds of the offer for sale after deducting their portion of the offer related expenses and relevant taxes thereon and Tejas would not receive any proceeds from the offer for sale. In addition to the aforementioned objects, Tejas expects to achieve the benefits of listing of equity shares on stock exchanges, which will result in the enhancement of the company s brand and creation of a public market for its equity shares in India. Page 7

8 Key risks and concerns 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, business, results of operations and financial condition will be materially and adversely affected. Furthermore, these large customers exercise substantial negotiating leverage with the company, which could adversely impact its results of operations. For FY15, FY16 and FY17, gross revenue from the sale of products and services (excluding sales to EMS vendors on a pass-through basis) to its top five customers amounted to 56.6%, 67.8% and 58.8%, respectively of the consolidated revenue from operations (gross). Technology risk The networking equipment market is characterised by rapid technological changes, with new product introductions, technology enhancements and evolving industry standards with respect to the protocols used in data communication and telecommunication networks. The company s future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address these changes as well as current and potential customer requirements. New products based on new or improved technologies may render existing products obsolete. The introduction of new and enhanced products may also cause the existing customers to defer or cancel orders for existing products. In addition, a slowdown in demand for existing products ahead of a new product introduction could result in a write-down in the value of inventory on hand related to existing products and/or a charge for the impairment of long-lived assets related to such products. The company in the past has experienced a slowdown in demand for existing products and delays in new product development Highly competitive market The networking equipment market is highly competitive, rapidly evolving and is characterised by frequent introductions of new and improved solutions, applications and technologies. Furthermore, competitors include large global companies such as Huawei Technologies Company,, Nokia Corporation, ZTE Corporation, and Ericsson, specialised optical network equipment providers such as Ciena, Coriant, Fiberhome, Adtran, Adva, ECI and Infinera and Ethernet switches and IP router providers such as Cisco, Juniper, Huawei and HP. Thus, there would also be risk of competitive pricing as well as higher bargaining power of its clientele. Legal Proceedings There are outstanding legal proceedings against the company that are incidental to its business and operations, including tax proceedings. These proceedings are pending at different levels of adjudication before various courts, tribunals and appellate tribunals. The company has 40 tax litigations against it wherein total amount involved is crore. An adverse judgment in any of these proceedings, individually or in the aggregate could adversely affect the business Page 8

9 Financial Summary Exhibit 9: Profit and Loss Statement ( Crore) FY13 FY14 FY15 FY16 FY17 Gross Sales Less: Excise Duty Net Revenue Consumption of Raw Materials Employee Cost Other expenses Total Operating Expenditure EBITDA Other Income Interest Depreciation Exceptional Items 48.8 (30.5) PBT (78.8) 2.8 (17.9) Total Tax Net Profit / (Loss) for the year (79.0) 2.8 (17.9) Exhibit 10: Balance Sheet ( Crore) FY13 FY14 FY15 FY16 FY17 Equity Capital Preference Capital Forfeited shares 3.3 Reserve and Surplus Total Shareholders funds Total Debt Liability side total Net Block Capital WIP Investments Inventories Debtors Cash Loans & Advances Other Current Assets Total Current Assets Creditors Provisions Other Current Liabilities Total Current Liabilities Net Current Assets Assets side total Page 9

10 Exhibit 11: Key Ratios FY13 FY14 FY15 FY16 FY17 Per Share Data ( ) EPS - Diluted (8.8) 0.3 (2.0) Operating Ratios (%) EBITDA / Net Sales PAT / Net Sales (21.4) 0.7 (4.6) Inventory Days Debtor Days Creditor Days Return Ratios (%) RoE (24.6) 0.9 (5.4) RoCE RoIC (0.9) EV / EBITDA Market Cap / Sales Price to Book Value Solvency Ratios (x) Net Debt / Equity Debt / EBITDA Current Ratio Quick Ratio Page 10

11 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction; Buy: >10%/15% for large caps/midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more; Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai research@icicidirect.com Page 11

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