Tejas Networks – A strong play on digital infrastructure
Tejas Networks is an India-based optical and data networking products company. Company manufactures products which enable telecommunication networks that carry voice, data, and video traffic over optical fiber. Its products cover access, metro and long haul networks, but primarily cater to former two segments. It has customers in 60+ countries but India is its biggest market (82% of FY18 revenue). India-based R&D and manufacturing help it run a cost-efficient business model vs. global players. Company is set to capitalize on opportunities that arises from increasing fiberization of networks amid rising data demand. Strong order book of Rs 5.8 bn at end of FY18 helps push up revenue post weak FY18 and government push for rural connectivity (BharatNet 2, Rs 30-50 bn opportunity) along with Make in India/Preferential Market Access (PMA) Policy increases demand for Tejas’ products.
Tejas manufactures products in India through partnerships with Electronics Manufacturing Services (EMS) companies. Company has three revenue segments i.e., Products, Services and other operating revenue. Products Consists of manufactured goods including optical and data networking products and component sales to its contract manufacturers. Services include of maintenance, installation & commission revenue and other operating revenue. Other operating revenue consists of export incentives, duty drawback, sales commission and royalty income.
Company’s clients include telecommunications service providers, internet service providers, utilities, defense companies, and government entities in over 60 countries. India is biggest market of Tejas (82% of revenue in FY18) with 60% of the revenue coming from Indian PSUs. While products contributed 90% to the top line in FY18 remaining 10% came from services segment. Tejas has significant client concentration with 57% of revenue from top 2 clients (FY18) and most of the company sales comes in terms of repeat business (88% in FY17) from existing clients.
Multiple growth drivers – higher bookings lend revenue visibility for FY18-20E:
Exponential growth in connected devices and growing broadband penetration, Massive investments in optical fiber networks driven by surge in data/video traffic, Network up-gradation by telecom operators especially their metro optical networks, Enterprises adopting higher-speed Ethernet services driving bandwidth demand with rise of cloud computing, Next-gen players like Amazon, Facebook and Google building captive optical networks for data center interconnects and Investments in digital infrastructure by governments globally to provide broadband services especially in rural areas are the key growth drivers.
Telcos and Bharat Net -2 to drive fiber network demand in India:
Tejas to benefit from increasing fiberization of networks amid rising data demand. Less than 25% of cell towers in India are connected on fiber vs. 70-80% in developed countries. Indian telcos have planned over Rs 600 bn capex – mostly for optical infrastructure and 4G expansion. Intra-city networks requires large investments in both capacity and fiber-reach; Inter-city investments in fiber will most likely be only for upgrade in capacity. Government focus on improving rural connectivity is expected to create Rs30-50 bn of equipment demand is expected from BharatNet Phase 2 which is to be implemented in 2 years.
Products across the network infrastructure and asset light structure:
Tejas’ strategy is to focus on end-to-end networking products for three networks types – access, metro and long-haul. Tejas is well-positioned to capitalize on the expected growth in optical capex by communication service providers (CSPs) GPON expanded its addressable market to include residential and enterprise broadband access over optical fiber. Tejas intends to invest in >100G, converged packet optical (CPO), optical transport network (OTN) and reconfigurable optical add-drop multiplexer (ROADM), which are expected to register high growth.
Major portion of Tejas operations are in India (except for international sales and support) that leads to significantly lower operating expenses vs. global competitors. Company outsources most of its manufacturing to Electronics Manufacturing Services (EMS) companies, while it does the final integration, testing and quality control in-house. This allows Tejas to stay asset light and scale up production without increase in capex. It maintains direct relationships with strategic component suppliers to get technical support, favorable pricing and short delivery times.
Company’s competitive strength backed by consistent investments in R&D. Over 50% of employees work in R&D; Tejas R&D head count increased by 21%YoY in FY18. Optical and data networking products business is characterized by high-entry barriers due to initial investments in R&D, demand for skilled professionals and time taken to successfully develop networking products/ solutions.
Tejas is entitled to a deduction at the rate of 200% (150% from FY18-20;100% from FY21) of scientific R&D expenditure.
Fundamentals to improve further from current levels.
Tejas’ gross revenue from operations has posted 15% CAGR over FY14-18. We expect topline growth to remain healthy (32% CAGR over FY18-20E) led by healthy order-book of Rs 5.79 bn (highest ever in its history – 80% of order-book to be realized as revenue in FY19) and Increasing data demand leading to higher capex by telcos and Government initiatives to improve rural connectivity.
EBITDA margin increased in FY18 on higher sale of high margin products. We expect EBITDA margin to increase to 23.2% on high margin services revenue share increase and operating leverage. Capex/ sales has declined since FY13 as Tejas outsources most of its manufacturing to reputed electronics manufacturing services (“EMS”) companies, thus allowing the it to stay asset-light. Tejas has managed to generate positive FCF since FY15. We expect this FCF to be positive in FY19-20E. Debt level has declined post equity raising in FY18. We expect net cash levels to keep improving in FY19-20E.
Tejas’ days of inventory holding was 83 days for FY18, down from 210 days for FY15. Inventory as a percentage of gross sales reduced to 25% in FY18 from 54% in FY15. We note that FY18 inventory number of days was higher at 83 vs. 71 days in FY17 due to build-up of inventory in anticipation of pending orders. Company’s general credit terms vary across geographies and type of customer, but has remained on the higher side. The company has been focused on reducing trade receivables days. Trade receivables number of days has declined from 253 days in FY15 to 135 days in FY18.