Sterlite Technologies | Digital India play


(vijay) #1

Sterlite Technologies:

They are the largest manufacturers of Optical Fibers and Optical Fibre Cables (OFC) in India with around 35-40% market share. Their USP is vertical integration - they are the only player who manufacture silica from sand and then turn it to optical fibres. They have facilities in China and Brazil as well

One of the biggest beneficiaries of data explosion and digitization. To give you some context here - India today has around 70-80 mkm fibres laid out Vs close to a billion km laid out by China and 500 mkm by South Korea

The current airwave mode of data transfer in India is not sufficient for 4G roll out and they require optical fibre. Reliance Gio, Vodafone and Airtel have huge capex planned for 4G which will require overhaul of existing towers as well as new towers with optical fibre connectivity
Government has huge plans for fiberization. Read this

Demerger play: The company today has 2 businesses - Telecom and Power. By end of fy16, the telecom division will be demerged and the power business will be taken private. Total company today is valued at around 4000 Cr mcap and the unlisted business will be worth 800 Cr. If you wish to exit the power business, you will get around 22 Rs preference share within 30 days of demerger. Read the demerger details here

Valuation of telecom business: Telecom business will do EBIDTA of around 450 Cr. They have already done 250 Cr in H1 Fy16. Total debt transferred to telecom division is around 1000 Cr and the interest outgo will be 100 Cr. Post depreciation of around 19 Cr per quarter and tax of 28%, the PAT comes to be around 150 Cr. At market cap of ~2600 Cr [3400*(86-22)/86] of the telecom business, you are getting this business at around 17 PE. Telecom if a 20+% EBIDTA and 25% ROCE business. So, I think it is a good buy

Management reported that they plan to take their revenues from around 1500 Cr today to around 8000-9000 Cr in the next 5 years.They are doubling the OFC capacity from 7 million cables to 15 million cables by Q4FY16…this should provide a revenue & PAT boost to the company since capacity utilisation is high…However margin will deteriorate since OFCs have a lower margin than plain optical fibres…But management has guided for EBITDA margins in the range of 21-22%

End to end solutions provider: Currently, around 10% of their revenues come from service and solutions- design, implementation, software etc. They plan to grow this business going forward.
Sterlite’s telecom division acquired Elitecore Technologies last quarter (Revenue: 147 crore; EBITDA: 16 crore; debt free company). Elitecore’s CAGR is 25%; company has been profitable for the last 7 years
Another important point is that company has a large NFS order in J&K (~Rs1300 crores). The revenue impact of the order starts from Q2 onwards…In FY15 company had just recognised 68 crores of this revenue.

Risks to this thesis:

Considering the bad management reputation (Vedanta group - Anil Agarwal), I am sceptical that a plain commodity like OF and OFCs have EBITDA margins of 21-22%. My suspicion is that the company is transferring the power segment profits to the OF/OFC segment. This makes the power segment numbers look bad enabling the company to take the power division private since most shareholders will opt for preference shares looking at the bad nos. The major risk is that the telecom division margins suddenly drop off after the demerger…If you have a look at FY14 and FY13 nos…telecom segment had decent margins of 12-13% which have now increased to 22%…The management attributes the increase in margins to improving capacity utilisation and operating leverage…But is such an expansion in margin really possible due to increasing operating leverage only ??

Mgmt salary is really high…however I wouldn’t want to miss out on a stock on just this fact alone…The cost of missing out is high…

Government orders such as NPS etc generally have payment issues and can impact receivable days

Overall, we are getting a great business with 25% ROCE at less than 20 PE. I am expecting a good rerating post demerger. Many past demerger plays have been very rewarding - Entire Alembic group had market cap of 900 Cr in 2010 and now Alembic Pharma itself is 13000 Cr and Alembic ltd is 1000 Cr. Inspiration has been Joel Greenbalt’s book - You can be a stock market genius!

Disclosure: Invested at 86


(Dhairya) #2

Hi @Sailor1980, this is just what i was thinking as well. The power business was acting as a drag on the telecom business and this was leading to suppressed prices. The demerger makes sense as most of the debt on the balance sheet was pertaining to the power business.

With respect to EBITDA Margins of OF/OFC segment, you have raised an interesting point. Will need to do some more research on EBITDA margins of this industry.

Disc: Invested since 60 levels


(Abhishek shah) #3

Hi,

I checked the EBITDA margins of Vindhya Telelinks - which is in the same business. Their EBITDA margins are also ranging between 20-22% since last 3 quarters. Before that they had poor margins. I think the EBITDA guidance given is correct. Demand has increased for OFC and will be more in coming years. Only issue is mgmt !!

Could you please give some more information on the J&K order bagged by the company. Also any other orders in pipeline for the company?? I am interested.

Disc: Not invested.


(sivakkri) #4

One reason why EBITA margins for cable companies have increased in the recent past is because of the reduction in raw material prices (refer to Vindhya Telelink’s last qtrs “Cost of materials consumed” against same quarter last year). One needs to take a call based on how long these raw material prices will be favourable.
Disc: Not invested.


(Abhishek shah) #5

Vindhya and other companies like Aksh in the sector command PE of 17-19…Sterlite commands low because of power sector. Once the power is demerged…we can see good value in this business…


#6

Excellent write up, Vijay.
Substantial order book, debt reduction in next few quarters and business visibility for next 2~3 yrs due to various digital initiatives might result in YoY growth.
Few more risks:
1-Current business profile does not seem to be stickier with predictable cash flows.
2-Management does not walk the talk. For example – Elitecore acquisitions was mentioned to be fulfilled with internal accrual and cash. Finally, it was done with debt.
Disclosure : Invested for tracking purpose. Roaming with a truck to load up as an opportunistic bet, if price is attractive to make it a no-brainer (power business comes free—wishful thinking :smiley: ).
As power business might be listed back after few years to provide the exit to PE investor, it might be the real wealth creator! As this is an assumption, hence the wishful thinking :smiley: .
Let’s focus on Power business which is being taken away from shareholders via demerger.

  1. Why does management load it up with higher debt as it does not seems to be generating enough cash to service it (per say carved out financials for FY15 and H1 of FY16)?
  2. Is this the real Gem which was nurtured with the cash flows of telecom and is at the inflection point and grim picture is portrayed to ensure that it goes offline smoothly?

Open to Valuepickers for hints to dig further in to it.


(vijay) #7

@sivakkri I remember the CFO mentioning in one of the con calls that raw material fluctuations are generally passed through to their clients. So, not sure of this.

@Surender The worry about power business being nurtured by the telecom business is very difficult to verify. If for a second, you put yourself in the shoes of the promoter and ask where would you like to bet on for the next 3-4 years? If feel it should be in telecom business where they can create huge market cap. This would not be possible if an annuity kind of front ended cash guzzling business is saddled on the EPS driven telecom business. For me, the key question is “Can the telecom business grow multiple fold in a profitable way?” and not “Is the promoter underestimating the value of power business and later profit from it?”

Vijay


(Abhishek shah) #8

what is the order flow - defence is ok. but are they getting continous order flows. Anyone who can provide the details??


(vijay) #9

As per the Q2 Fy16 investor presentation:

- Telecom order book stands at Rs 2009 crore, of which services and supply of products as part of the NFS order was at around Rs 1900 crore and should be executed by the end of 2016

-The telecom products business continues to win new customers globally and has recently been selected to help a global operator expand its network across 50 Towns and over 500,000 buildings in Ireland

Vijay


(anand) #10

Are you sure Aksh commands a PE of 17? TTM PE is around 8. HFCL and AKSH at present are in the 8 PE range and seemed undervalued as compared to its peers. Of course, i’m considering only PE here.
DISCL: Invested in both AKSH and HFCL


(anand) #11

Also some of these companies are carrying forward their earlier losses, and getting tax benefits. So one needs to take into account how long these tax benefits can be enjoyed.


(Abhishek shah) #12

sorry anand, I correct myself. Mistake on my part.


(anand) #13

Both HFCL and AKSH, digital india plays, in the past few days have handsomely beaten the index. signs of more to come ? :unamused:
https://www.google.com/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1449050400000&chddm=30&chls=IntervalBasedLine&cmpto=NSE:HFCL;INDEXBOM:SENSEX;NSE:STRTECH&cmptdms=0;1;0&q=NSE:AKSHOPTFBR&ntsp=0&ei=8HheVvGbMImxugSY_5XoAQ


(Girish) #14

There was article recently in ET where the CEO says power business will turn around this year. This is like equity stub. As the debt is reduced the equity portion will rise exponentially. The crisil has valued the power business at Rs 30 as of today. Many investors will take Rs. 22 and opt out. The remaining ones…promoters and insiders will turn around the business and relist with hefty profits. This is a business where the insiders will make more than 10x kind profits in just next 3-4 years. Look at ET article and see their focus on that business. They are using state of the art technology to solve some of the problems. It does not come across as neglected or unloved business. In fact management commitment comes across as very very high in that interview.


(Girish) #15

The main risk here is promoters. If you see history of this stock you will find that this stock has not created any shareholder wealth in the last 16 years. The promoter reputation is really poor. We need to see how the future pans out. I have my doubts.
But I agree that the demerger will unlock some value. I am still not convinced that this is buy and hold forever kind of stock. Difficult to partner with such promoters over a long period. But this may be great opportunistic trading idea over next 2-3 year period provided you buy at lower price.


(praveen706) #16

I agree completely with Girish promoters have always shortchanged investors from sterlite to madras aluminium and now cairn.Even if there is turn around they will come up with a trick or two to take the money out to any of their group companies. .A good opportunity for a company will not be rewarding for shareholders if management is circumspect.Hence please exercise caution


(Nelson) #17

Question to experienced people on this Board:

If shareholders choose to remain invested in the demerged power co and an IPO does not come about in the next 4 to 5 years, what sort of exit options does an Investor have?

I am an existing shareholder but facing a big dilemma when it comes to choosing between the two options.


(Girish) #18

Nelson:
In that case you will be at the mercy of promoter and management. If there are other strong PE investors invested in this unlisted entity then you have a chance because they will ask for exit. But this power division is like a lottery- very high risk and high reward type. Like real option type. The promoters are absolutely unscrupulous as some one rightly said above. They are not the party you want to partner with for long term. I think there is unanimity in investor community on that one point.:slight_smile:


(niranjant) #19

How do we get out, I’m not seeing any notification or detailing on the exit method anywhere!. the whole demerger and merger business has to be straightened out!.

Adani Port and others have already created enough ruckus!.


(Girish) #20

In recent interview CEO has clearly said that they have no plans to list power business in the near future. They are making every thing to discourage retail to exit at 22.5. They don’t want you in on their future journey really.
On the other hand if you insist on continuing then there is no clarity on how you can exit if you want to exit in the future. You may get badly locked in. And you do not want to get locked in indefinitely with such promoters.