E2E Networks Ltd - Listed small Cloud computing player

Stock Opportunities Untested - but worth a good look
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True. I’ve complained on this forum of vague number provided in concalls before. I hope Dua learns that number uttered, even in the most hypothetical scenarios, will be quoted back.
800cr. did seem like surreal and actually got my heart racing due to the below calculation:

If we look at it from an annual asset turn perspective where capex this year, gives revenue next year, these are the numbers we get:

Assets: 800 (this year) + ~200 (existing 210 - 12 intangible assets ) = ~1000 cr. This will be in FY24-25
Revenue in 25-26 from above at 1.5x asset turn = 1000 X 1.5 = 1500 cr.
Assume, PAT margin is 15% (24% now - 9% debt interest assumed) = 1500 * 0.15 = 225 cr.
EPS = 225 /1.45 = 155 Rs/ share
PE (in todays price) = 1818 (CMP) / 155 = ~11.7

Now these are quite conservative assumptions. It does not assume capex will give returns within the same year. PAT is assumed low. No new CAPEX and returns in FY25-26.
I have not accounted for mounting depreciation but the point is that the dream of these numbers go my heart rate up and that does not happen often.

With the 800cr. assumption gone, let’s see where this goes. Will have better idea in H2.

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The management has set an asset turnover guidance of 0.5 to 0.6. They may be taking a conservative approach, but assumption of a 1.5x asset turnover seems aggressive in comparison.

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You’re right. I should have clarified. As shown in my numbers, my assumption is that this year’s assets give return next year. If we take the asset turn the typical defined way it will indeed be much lower as you pointed out. I calculated taking in a lag of 1 year (as shown in my rough calculations). Kind of a forward looking asset turn as I think asset turn during the time period of heavy investment will give quite low asset turn for the period as the infra is being purchase, delivered, installed and commissioned.

Thanks for pointing it out. I hope this clarifies it.

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Management provided guidance about asset turnover during the conference call

Pankaj Shah: Okay, got it. And sir how should one look at the asset turn, so earlier we used to get a 0.7x over a year. So does this increase with time or how should we look at?

Tarun Dua: See, it’s very, very difficult to kind of, these are all averages, in the sense that like the asset turn also relies on a number of things, the period for which the customers are using the services,so, then there is more scarcity in the market, people want like longer contract period, when there are less scarcity, then obviously people want like shorter periods, but that doesn’t mean that they are going away tomorrow, day after or next month. But they also tend to end up paying a certain percentage more for shorter periods. Now, that being said, like there is also the nature of SKUs, so for the same underlying hardware, assets, like there are a number of
ways in which the assets get monetized due to the nature of the software capabilities as well.
So over there, for each different SKU, the asset terms could vary from all the way from point
0.5 to even like 2. So what is the final blend we are able to achieve like, is again something w
can look back into the past and say that, okay this was what was achieved but, there is a lower bound for that which we can predict, which is like somewhere, anywhere between say 0.55 to 0.6. But that’s the lower bound. But, on the other hand, like there is no upper bound in a software driven cloud, like where, what sort of capability you can bring to the table to achieve like an asset turn. So normally, if you ask me, that was not how we look at our business, we look at our business as a technology business, very focused on figuring out the various industry solutions. And over there eventually like, the asset turn doesn’t matter, because it’s like, very,very capability and technology and software driven business and it’s not about being the cheapest on the market. It’s about creating enough value for the customers.

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Couple of interesting snippets from the transcript:

Operating leverage and the scope for margin expansion:
"
So, only one question I have, so the margins have really improved the EBITDA margin, is it
something that is sustainable in future quarters or in upcoming years?
Tarun Dua: Ours is a platform business so, the overall team size, the platform size doesn’t need to really
increase with the amount of cloud business that we do. So, we can potentially scale up the
business 10x where the platform remains practically the same in terms of the size of the dev
team and the size of the operations team, it needs to grow very organically compared to,
whatever the growth on the side of the content revenue. So that way, there is always any
platform business, the scope for growth of margins is always there
"

On what they perceive as their USP:
"
Aman: My question is, what is our USP over the, if we are in a competition with the largest player or
an emerging domestic player, somewhere what we see the competition that makes us different
from the competitor, which is infrastructure heavy player and what add on’s we provide in
terms of cloud services to our clients?
Tarun Dua: So there is a long list of cloud services that we have been providing from last many years. And
typically, what happens with software usage is that software usage is a habits, so whether it’s
a larger player with like a bigger piece of software, whether it is like a player which is more
infra heavy, less software, ultimately the differentiator would become the stickiness of the
software that we eventually produced, with the help of like understanding from our customers,
that we build from our customers. So ultimately the differentiator is going to be the software
platform that we are building.
Aman: So are you trying to convince me that we are.
Tarun Dua: I am not trying to convince you of anything.
Aman: No, are we at better.
*Tarun Dua: I only want to convince our customers to use our product, I don’t need to convince anyone *
else.
"

Management sees Op margins over the medium term to be around 60%:
"
Pankaj Kumar: Okay. So, can we say that we have moved from +50 percent kind of margin to +60 percent kind
of margins, is that a reasonable estimate or reasonable understanding?
Tarun Dua: I already answered this question, in the medium term and the long term the trend should
sustain.
"

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I got the sense that this time, Management was treading the waters carefully regarding not being perceived as giving any numbers as guidance, after the 800 cr. So they were going out of their way to clear any guidance being implied from their statements.

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Company has said till June 2024 have deployed 450 H100(s) and capex in FY24 and Q1FY25 combined is 209 Crores, majority is to procure above chips.

And now in current July 2024 presentation, they have mentioned there is plan to deploy 250 H100(s) in July 2024 i.e., from Q2FY25 Quarter, hence a fair estimate of 100-125 Crores of capex is expected in Q2FY25, which is a good momentum in capex and also shows the growth tailwinds in the industry.

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Big boost and visibility for E2E networks, being one 1 among around 18 Meity empanelled and 1 among 3 to 4 H100 gpu Indian cloud service providers…(Govt being promoting local companies), a big booster in coming months and have to wait to see how it pans out.
Note: Meity budget allocated 10000 Cr as part of India AI mission for 5 year plan, also 500 Cr in July budget…

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This is true but I haven’t considered E2E taking on gov projects yet. I liked it when Tarun Dua said they aren’t applying to any gov projects right now. Gov. being the gov comes with its own set of challenges and will probably hold the leverage in terms of payment terms and obviously will be a bidding to the lowest bidder. Promoting it for being a cloud player via programs and incentives is great though.

I think E2E realizes this and considering Dua’s statement that 90% of their capacity on H100 is being utilized, they are pretty happy with the way things are going.

I’d hate and reconsider my position in the company is the Indian Gov. becomes its largest customer.

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#E2E Networks raise 420.51 cr through preferential allotment at an issue price of ₹1674.50.

Ace investor Ashish Kacholia and other lead investors also enters through this route… with this, we can infer capex plan on track and 20 to 25% export target by next year mentioned in concall…it’s long theme to play over short, medium and even long term… Ofcourse, Black swan event if any is exceptional …

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I find it odd that they raise Rs 420 cr in Aug and not a word about the fund raise or plans for deployment in the July concall! Secondy, wouldn’t debt have been better than diluting our holding? Plus the fact that the promoter is also diluting little by little.

Discl: I booked > 50% in late July because the valuations and the inbuilt expectations were making me uncomfortable. Needless to say, the subsequent price rise is making me even more uncomfortable! ;-)*

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They have already said that ₹800 Cr would be required in the earlier concall. One more fund raise is possible.
Debt to equity was already 2, equity raise will bring this number down.
Promoter share is reducing due to ESOP scheme. Promoter has not sold in open market and is also applying in preferential issue.

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I think they’ve given hints of raising funds from past 2 concalls when Tarun Dua made the blooper of declaring the well discussed 800 crore and backtracking.

He also mentioned they are considering a mix of internal cash accruals, debt and preferential allotment for raising funds.

Further, I don’t think the company needed to have discussed it in the previous calls as a half baked plan couldn’t be discussed. And yes, they haven’t raised the funds yet. It is awaiting voting from shareholders on September 11. If they had declared they are raising funds, then immediate question would be who are you raising it from, right? So, this is the plan. And I think in the AGM, the obvious question of fund deployment breakdown will be grilled and will be the center of attention. The voting extends to 30 minutes after the AGM so, technically the votes can wait till then.
Having said that, based on the promoter holding, I don’t think it’ll matter how general public votes. I do agree, however, that the use of funds could be published before the AGM (there’s still time) as that would give people time to prepare what and how to ask instead of winging it in the AGM itself.

The channel for fund raising is a matter of debate with no end. Debt comes with no dilution but interest costs that hits the profitability ratios and NPM. Preferential allotment comes with wider participation (used for projecting confidence and high profile portfolio, viz. Kachholia) which further boosts confidence and participation and the number of shareholder right now is relatively small. I do see the company doing a split in the near future (12 months) as the price is getting high and the number of shares is quite low. Anyone who’s not interested in dilution could shore up more shares to maintain their holding, although it’ll be at a steeper price than the pref. allotment (at a ~34% premium). Overall, imo I don’t like the dilution I’ll get hit with but understand it as a necessary evil.

On account of promoter dilution, Tarun Dua holding went down by 0.05% which (0.05% of 1…45 cr. share X 2272 CMP) = INR 1.64 cr. This is pretty small but definitely worth asking in the AGM or as @akash_das has mentioned, is ESOP, so inconsequential from our perspective.

@akash_das Tarun Dua is not in the list of people buying in the Pref. issue though and he’s the one whose holding went down.

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First five members applying are of promoter group so it’s not like the promoter is bailing out.

https://nsearchives.nseindia.com/corporate/E2E_19082024132200_FinalOutcomeofBME2E.pdf

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I appreciate the inputs. Very helpful!

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Any thoughts on the valuation?

A quick look at reverse DCF (to ponder over the growth assumptions built into the price) per Tijori yields the following:

image
image1331×560 25.5 KB

90% growth required over the next 5 years per to justify this valuation! :astonished: In tech where the obsolescence cycle is very short, looking beyond 5 years does not make sense, IMHO.

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Thanks a lot for this,
Which website you have used to come up to this snapshot / number ?

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Whether DCF (or reverse DCF) apply to a company like E2E is debatable. I don’t think it is. The first input to DCF is the free cash flow which is directly dependent on Capex. Now the Capex story for E2E has suddenly changed/changing. The latest (FY24) fixed assets are 210 cr. The new cash injection is 420 cr. If all of it were to go to Capex that means we’ll have a 3X fixed assets at the end of this FY. Even if it not all funds are deployed on Capex, 2X fixed assets in this year is a fair assumption.

IMO, DCF is not tooled to handle this case. DCF is for large, stable, low Capex companies with predictable earning outlook. E2E doesn’t meet any of those criteria!

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Tijori

E2E Networks Ltd. | Tijori Finance