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Tulip IT Services Limited - Views on News from Equitymaster
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Tulip IT Services Limited
Dec 8, 2005

Issue Summary

  • Size: Rs 0.9 bn to Rs 1.08 bn
  • Offer Price: Rs 100 to Rs 120 per share
  • Shares on offer: 9 m
  • Bid/Issue opens on: December 9, 2005
  • Bid/Issue closes on: December 15,2005
  • Minimum subscription: 50 shares

Objects of the issue

  • To expand the Internet Protocol / Virtual Private Network (IP/VPN) wireless business

  • Expansion of network coverage to 130 cities of the country.

  • Improving the capability to provide data/voice over IP/video connectivity with
    i. High uptime
    ii. Flexible bandwidth on demand.

Company background

Tulip IT Services is a leading IT infrastructure and connectivity provider. It provides network integration services, rural and statewide networks and inter-city and intra-city wireless-based IP/VPN connectivity. The company was started in 1992 as a reseller of software and hardware products and provider of maintenance contracts for networks. Subsequently, it migrated into network integration, where, as a comprehensive network integrator, it designs and develops networks for clients, provides networking equipment from other vendors, manages the integration and implementation of these projects and provides network management and maintenance services. The company recently diversified into providing wireless-based IP/VPN based connectivity solutions.

The company has a hybrid business model, with two principal lines of business:

  • Network integration and management services
  • Wireless based IP/VPN connectivity

Promoters

Lt Col Hardeep Singh Bedi (Founder), 52 years, is National Defence Academy-qualified. He worked as an instructor in the Army’s Faculty of Computer Technology at MCTE, Mhow. After retiring from army he started Tulip IT Services to utilise his entrepreneurship skills in the field of IT.

Mrs. Maninder Bedi, w/o Lt Col H S Bedi, aged 45, is a Post Graduate in Chemistry, with diplomas in Computer Applications and Industrial Management from the Directorate of Small Scale Industries. She also has extensive experience in teaching, and is involved in the company as head of the Administration and Human Resource functions.

Sector

The Indian IT sector can be broadly defined into three major sectors - IT services, IT-enabled services (ITES) and hardware. Network integration spans across the IT services and hardware sectors. It consists of network design and consultancy, product selection and supply, project management, integration and implementation and lastly, network management and maintenance. The market size of the network integration business has increased from Rs 33.7 bn in FY04 to Rs 41.6 bn in FY05, as per Voice & Data. The industry is fairly consolidated, with the top 10 players controlling 71% of the market share. The growth in this business is driven primarily from banking, finance, insurance, telecom service providers, BPO, manufacturing companies and government initiatives.

The Indian market for the IP/VPN services was around Rs 2.3 bn in 2003 and expected to reach Rs 11.4 bn by 2008. Virtual private network (VPN) is a private data network that makes use of public telecommunication infrastructure, maintaining privacy through the use of tunneling protocol and security procedures. BPO units and MNCs spread across geographical regions are the main clients.

Reasons to apply

Leading player in the country: Tulip IT Services has a hybrid business model, with two principal lines of business – network integration and management services, and wireless-based IP/VPN connectivity. The company is a leading network integrator (NI) in the country, providing design, deployment and maintenance of networks. It has successfully deployed large-sale wireless and wireline networks to some big corporate houses like Bank of Punjab, Punjab National Bank, HDFC Bank, Hindustan Times and Pizza Hut and has a proven track record. As per Voice & Data, the company is the fourth-largest player in India, with a market share of 7.3%. Tulip is the fourth-largest network integrator in India after players like Wipro Infotech and HCL Comnet.

Strengths in ‘last mile’ wireless-based connectivity: Tulip IT has a proven record of providing ‘last mile’ connectivity through wireless-based solutions. The company provides these solutions against leased lines and VSAT-based connectivity solutions provided by competitors, which is one of the main reasons for its success. Almost all the existing players in this field use copper network for last mile connectivity apart from using owned or leased fibre lines for inter-city connectivity. This technology has advantage over the copper lines, like lower susceptibility to natural and man-made hazards, thereby requiring lower maintenance, higher uptime of above 99% as compared to 97% provided by leased lines on copper loops for ‘last mile’ in non-metros and the flexibility of providing bandwidth on demand from 2 KBPS to 1 GBPS against fixed bandwidth under copper-based solution.

In fact, a major advantage of using wireless-based solutions is that it has made certain areas that were not feasible to tap earlier, more feasible now. The cost of extending this service to remote areas was very high and wireless solutions have changed this. This factor is undoubtedly a strong differentiator for Tulip as compared to other network integrators and has the ability to enable the company to win more business in future.

Increasing focus on high-margin IP/VPN business: The addition of the wireless-based IP/VPN network will allow the company to further strengthen its offerings as a network integrator by providing total network solutions. With a well-spread large network and an overall technical advantage, the company is poised to grab a large share in the fast expanding Indian IP/VPN services market. This business has higher margins than network integration and the potential is very large. According to IDC, the market for IP/VPN services is expected to grow from Rs 5.4 bn in 2005 to Rs 11.4 bn in 2008, a CAGR of nearly 29%.

In FY05, Tulip earned over Rs 250 m from this business and the contribution of the business is expected to increase in the future. This will have the benefit of improving the margins of the company. In fact, the effect of this can be seen in 1HFY06 itself, where EBIDTA margins have risen to 12.4%, from 5.8% in FY05. While the company has not given separate break-ups for this business in terms of margins, it can be gauged from the fact that in FY05, when the contribution of IP/VPN was just over 4%, overall margins were at 5.8%. In 1HFY06, on the other hand, with this business contributing nearly 13% to revenues, margins have soared to 12.4%. The company’s intention to invest more in this business is undoubtedly on the right track.

Reasons not to apply

Leased inter-city network: Tulip provides inter-city connectivity through lease arrangements rather than through capital investments in connectivity assets. Therefore, its ability to offer quality telecom services depends entirely on the network quality maintained by other operators, like RailTel, GAIL and PowerGrid Corporation of India. It has to depend on the operators for the quality of services and also their continuous availability. While the company does have the option of switching from one company to another, its dependence on external parties could render it vulnerable to fluctuating service quality in future.

Technological changes: The telecom industry is subject to rapid technological obsolescence. Newer technologies are continuously evolving and as a result, if Tulip is unable to keep up with the pace of technological change, its business could be adversely impacted. The cost of implementing new technologies could be substantially high and make its business unviable. Therefore, Tulip has to constantly keep abreast of the latest technologies in the telecom industry globally. One such technology under implementation is WiMAX, i.e. Worldwide Interoperability for Microwave Access, which enhances coverage capability and multifolds the bandwidth carrying capacity of equipments in the network. Thus, Tulip needs to be prepared to face such changes.

Financial Snapshot
(Rs m) FY01 FY02 FY03 FY04 FY05 1HFY06
Total Sales 419 714 2,029 2,747 3,422 1,955
Other Income 1 0 1 2 6 2
Total Expenditure 404 683 1,980 2,639 3,223 1,713
EBIDTA 15 31 49 107 199 243
EBIDTA margin (%) 3.7% 4.3% 2.4% 3.9% 5.8% 12.4%
Depreciation 2 3 4 7 10 6
Financial expenses 5 6 9 21 35 31
Profit Before Tax 9 21 37 81 160 208
Tax 1 5 13 15 21 41
Net Profit After Tax 8 16 24 66 139 167
No. of shares (m)* 29 29 29 29 29 29
Annualised EPS (Rs) 0.3 0.6 0.8 2.3 4.8 11.5
* Post issue diluted number of shares

Comparative valuation and comments

Based on the earnings per share (EPS) of Rs 4.8 per share, the Tulip offer comes at a price to earnings (P/E) multiple of around 25.0 times, which is at the higher end of the price band (Rs 120) on the post-issue equity base. At the lower end (Rs 100), the P/E multiple works out to 20.8 times trailing FY05 earnings. This appears to be quite expensive when compared to its peer company like HCL Infosystems, which trades at 18.9 times its trailing earnings.

However, if one takes into consideration the fact that in 1HFY06, the annualised EPS comes to around 11.5 and on this basis, the IPO is valued at a P/E multiple of around 10.4 times at the higher end and 8.7 times at the lower end of the price band. Tulip is earning an increasing share of its revenues from the high-margin IP/VPN business and going forward, this proportion is expected to increase. In fact, on an annualised basis, in 1HFY06, this business grew at 233% YoY. Therefore, a potential investor must consider that there is a strong possibility of a margin upside. Also, the government has set aside funds to the tune of Rs 33.3 bn for connecting panchayats around the country and this is undoubtedly a strong opportunity for the company in the form of rural connectivity. Although it is a tender-based system of awarding contracts, given Tulip’s strong differentiating factor in the form of its strength in wireless-based connectivity solutions, there is a good chance of winning business from this opportunity.

A comparison has been given with HCL Infosystems and CMC, two other major network integrators. It is clear that on most of the parameters, Tulip scores over its competitors on most of the operating parameters.

(FY05) Tulip IT
Services
CMC HCL
Infosystems
Net sales (Rs m)* 3,422 2,500 2,780
Operating profit margins (%) 5.8% 5.1% 5.6%
Net profit margins (%) 4.1% 3.0% 3.5%
Diluted EPS (Rs) 4.8 15.2 12.9
Price to earnings ratio 25.0 31.5 18.9
Price to book value 5.2 4.1 9.9
Price to sales 1.0 0.9 0.6
* Only the network integration revenues for these companies are considered.

Therefore, on comparison with its peers, we believe that the issue appears reasonable, if taken on an annualised 1HFY06 basis. The company is considerably cheaper than CMC, which has seen difficult times of late and is considerably cheaper than even HCL Infosystems on an annualised 1HFY06 basis, a company against which Tulip scores in terms of operating metrics. Going forward, given an ever-improving margin profile and increasing revenues from IP/VPN as well as strong potential in the rural connectivity business, we would say that the issue appears reasonably priced. However, we must add here that the company is also prone to high risk, given its dependence on technology, which is prone to obsolescence. Therefore, investors with an appetite for high risk may consider this issue.

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