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Tanla Solutions IPO: Our view - Views on News from Equitymaster
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Tanla Solutions IPO: Our view
Dec 11, 2006

Tanla Solutions, a small size telecom technology services provider, is issuing 15.9 m shares as part of its follow-on public offering. The issue is on for subscription starting today and will remain open till December 14, 2006. The offer price is between Rs. 230 to Rs. 265. The company plans to raise Rs 3.6 bn to Rs 4.2 bn (at the lower and higher price level respectively) from this issue and the shares will be listed on the NSE and BSE. As a matter of fact, Tanla already trades in Hyderabad, Ahmedabad and Madras stock exchanges. The minimum subscription level for retail investors is 25 shares. Through the proceeds of this issue, the company plans to fund its growth by setting up a development centre in Hyderabad, a disaster recovery centre, overseas marketing offices and R&D and product development facilities. In this write-up, we have analysed the company and have arrived at our view won the issue.

Company background
The company was started in 1995 to establish a dairy farm, dairy processing and a mineral water processing plant with the name of Maruti Dairy Products. It was then taken over by the present promoters from the previous ones in 2000. The name was changed to Tanla Solutions Ltd. in order pursue information technology and allied activities as the core areas of operations. Commercial activity in the new line of business was started in 2000, focusing on telecom signaling solutions and messaging infrastructure. In 2004, the company acquired a telecom services company in the UK, Techserv Teleservices (UK) Ltd. [now Tanla Solutions (UK) Ltd.] and a software development company, Smartnet Communications Systems Pvt. Ltd. (Delhi). In 2005, it acquired Mobizar Ltd., an aggregator service provider in the UK. Tanla Solutions provides integrated telecom infrastructure solutions and products.

The company has presence in the non-voice segment of the mobile telecom segment. It is provider of integrated telecom infrastructure solutions and products. Services of Tanla can be classified into three broad categories:

  • Telecom signaling solutions.

  • Aggregator services.

  • Offshore services.

Telecom signaling solutions (TSS): Tanla provides various product and services to the network operators for effective handling of the non-voice operation by them. In TSS, it has developed following products:

  • Short Message Service Centers (SMSC): SMSCs reside in the mobile operator’s network and enable operators to send and receive messages.

  • Missed Call Alerts: Notifies users about calls missed when user was logged off from the network.

  • Multimedia Messaging Service Centers (MMSC): Deliver audio, text, pictures and video between different devices and technologies.

  • Single IMSI, Multiple MSISDN (SIMM): Allows mobile operators to offer local numbers to frequent roamers within regions and countries.

Other services include ring-back tones, call-routing solutions, and ‘welcome-roamers’ messages sent by mobile operators to roamers, etc.

Messaging Applications and Billing (Aggregators) Services: Tanla provides channel or interface between mobile communications products and services developers (content providers) and mobile network operators. Aggregators offer end-to-end services and are connected to all the telecom operators of the country. Tanla Mobile Ltd. (UK), the company’s subsidiary provides services in the UK market.

Offshore Development Services: Tanla provides offshore technological expertise to content providers, who do not have substantial in-house technical expertise. A part of the attraction of the services to customers is Tanla’s ability to provide services from India where the cost base is lower than it is in the UK or other countries.

Promoters
Uday Kumar Reddy (Chairman and Managing Director) has been spearheading the company since the take-over from the earlier promoters. He holds a Master degree from Manchester Business School (UK).

Gautam Sabharwal (Director, Global Business Development) holds the Master degree in Management from the Westminster Business School (UK). He is responsible for planning, organizing and controlling the company’s product and service lines.

Satish Kathirisetti (Director Technical) holds a Master degree in engineering from the Madras Institute of Technology. He has vast experience in the areas of Telecom and Systems Engineering. He is responsible for product strategy and technical direction of the company’s solutions. He looks after the research and development activities of the company.

Anoop Roy Kundal (Director - Operations) holds B.Tech from IIT, Delhi; he is responsible for the company’s product delivery and operations. With more than six years of experience in object-oriented designs and enterprise software development, he has been a key member at SmartNet (an IT solutions company) and has expertise in architectural designs and applications development and deployment.

Navnit Chachan (Director - Research and Development) is a B.Tech from IIT, Delhi, and works in designing, developing, implementing and enhancing software programs in various operating systems.

Reasons to apply
High operating leverage: Tanla Solutions’ business model thrives on the low capex for additional growth. Thus, to that extent, the business model is highly scalable. Scalability is higher in the signaling solution business, which includes products lingering on the higher technological leverage. In the aggregator space, the revenue sharing principle also stems operating leverage. Going forward, the increased usage on non-voice services in the relevant markets will lead to increased volumes and revenues, which will outpace the increase in expenditure growth. As such, increased technological leverage is likely to expand profitability at a faster clip.

Robust business model: Tanla, of late, has shifted from licensing agreements to revenues sharing agreement with network operators. Also, given the fact that operating cost is more or less stable, additional volumes will flow directly to the pre-tax profits, thus improving profitability significantly. Also, the move works well in generating volumes, as clients get to convert their fixed cost into variable cost, thus lowering risk to that extent. The revenues streams for Tanla Solutions are also diversified with signaling business, with strong margins in the range of 85%-90% contributing 20% of the revenues. Secondly, aggregator business, which contributes 67% to the revenues, has EBDITA margins of 35% to 40%. Moreover, this stream provides strong annuity flows to the company. Finally, while the offshoring stream contributes 12% of the net revenues, it commands decent margins in the form of India specific cost advantage.

Diversification moves: In the wake to expanding beyond existing geographies, Tanla has planned to operate in the US and Australia. The company plans to begin its operation in the US from FY08 onwards. The basic aim of the company is to diversify in the US market and Asia-Pacific markets. This will not only boost revenues but will also help the company diversify its geographical and currency risks.

Strong non-voice growth in Europe: Tanla gets majority (around 90%) of its revenues from the UK market. Now, with a deeper penetration of 3G services, revenues for the non-voice segment are expected to improve significantly. Also, the fact that the European market is fast saturating in terms of revenues from voice segment, the network operators essentially will have to take steps to boost revenues from non-voice segments, which in turn will benefit technology service providers like Tanla.

Strong client metrics: Tanla has had six years of operating history whereby it has tied up with strong domestic players like Reliance, Essar and Airtel. Also, the company’s UK client metric is strong as, in the aggregator business, it has strong clients in the form of Vodafone, Hutchison 3G, Virgin, and O2. The dynamics of aggregator business calls for strong relationship with content providers and network operators. Thus, going forward, the company is expected to benefit from the virtuous circle of prosperity. This can be explained from the fact that strong client metric will attract more and more content providers, which in turn will bring in greater number of clients.

Creating barriers to entry: Tanla made its foray into the aggregator business via the inorganic route and is the sole addition to the aggregator space in the last two years. This makes it apparent that high barriers to entry exist in the business. As a matter of fact, any aggregator has to establish credentials before network operators regarding strong support at the content provider end, while at the same time content providers ask for strong client metric from the aggregator. This loop restricts, to an extent, entry of new players in the segment.

Consolidation in the aggregator space: Aggregator space in the UK market is highly fragmented with the largest player accounting for just 17% of the market share. Tanla has a 2% market share in the space. Currently, 11 aggregators work in the UK market with key players being Mblox, Ericsson, and WIN. The fragmented market share and more number of players in the segments usually characterise a sunrise industry. However, as the industry matures, consolidation is expected to pick up pace. Tanla, with a visionary, strong and capable management team at the helm, is set to leverage on the same.

Reasons not to apply
High debtor days: Days sales outstanding in this business are about 70-90. This follows the broader trend in the telecom industry, where a user is billed monthly and given a credit period of around 20 days. This broadly covers 50 days. Another 30 days go in passing on revenue from the mobile operator to the aggregator. For FY06, Tanla’s debtor days were 137 days (72 days in FY05). High debtor days can lead to significant working capital constraints.

Industry risk Tanla has presence in one vertical, which brings in an industry-specific risk. Downturn in the telecom industry would affect the company’s performance and, to that extent, there are concerns with respect to the company’s sustainable long-term growth.

Financials
    Consolidated financial snapshot…
    (Rs m) FY05 FY06 1HFY07
    Total sales 224 630 871
    Total expenditure 146 279 424
    EBDITA 78 351 446
    EBDITA margin (%)34.9%55.7%51.3%
    Other income 3 1 1
    Depreciation and amortisation 4 8 13
    Interest - - -
    PBT 77 344 434
    PBT margins34.5%54.6%49.8%
    Tax 9 42 77
    PAT 68 302 357
    Net profit margins30.6%48.0%41.0%
    Fully diluted EPS* 1.4 6.0 14.3
    Price to earnings** 18.6
    * Annualised 1HFY07 earnings    ** At the higher price range of Rs 265 per share

Valuations
In the absence of the any other listed entity in the same stream of business on the domestic turf, making a comparative valuation analysis for the company difficult. At the upper end of the price band (Rs 265), the stock is valued at 18.6 times its annualised 1HFY07 earnings.

Tanla Solutions has its presence in the fast growing telecom vertical and has, over the past few years, developed relationship with key services providers in India and the UK. The company operates at superior operating profit margins, has high return on equity and has no debts on its books. With the telecom technology space heating up in consequence with the growth in the front-end market, we expect competitive pressures (through consolidation) to intensify for smaller players like Tanla. However, that will still take some years to happen.

As such, considering the investment rational and concerns mentioned above, we recommend a ‘Subscribe’ to the issue, though strictly for high-risk long-term investors. As for the defensive lot of investors, direct exposure to the telecom services provider space (who will be the first to benefit from higher usage of value-added services) will be better option.

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