Tata Communications (TCOM) has recently announced its acquisition of Kaleyra Inc., a prominent CPaaS (Communications Platform as a Service) player listed in the US. The deal was valued at $250 million and is expected to provide several advantages to TCOM.
TCOM’s acquisition of Kaleyra, which is recognised as one of the top five CPaaS players, is a significant move. The enterprise value of $250 million implies an EV/Sales and EV/Ebitda multiples of 0.8x/ 13x on CY22. These valuation metrics suggest that the acquisition was made at a reasonable price. This acquisition is expected to accelerate TCOM’s growth trajectory. TCOM has faced challenges in achieving growth, and Kaleyra’s portfolio, which complements TCOM’s offerings in the US and EU, can help overcome this hurdle. The CPaaS vertical is experiencing rapid growth in the Enterprise telecom market, with a market size of $12 billion and a CAGR of 25%. However, TCOM’s near-term investments in capital expenditures (capex) and operating expenses (opex) may dilute its Ebitda margin guidance of 23-25%. This is in addition to the potential impact from the earlier Switch acquisition. Additionally, these investments could increase TCOM’s capex to approximately $600 million. Despite the acquisition, the rating for TCOM remains neutral. The assigned target price is Rs 1,450 per share, derived from applying 8x/3x Ebitda multiples to the Data/Voice business. For a potential valuation rerating, sustained improvement in earnings growth visibility will be crucial.
CPaaS is an attractive space with a market size of $12billion globally. It is one of the fastest-growing scalable businesses thanks to high demand; hence, it needs limited hard selling. The CPaaS market is estimated to expand by a 25% CAGR over the next few years, including traditional SMS messages to RCS messaging, and video and audio collaborations.
TCOM aims to double its digital revenue from Rs 140 billion to Rs 280 billion over FY23-27. Excluding the slow-growing (mid-single digit) core connectivity business, the digital platform and services (DPS) vertical contributes Rs 45billion to total revenue (TCOM aspires to achieve 50% revenue contribution, i.e., Rs 140 billion).
In line with our view that the ambitious growth targets stated in the analyst meet may require near-term high capex and opex, the acquisition could increase net debt by 22% to Rs 68 billion, along with margin dilution. But we like two things about this acquisition: (i) TCOM is upping the ante on growth efforts as it has seen limited growth in last few years; and (ii) a reasonable price for a value-creating company.
We build in revenue/Ebitda CAGRs of 12/10% over FY23-25E, without factoring growth from recent acquisitions, which could drive healthy growth in the long term but may dilute near-term earnings. TCOM’s strong FCF of Rs 12-14 billion, despite an increase in capex, could allow it to scout for growth opportunities with a healthy ROCE target of over 20%.