External funding imperative for Tulip Telecom

Shares of Tulip Telecom Ltd have declined by 13% in the past three trading sessions, after the company’s March quarter results turned out to be a huge negative surprise. Tulip Telecom is an enterprise communications service provider and was doing relatively well until the first half of the previous financial year, when its revenue grew by 22% from a year earlier.

But revenue growth fell to 14% in the December quarter and a mere 3.7% in the March quarter which, according to an Emkay Global Financial Services Ltd analyst, is the lowest in the company’s history. The company had said after announcing its December quarter earnings that growth will drop to around 15% in financial year 2012-13, owing to tough economic conditions. According to the Emkay analyst’s post-earnings note, Tulip is now saying that revenue will remain flat. The sharp drop in growth in the March quarter makes it evident that the company isn’t being conservative.

Because of the tough economic conditions, the company has had to resort to offering discounts, affecting both revenue and profitability. And because of the pricing pressure, the company has said that margins will contract in FY13. Analysts at Motilal Oswal Securities Ltd have cut earnings estimates for the company by as high as 43% and 51% for FY13 and FY14, respectively.

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In the March quarter, too, margins contracted. While revenue grew marginally, earnings before interest, taxes, depreciation and amortization fell by 9.3%. More importantly, profit before tax fell by as much as 44% year-on-year, thanks to a huge jump in interest costs. The company is highly leveraged, so flat revenue and declining profits are extremely bad news for its investors.

Tulip has been aggressive with its capital expenditure programmes, and net debt rose to Rs2,330 crore by the end of March, from Rs1,430 crore a year ago. According to Emkay, the company has forecast capex of an additional Rs600 crore-Rs650 crore for this financial year. Even when the company’s revenue and profit were growing in double digits, its high leverage was a worry for investors. With profit and cash flow now expected to decline, raising funds is critical.

The only reason Tulip Telecom’s shares didn’t fall at a much sharper rate is that they had already gone down by 40% in the six months before the earnings announcement. At current prices, Tulip’s shares are about half their levels six months ago.

There is a glimmer of hope for the company in that there is a likelihood that its 13% stake in Qualcomm Inc.’s Indian operations (which it had acquired for Rs140 crore) may get sold to Bharti Airtel Ltd, according to news reports. But this will only provide some respite for the company, and it is imperative that it ropes in a strategic partner in its data centre business. With operating cash flow generation coming under further pressure, external funding is imperative for the company.

Graphic by Yogesh Kumar/Mint

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