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Ortel Communications Ltd (ORTEL IN) Owning its growth; B2C company at B2B valuations

Page | 1 | PHILLIPCAPITAL INDIA RESEARCH

INDIA | MEDIA | Initiating Coverage

26 May 2016

Ortel is a regional cable TV and broadband provider focused on the states of Odisha, Chhattisgarh, MP, AP, WB, and Telengana. Its combination of last‐mile ownership and superior broadband distribution infrastructure makes it the best distribution model in the industry (proven in developed markets), positioning it for long‐term success. Its investments in its network and platform put it in a strong position to benefit from rising demand for high‐bandwidth broadband services. Given its strategic strengths, it is well‐placed to clock impressive revenue/EBITDA CAGRs of 36%/46% over FY16‐18. We believe its assets and its management’s continued execution warrant a premium multiple. We initiate coverage on Ortel Communications with a BUY rating and value it using DCF methodology, arriving at a one‐year forward target price of Rs 300. Differentiated last‐mile model commands highest operating margins among peers: Unlike most national MSOs, which follow a B2B model, Ortel has differentiated itself by focusing on ownership and control of the last mile (currently owns 90% of its subscribers). At ~0.65mn, its primary subscribers are at a similar scale or even higher than some national MSOs. Direct collections from subscribers help in: (1) controlling trade receivables (43 days vs. 100‐130 days for other MSOs), (2) reducing revenue leakage to LCOs (ARPU is 30% higher than other MSOs), and (3) in commanding the highest operating margins among peers (34% vs. <20% for other MSOs). We also believe that the digitisation of phase‐3 and 4 areas will enable Ortel to significantly grow its Revenue Generating Units (RGUs) over the next two years. Currently, it has a low net debt‐to‐equity ratio of 1x, which provides considerable headroom for more debt‐funded acquisitions of RGUs, without stretching the balance sheet too much. Well‐positioned to benefit from rising demand for high‐speed broadband services: Ortel's investments in its network and platform put it in a strong position to benefit from rising demand for high‐bandwidth broadband services. Given low penetration of broadband products in Ortel’s markets, it seems well placed to triple its broadband RGU in the next three years, implying subscriber CAGR of 44% from FY16‐19. Also, contribution from this high‐margin revenue stream (EBIT margin of 60% vs. consolidated EBIT margin of 52%) is estimated to increase to 25% from current 16%, implying revenue CAGR of 48% over FY16‐19. Current penetration of broadband RGUs is ~10%, which leaves substantial upside to improve, even beyond FY19. Ortel to see impressive revenue and EBITDA growth over FY16‐18: We estimate that Ortel’s revenue will see a CAGR of 36% over FY16‐18 due to robust RGU additions and digitisation. Similarly, EBITDA should see an impressive CAGR of 46% over the same period. Margins should improve by 500bps over FY16‐18 aided by: (1) improvement in cable ARPU, (2) higher revenue contribution from broadband business, and (3) stable content costs. However, due to higher depreciation and amortisation expenses, PAT CAGR of 25% will be lower than revenue and EBITDA growth. A B2C company that is available at a B2B valuation: The investor community has been disappointed with the poor operating performance of some of the listed MSOs over the last few years, as their huge financial investments have yielded little improvement in their return matrices. With its differentiated business model and its management’s continued execution, we believe Ortel will command a premium over other listed MSOs. With 65% incremental RGUs coming from emerging markets during FY16, Ortel has proved that its last‐mile approach can work even outside its home state. We value the company on DCF using a WACC of 12.1% and terminal growth rate of 5% to arrive at a March 2017 PT of Rs 300, implying an upside of 80%. At our target price, it will trade at 10x/8x FY17/18 EV/EBITDA.

BUY CMP RS 180 TARGET RS 300 (+68%) COMPANY DATA O/S SHARES (MN) : 30MARKET CAP (RSBN) : 5.4MARKET CAP (USDMN) : 8252 ‐ WK HI/LO (RS) : 231 / 158LIQUIDITY 3M (USDMN) : 0.012PAR VALUE (RS) : 10 SHARE HOLDING PATTERN, % Dec 14PROMOTERS : 51.6FII / NRI : 28.4FI / MF : 3.2NON PRO : 15.3PUBLIC & OTHERS: 1.5 PRICE PERFORMANCE, %

1MTH 3MTH 1YRABS 0.8 5.8 ‐3.4REL TO BSE ‐1.5 ‐2.1 3.1 PRICE VS. SENSEX

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145

May‐15 Aug‐15 Nov‐15 Feb‐16Ortel BSE Sensex

Source: Phillip Capital India Research KEY FINANCIALS Rs mn FY16E FY17E FY18ENet Sales 1,878 2,842 3,496EBIDTA 618 1,043 1,325Net Profit 120 252 170EPS, Rs 4.0 8.3 5.6PER, x 45.4 21.7 32.1EV/EBIDTA, x 10.5 6.9 5.4P/BV, x 3.9 3.3 3.0ROE, % 8.6 15.3 9.4Debt/Equity (%) 92.8 151.4 164.8

Source: PhillipCapital India Research Est. Manoj Behera (+9122 6667 9973) [email protected]

ORTEL COMMUNICATIONS INITIATING COVERAGE

Business model superior to existing MSOs The business dynamics of India’s pay‐TV market is changing significantly, with government‐mandated digitisation acting as a catalyst. Government of India has mandated digitisation in India in four phases. Phases 1 and 2 are already over (top 38 cities in India). Phase‐3’s deadline was December 2015 and phase‐4’s deadline is December 2016. In the entire analog cable value chain, organized MSOs capture limited value; it is currently dominated by unorganized LCOs. Here are key issues plaguing the cable model: • Greater bargaining power rests with the LCOs: MSOs and LCOs have a mutually

dependent relationship; LCOs control the last‐mile operations and MSOs control the scale functions. Since the last mile is handled by the LCOs, the flow of subscription revenue (which is collected by LCO) to MSOs remains below par. In order to usher in a digital‐cable regime, TRAI has issued a directive in 2012 specifying 55:45 revenue sharing for MSO:LCO for FTA channels and 65:35 for pay‐TV channels. Despite TRAI’s order, the revenue share is not even close to the baseline number.

Dependence on LCOs for last‐mile connectivity is hindering the implementation of packaging and tiering

• Cutthroat competition among MSOs to grab higher subscriber market share: In the analog cable regime, it was very easy for an LCO to switch to a new MSO. An LCO that switched would not only impact MSO’s subscription revenue, but also impact carriage revenue. While MSOs have agreed in‐principle to stop poaching LCOs from each other, they still need to implement this strictly.

MSOs have very few direct subscribers and therefore, are heavily dependent on LCOs for last‐mile connectivity. This, coupled with the loose arrangement between an MSO and an LCO makes the MSO vulnerable to any entry by a player with deep pockets. Digitisation was supposed to change the entire equation The government’s DAS mandate was the big hope – with encrypted signals and deployment of STBs at customers’ premises, 100% subscriber addressability was to be ensured, resulting in improved share of ARPUs for MSOs. While the seeding of STBs was done on time, it has only been a ‘technical digitisation’ and not true digitisation; the process of collecting consumer‐level data and the implementation of packaging/tiering has been painfully slow. The old practice of customers paying for the base pack and receiving all channels is still continuing at many places, with LCOs reluctant to roll‐out channel packages. MSO’s share of consumer ARPUs remains sub‐par and disputes with LCOs and broadcasters lead to churn‐out of subscribers (to DTH) even in phase‐1/2 markets. Last mile connectivity is the key differentiator for Ortel Unlike most national MSOs, which follow a B2B model, Ortel has differentiated itself by focusing on ownership and control of the last mile (it owns 90% of its subscribers). Due to this, Ortel ensures legally approved rights of way, superior service, minimal leakages, and that the quality of its network is uniformly maintained. Direct access to subscribers also limits large‐scale churn (essentially LCO churn). Direct collections for subscribers help in controlling trade receivables and reduce revenue leakage to LCOs.

Ortel owns 90% of its subscribers, which ensures that quality of network is uniformly maintained along with superior customer support service



ARPU comparison – Ortel vs. other MSOs

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Q1FY15 Q2FY15 Q3FY15 Q4FY15 Q1FY16 Q2FY16 Q3FY16

Hathway* ‐ Phase I ARPU Hathway* ‐ Phase II ARPUOrtel ‐ Analog ARPU Ortel ‐ Digital ARPU

Ortel ARPU is 30% higher than that of Hathway

*‐ARPU of other MSOs are also in similar territory

Source: Hathway company presentation, PhillipCapital India Research Comparison of receivable days – Ortel stands out Receivable days FY13 FY14 FY15Ortel 38.2 42.1 42.4Hathway 94.9 100.1 108.3Siti Cable 67.8 76.5 105.5Den Networks 123.7 119.3 129.6

Source: PhillipCapital India Research Highest operating margins among peers: Ortel’s last‐mile connectivity allows it to command the highest operating margins amongst its peers, as there is no revenue sharing with the LCO. Last mile also ensures that the company addresses customer grievances on a real‐time basis. Over the last five years, its EBITDA growth has outgrown revenue; its margins have expanded to 34% in FY15 (33% in FY16) from 29% in FY13. EBITDA margin comparison across all MSOs EBITDAM (%) FY13 FY14 FY15Ortel 28.8% 28.6% 34.1%Hathway 24.2% 19.0% 14.2%Siti Cable 15.5% 16.2% 15.2%Den Networks 22.0% 24.8% 6.8%

Source: PhillipCapital India Research



Ortel’s differentiated business model explained

Business Model

B2B model operated through

franhchises/LCOs; 60‐70% of subscription

revenue is shared with the LCOs

B2C model focused on primary points enables Ortel to capture entire subscription revenues

Carriae and Placement (C&P) Revenue

Continue to depend highly on C&P, which accounts over 1/3rd of operating revenues

Low dependence on C&P holds Ortel in good stead as

digitalization would gradually abolish

carriage

Cross‐selling

Dont have the ability to provide broadband and other services as the network is owned

by LCOs

Easier to offer a full range of services, leading to better

margins

Working Capital

A longer collection cycle, with receivable days ranging between

100‐130 days

Direct collections enable better cash

flow management and a healthier working

capital cycle

National MSOs

Ortel Communications

Ortel’s primary subscriber base is one of the highest in the industry

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Hathway Siti Cable Den Networks In digital Digicable Ortel Cable Ortel Cable*

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*‐FY16 primary subscriber numbers




Cable TV providers well placed to offer broadband Globally, it has been proven that the business that can (1) integrate the TV and broadband ecosystem and (2) become the ‘go‐to’, ‘anytime‐anywhere’ access point for TV, smartphones, and tablet viewing – will create a huge competitive advantage. Cable service providers with broadband infrastructure are especially well positioned to develop such advantages. Broadband cable remains the highest return product for distribution platforms in most developed markets. Single product internal rate of return (%) (USA)

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Cable Video Cable VOIP Satelite TV Cable Boradband

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Globally, broadband cable remains the highest‐return product for distribution platforms

Source: Ortel RHP, PhillipCapital India Research

The key advantage for cable operators in global markets stems from return‐path or two‐way technological infrastructure. This allows cable operators to offer high‐speed broadband services. Once the cable network is upgraded and reverse‐path‐enabled, the ability to offer new services such as high‐speed internet makes a compelling proposition. The other advantage to cable operators will come in the form of large‐scale fibre backhaul availability, which could reduce capital expenditure and the time required to expand to new territories. Additionally, it also allows operators to focus on last‐mile upgrades to coaxial networks that are capable of providing broadband services. Cable operators globally have excelled at effectively selling triple or quad‐play service offerings. Cable broadband services in India are below par, but structural drivers are intact In India, wire‐line broadband penetration is abysmally low vs. other developed markets. Even wireless broadband penetration (though growing at a rapid pace) is below 10% and wireless service providers are grappling with spectrum crunch while launching services at an affordable price. Low penetration is due to unavailability of an affordable data ecosystem and inadequate infrastructure deployment by incumbents. We believe that in the future, the following structural drivers will aid rapid adoption of cable broadband in India: • An enabling ecosystem for data usage: As per the FICCI‐KPMG 2015 report, the

number of internet‐enabled smartphones in India are likely to see a CAGR of 30% from CY14‐19. Tablet penetration in India is only 2%, and is likely to pick up significantly with more affordability. Multiple user screens will lead to higher bandwidth consumption.

• Significant divergence in data rates: Currently, 1GB of data on a 3G/4G network costs Rs 250 vs. Rs 30 in DOCSIS 3.0 (current plans across service provider offer 20GB data for Rs 650 at 7‐8 Mbps). Not surprisingly, consumers prefer cable broadband for heavy usage.



• Higher return on investment: Providing broadband services via cable networks enables higher return on investment due to lower operating costs from leveraging existing two‐way cable‐TV network infrastructure.

Ortel is well placed to grab the opportunity Ortel is one of the first private‐sector companies to be granted ISP license by the Government of India. Currently, it is capable of providing data services at a speed of up to 100MBPS through cable modems with DOCSIS 3.0 standard through its HFC network. Its fibre backbone and ‘last mile’ network enable customers to access high‐speed services. It offers various packages to customers with speeds ranging from 0.5mbps to 50mbps, with various monthly plans. Broadband RGU to increase significantly over the next couple of years Over the last few quarters, Ortel has taken multiple initiatives that we believe will aid in significant growth in broadband RGU for the company: • To have better focus on its broadband business, it appointed Mr Jiji John as the

vice president of this business. Mr Jiji is an industry veteran with over 18 years of experience in business development, strategic planning, and channel management. In his earlier stint with Asianet broadband, he was instrumental in setting up the broadband business for Aisanet Cable. We believe that his rich experience and deep understanding of the sector will help Ortel strengthen its position in the broadband segment.

Ortel has taken multiple initiatives in the broadband business, which will enable it to clock superlative growth in the business over the next few years

• In a cross‐selling move, Ortel offered a year’s worth of free broadband to its digital cable subscribers in Orissa, West Bengal, and Chhattisgarh. Simultaneously, existing broadband subscribers were given a chance to sample Ortel’s digital‐cable offering. It has also tied up with OTT platform ErosNow to launch a streaming service called Ortel Broadband Movies, creating an outlet for video‐data consumption.

• In January 2016, it introduced a WiFi public hotspot service, which grants wired broadband subscribers public access to wireless broadband on their existing internet accounts.

• In May 2016, it introduced a wide range of plans including 100mbps mega‐speed DOCSIS 3.0 broadband internet in Odisha. The new broadband plans range from 2‐100mbps and provides the company a head start over competitors

Given low penetration of broadband products (wireless + wireline) in Ortel’s market and renewed marketing vigour for the broadband product, we believe that the company is well placed to triple its broadband RGU in the next three years. Growth of broadband RGU – historical and estimated

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Broadband RGU46% CAGR

Source: Company, PhillipCapital India Research Estimates



We believe that current penetration (6% in FY16, expect 11% in FY19) of homes leaves substantial upside for total penetration of broadband services within Ortel’s footprint. Growth of broadband RGU – historical and estimated

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Broadband RGU HH Passed

Penetration(%)




In expansion mode; RGUs to rise by 42% in FY17 Ortel has set an ambitious target of adding ~300,000 RGUs to its existing base of ~700,000 by FY17. We believe that digitisation of phase 3/4 areas will enable the company to achieve its RGU target. This is because, most LCOs/MSOs in this market would have small scale and lack the financial capability to upgrade their network and seed STBs. Also, the LCO community is facing serious competition from DTH operators and is rapidly losing subscriber base to them. They are most likely to align with an MSO (like Ortel), which has bigger scale and has deep pockets to take care of the financial commitment needed to upgrade and digitise the network. Such an alliance would save them from tax‐payment hassles (service and entertainment tax) to government authorities. We believe there is enough opportunity for Ortel to significantly grow its existing subscriber base. Going ahead, its geographical mix would be more diversified with non‐Odisha market contributing at least 35‐40% of RGUs from 10% in FY15.

Digitisation of phase 3/4 areas will enable the company to achieve its RGU target

Ortel has demonstrated (in FY16) its capability to quickly execute the acquisition process and integrate the acquired RGU with itself. Ortel added 171,081 RGUs in FY16 with another 86,797 RGUs in the pipeline (deal signed but not integrated yet). 49% growth in RGUs in FY16 gives us confidence that Ortel will be able to achieve similar growth in FY17. RGU additions – Historical and estimated


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Analog cable RGU

Digital cable RGU

Broadband RGU30% CAGR

Buyout of LCO works reaping rich dividends, even in non‐core markets Ortel’s strategy of buying out of LCOs has not only reaped rich dividends in its core market (Odisha), but has also enabled it to gain share in neighbouring states (Chhattisgarh, Madhya Pradesh, Andhra Pradesh, Telangana, West Bengal). With 65% incremental RGUs coming from these states during FY16, Ortel has proved that its last‐mile approach can work even outside its home state. Funding requirement for acquisitions of RGUs will stretch its balance sheet As per its arrangement with LCOs, Ortel pays an upfront fee (Rs 1000 per subscriber) to acquire an LCO’s network equipment and infrastructure. The remaining payment is made in parts to the LCO, which is required to enter into a revenue‐sharing arrangement with Ortel in return for 25‐30% of its TV‐subscription revenue over the following five years. Staggered payments mitigate the risk of a re‐entry by the LCO, while helping Ortel control its cash flow. After it pays upfront fees, Ortel dismantles the LCO’s existing network so that the latter cannot tinker around with the network. It then lays down its own improved network that is capable of providing broadband and cable TV services. Ortel’s focus



since its inception has been to own the last mile, so that it can cross‐sell its product and realise higher ARPU. The funding requirement for acquiring a subscriber is Rs 5,900 (see table below) and hence Ortel’s funding requirements over three years would be to the tune of Rs 3.7bn. The company intends to fund this via internal accrual, debt, and vendor credit from the STB manufacturer. Funding requirement for acquiring an RGU Network cost ( Rs ) One‐way network cost 800Two‐way network cost 1600Initial penetration 50%:50%Blended cost 1200RGU to Home passed penetration 60%Overall cost 2000Drop cable cost 250Total network cost per HP 2250STB/Modem subsidy 900Backend cost 250Total network cost 3400 Acquisition cost (in Rs per RGU) Upfront payment 1000NPV of future revenue sharing deal 1798Total payout to LCO 2798 Split of acquisition to Organic 90%Net capex per RGU 5918

Source: Company, PhillipCapital India Research Capex requirement (in Rs mn) FY17‐19

Source: Company, PhillipCapital India Research

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1187.45

3709.35

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Low D/E ratio leaves enough headroom for debt‐funded acquisitions Ortel has a low net‐debt‐to‐equity ratio of 1.0x (FY16 estimated), which provides considerable headroom for more debt‐funded acquisitions of RGUs without significantly stretching its balance sheet. Hence, despite company incurring considerable capex over the next couple of years, its leverage ratios will continue to remain at comfortable levels. We estimate its net‐debt‐to‐equity and net‐debt‐to EBITDA ratios to peak in FY17 and improve from FY18, as it starts migrating its newly acquired subscribers to higher‐value packs. Net‐debt‐to‐equity and net‐debt‐to EBITDA ratios to peak in FY17


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Net debt to ebitda Net debt to equity



Revenue CAGR of 36% over FY16‐18 RGUs to double by FY17‐18 from FY15 Currently, the company has ~700,000 RGUs (90% cable, 10% broadband), but it has ambitious targets of adding 300,000 RGUs in FY17. As the industry heads into the final stage of digitisation, Ortel’s cable business seems in a sweet spot. Most of its target markets are in phases‐3 and 4, where LCOs are small and keep losing share to DTH providers. This leads us to believe that Ortel can indeed achieve its 1mn RGU target by FY17. Cable ARPU to improve by 20% after complete digitisation of phase 3/4 areas Ortel’s current analog cable ARPU is Rs 140 – at a 20% discount to the digital cable ARPU. When the entire phase 3/4 areas are digitised and the entire subscriber base is on a digital platform, we expect cable ARPU to increase by 20%. Digital cable ARPU would be higher than analog due to packaging and tiering. Similarly, current penetration of HD subscribers is <1%, and hence increased penetration of HD subscribers can provide impetus to cable services ARPU (HD ARPU is Rs 75‐80 higher than digital cable ARPU). Carriage revenue to increase by 10% over FY16‐18 Carriage revenue (18‐19% of the total operating revenue) should increase by 10% over FY16‐18, despite complete digitisation of phase 3/4 areas. Ortel will continue to command carriage/placement revenue from broadcasters due to its leadership position in the Orissa market. It is in the process of increasing its footprint outside Orissa and by FY17‐18, RGUs from non‐core markets should constitute 40% of its overall mix. It currently receives minimal carriage revenues from non‐core markets. Therefore, when it achieves a meaningful subscriber base, it would be a better position to command carriage revenue from broadcasters. Historical and forecasted revenue growth rates

FY13 FY14 FY15 FY16 FY17E FY18E CAGR

Cable TV services revenue Connection Fees 12 12 31 84 308 131 62%Cable Subscription Fees 674 757 790 866 1,470 1,977 24%Channel Carriage fees 207 205 264 356 384 415 15%

Broadband services revenue Connection Fees 8 17 19 26 38 61 49%Internet Subscription Fees 246 258 270 303 452 745 25%

Other revenue stream Income from Infrastructure Leasing 22 8 145 213 160 136 44%Other Operating Income 29 29 29 30 30 31 1%

Source: PhillipCapital India Research Estimates



EBITDA margins to improve by 300‐400bps We believe there are multiple levers for Ortel to improve its EBITDA margins (ex‐connection fees) by 300‐400bps over the next couple of years. Cable ARPU to improve by 20% Consolidated cable ARPU to increase by 20%, which would be primarily driven by digitisation and implementation of packaging and tiering. Penetration of broadband RGUs to rise to 15% in FY18 from current 10% in FY16 Currently, Ortel’s broadband RGUs constitute only 10% of its total RGUs, as the demand for wired broadband in markets where it operates is yet to gather full steam. The demand ecosystem for broadband consumption will continue to evolve, and Ortel has already deployed broadband‐ready two‐way communication networks in most of its markets. We expect its broadband RGU penetration to improve to 15% by FY18, as it becomes more aggressive in its promotional activities. 4G launches by various telecom service providers would boost demand for cheap high‐speed data, which only cable broadband service providers can offer. The ARPU of a broadband RGU is 2.5x digital cable ARPUs and commands 75‐80% gross margins. Hence, increased penetration of broadband will improve EBITDA margins.

Ortel has already deployed broadband‐ready two‐way communication networks in most of its markets

Estimated growth of broadband RGUs

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Broadband RGU as a % of total RGU (rhs)

Source: Company, PhillipCapital India Research Estimates ARPU comparison of various products

FY16Analog cable ARPU 141Digital cable ARPU 178Broadband ARPU 398

Source: Company, PhillipCapital India Research Operating margins of emerging market to improve Currently Ortel’s emerging markets business contributes to 10% of the total revenue, but constitutes 24% of the total RGUs. EBITDA margin of the emerging markets is ‐30% vs. 47% in core markets. The reason for lower margins can be attributed to Ortel’s recent entry into new markets, which has resulted in higher fixed cost. Once the company achieves scale in emerging markets and starts cross‐selling its high‐margin broadband business, margins can improve significantly from current levels.



Operating matrices of core vs. emerging markets Core Emerging

Revenue(in Rs mn) 1,676 190EBITDA (in Rs mn) 779 ‐57Margins (%) 47% ‐30%Home passed 8,03,568 3,78,564RGU 535126 166066Source: Company, PhillipCapital India Research Content cost likely to increase at less‐than‐inflationary pace Ortel has tied up its content cost agreement with most broadcasters on a fixed‐fee basis, with an annual escalation clause of 5‐10%. Also, Ortel operates in a market where the demand for regional content is much higher and cost of regional content is much lower than Hindi content (on a per subscriber basis). Hence, the content cost per cable RGU for the company is likely to increase at less‐than‐inflationary pace (2‐3%) and is likely to lag cable ARPU growth. Estimated content cost growth for the company

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Source: Company, PhillipCapital India Research Estimates We estimate that over the next couple of years, it wills see an EBITDA CAGR of 46% with margins improving by 500bps. EBITDA and margin growth estimates

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A B2C company available at B2B valuations Over the last few years, investors have been disappointed with the poor operating performance of listed MSOs, which has translated into their desultory stock‐price performance. The government’s DAS mandate was the big hope for MSOs (with encrypted signals and deployment of STBs at the customers’ premises, 100% subscriber addressability was ensured, which was supposed to result in improved share of ARPUs for MSOs). While the seeding of STBs was done on time, it has only been a ‘technical digitisation’ and not ‘true digitisation’ – the process of collecting consumer‐level data and the implementation of packaging/tiering has been painfully slow.

The government’s DAS mandate was the big hope for MSOs, but it has only been a ‘technical digitisation’ and not ‘true digitisation’

Snapshot of Hathway’s consolidated financials FY13 FY14 FY15 Comment PBIDTM ( %) 25.7 19.2 15.6 Margin continues to decline as content cost burden is borne by the company CFO 663 2,340 2,263 No marked improvement in CFO as ARPU remains stagnant Purchase of fixed assets ‐4,680 ‐8,372 ‐4,408 FCFF ‐4,017 ‐6,033 ‐2,145 Dependent on external funding to meet its cash flow requirement

Source: ACE Equity, PhillipCapital India Research While other MSOs floundered, Ortel demonstrated improved financial performance due to its strategy of last‐mile ownership of its subscriber. In FY13‐15, its analog cable ARPU improved to Rs 145 from Rs 136 while EBITDA margin improved to 31.3% from 20%. Last‐mile ownership structure ensured there was minimal leakage of revenue to LCOs and cross selling of broadband products to the subscriber, which resulted in higher revenue realisation per subscriber. Snapshot of Ortel’s financials (Rs mn) FY13 FY14 FY15PBIDTM(%) 20.2 26.2 31.3CFO 514 481 663Purchase of fixed assets ‐83 ‐139 ‐329FCFF 431 342 334

Source: ACE Equity, PhillipCapital India Research Despite its superior operating and financial matrices vis‐a‐vis other listed MSOs, Ortel trades at par with them on an EV/EBITDA basis, which we consider unjustified. EV/EBITDA (x) FY16E FY17E FY18EOrtel 10.5 6.9 5.3Hathway 10.1 6.8 5.6Den Networks 17.6 4.9 3.2Siti Cable 10.0 8.0 5.7

Source: Bloomberg, PhillipCapital India Research



Initiate coverage with a one‐year PT of Rs 300 1) Over the last few years, Ortel has shown strong execution capabilities in

increasing its subscriber footprint while maintaining its DNA of controlling the last‐mile connectivity. It has also excelled in providing triple‐play services in its core market.

2) Ortel will continue displaying improved operating performance on higher digital cable (aided by government‐mandated digitisation) and broadband subscriber additions. It is on course to clock Rs 1/1.3bn EBITDA by FY17/18 implying a CAGR of 46%.

3) The consolidated ARPU of its cable subscribers will increase by 20% on digitisation and migration of analog cable subscribers to the digital platform.

4) Its investments in its network and platform put it in a strong position to benefit from rising demand for high‐bandwidth broadband services.

5) The company’s assets and management’s continued execution warrant a premium multiple.

We value the company on DCF, using a WACC of 12%, and terminal growth rate of 5% – to arrive at a March 2017 target of Rs 300, at which the stock will trade at 10x/8x FY17/18 EV/EBITDA. How we derived our DCF valuation… Rs mn FY17E FY18E FY19E FY20E FY21E FY22E FY23E FY24EEBITDA 1,043 1,325 1,576 1,815 2,047 2,287 2,542 2,805Tax ‐ (398) (473) (544) (614) (686) (763) (841)Non‐compete pay‐out (234) (275) (312) (351) (314) (224) (212) (200)Wcap changes 30 (0) (0) (1) (1) (1) (1) (1)Capex (1,466) (747) (371) (348) (401) (382) (325) (289)FCFF (628) (94) 420 571 718 994 1,241 1,474Disc Factor 1.00 1.12 1.26 1.41 1.58 1.77 1.99 2.23PV of FCF (628) (84) 334 405 454 561 625 661

Source: PhillipCapital India Research WACC calculation Risk free rate 7.8%Risk premium 6.0%Beta 1.2Cost of equity 15.0%Post‐tax Cost of debt 9.5%D/E ratio 1.03WACC 12.1%Terminal growth rate 5.0%

Source: PhillipCapital India Research Valuation date (Rs mn) 3‐31‐17PV of CF 2,957FCFF in terminal year 1,474TV of CF 9,749Implied exit FCFF multiple (x) 14.7FCFF 12,706Implied exit EV/EBITDA(x) 7.7Net debt 3,543FCFE 9,163O/s shares 30Value per share (Mar‐15) 302Upside/downside 68%




Key risks and concerns (1) Increased competitive activity – Entry of a new player with deep pockets can

disrupt the pricing scenario in both cable and broadband services. However, since Ortel owns the last mile, it is in a better position to retain its customer base by offering similar price points

(2) Sharp drop in wireless data tariffs – Currently, wireless data tariff is 7‐8x of DOCSIS 3.0 data tariff; not surprisingly, subscribers prefer wireline broadband for heavy data usage. If wireless service providers cut their data tariffs to match the price of wireline providers, then Ortel’s subscriber growth will moderate significantly. However, wireless service providers are still grappling with spectrum crunch and debt burden, so, it is very unlikely that they will cut tariffs to such an extent

About the company • Regional cable television and broadband provider focused on the Indian states of

Odisha, Chhattisgarh, Madhya Pradesh, Andhra Pradesh, Telengana, and West Bengal.

• Total addressable market of ~5mn; currently has 701,192 revenue generating units.

• Strictly follows a direct‐to‐consumer business model, which allows full control over the last mile (91% of its subscriber base is under its own network).

• Built a two‐way communication network for ‘triple play’ (TV/data/voice) service delivery for its customer. It uses a HFC (hybrid fibre coaxial) network (combination of optic fibre in the backbone and coaxial cable in the downstream) with legal ‘rights of way’ for laying network.

• Its network is capable of providing broadband at a speed of up to 100 mbps by using cable modem with DOCSIS technology.

Ortel began operations in 1995; currently, its business is broadly divided into: (1) Cable television services comprising of: → Analog cable television services → Digital cable television services, including other value‐added services such as HD,

NVoD, gaming, and local content (2) Broadband (3) Leasing of fibre infrastructure (4) Signal up‐linking The company has grown both organically and inorganically – through buyout of network equipment, infrastructure, and subscribers of other MSOs and LCOs. It converts acquired subscribers to primary subscribers and improves the quality of services by upgrading or rebuilding their network with the last‐mile connection. By improving the quality and providing value‐added services, Ortel is able to limit large‐scale customer attrition to competing service platforms such as DTH providers and is also able to increase its revenue per user.



Historical revenue break‐up

Connection Fees‐Cable TV, 4.5%

Cable Subscription Fees, 46.1%

Channel Carriage fees, 19.0%

Connection Fees‐Internet, 1.4%

Internet Subscription Fees,

16.1%

Income from Infrasturacture Leasing, 11.3%

Other Operating Income, 1.6%

FY16

Source: Company Historical break‐up of operating cost

Programming Cost, 30%

Bandwidth Cost, 7%

Employee Benefits Expense, 18%

Other Expenses, 46%

Source: Company Key milestones Year Events 1995 Started business in Odisha 1998 One of the first private sector companies in India to obtain ISP license and start its high speed

internet services 1999 Investment of Rs 85mn by South Asia Regional Fund which is managed by a Mauritian subsidiary

of Commonwealth Development Corporation, United Kingdom 2000 Operations expanded to other parts of Odisha 2004 ISO 9001 : 2000 certified 2005 Crossed 100,000 RGUs 2006 Legal right of way granted outside Odisha in Chattisgarh 2007 (1) Legal right of way granted outside Odisha in West Bengal and Andhra Pradesh, (2)

commencement of provision of digital services 2008 (1) Investment of Rs 600 mn by NSR, (2) Crossed 200,000 RGUs, (3) Services launched outside

Odisha – in West Bengal, Andhra Pradesh and Chhattisgarh 2009 Crossed 300,000 RGUs 2010 Pilot project of internet telephony successfully launched 2011 Crossed 400,000 RGUs 2014 Crossed 500,000 RGUs 2016 Crossed 700,000 RGUs

Source: Company



Key management personnel Mr. Bibhu Prasad Rath • President and CEO

• With the company since 1999 • Bachelor’s degree in science from Utkal University • Qualified cost and works accountant • MEP from IIM Ahmedabad

Mr. Manoj Kumar Patra • CFO • With the company since 2008 • Bachelor’s degree in science from Berhampur

University • Chartered accountant • Previously with Reliance Retail

Col. Man Mohan Pattnaik • Chief Technical Officer • With the company since 2001 • Bachelor’s degree in electronics and

telecommunications from the Institute of Electronics and Telecommunications Engineers, Delhi

• Postgraduate diploma in business management from the Indian Institute of Management Studies, New Delhi

Mr. Chitta Ranjan Nayak • Senior Vice President (Operations) • With the company since 2004 • Bachelor’s degree in engineering from the Institute of

Engineers India and a postgraduate diploma in business management from Institute of Management Technology.

• Currently heads the company’s operations and its marketing activities

Mr. Jiji John • Vice President – Broadband business • Over 18 years of experience in strategic planning,

sales and marketing, business development, CRM • Management graduate from XIM, Bhubaneswar, and

BE from BITS, Mesra Source: Company




Financials

Income Statement Y/E Mar, Rs mn FY15 FY16e FY17e FY18eNet sales 1,548 1,878 2,842 3,496Growth, % 20 21 51 23Total income 1,548 1,878 2,842 3,496Raw material expenses 0 0 0 0Employee expenses ‐167 ‐225 ‐341 ‐397Other Operating expenses ‐848 ‐1,035 ‐1,458 ‐1,774EBITDA (Core) 533 618 1,043 1,325Growth, % 42.7 15.9 68.7 27.1Margin, % 34.5 32.9 36.7 37.9Depreciation ‐300 ‐317 ‐574 ‐703EBIT 233 301 469 623Growth, % 140.7 29.2 55.8 32.8Margin, % 15.1 16.0 16.5 17.8Interest paid ‐226 ‐236 ‐240 ‐496Pre‐tax profit 70 151 315 213Tax provided ‐15 ‐31 ‐63 ‐43Profit after tax 56 120 252 170Others (Minorities, Associates) 0 0 0 0Net Profit 56 120 252 170Growth, % (158.1) 115.7 109.3 (32.4)Net Profit (adjusted) 56 120 252 170Unadj. shares (m) 30 30 30 30Wtd avg shares (m) 30 30 30 30 Balance Sheet Y/E Mar, Rs mn FY15 FY16e FY17e FY18eCash & bank 1,184 290 803 1,336Debtors 181 313 428 527Inventory 5 130 130 130Loans & advances 157 408 618 760Other current assets 12 25 37 46Total current assets 1,540 1,166 2,017 2,799Investments 3 3 3 3Gross fixed assets 3,084 4,512 6,695 7,611Less: Depreciation ‐1,037 ‐1,354 ‐1,928 ‐2,631Add: Capital WIP 123 123 123 123Net fixed assets 2,169 3,280 4,889 5,103Total assets 3,741 4,503 6,991 8,006 Current liabilities 1,389 1,872 2,413 2,780Provisions 3 6 9 11Total current liabilities 1,393 1,878 2,422 2,792Non‐current liabilities 1,077 1,230 2,922 3,397Total liabilities 2,470 3,108 5,344 6,189Paid‐up capital 304 304 304 304Reserves & surplus 967 1,091 1,343 1,514Shareholders’ equity 1,271 1,395 1,647 1,817Total equity & liabilities 3,741 4,503 6,991 8,006 Source: Company, PhillipCapital India Research Estimates

Cash Flow FY15 FY16e FY17e FY18e

Pre‐tax profit 70 151 315 213Depreciation 300 317 574 703Chg in working capital 441 29 671 76Total tax paid ‐15 ‐31 ‐63 ‐43Cash flow from operating activities 663 350 1,010 1,282Capital expenditure ‐455 ‐1,428 ‐2,183 ‐916Chg in investments 0 0 0 0Other investing activities 70 449 557 47Cash flow from investing activities ‐385 ‐978 ‐1,626 ‐869Free cash flow 278 ‐629 ‐617 413Equity raised/(repaid) ‐69 0 0 0Debt raised/(repaid) ‐224 63 1,200 500Cash flow from financing activities 809 11 1,130 120Net chg in cash 1,087 ‐618 514 533 Valuation Ratios

FY15 FY16e FY17e FY18ePer Share data EPS (INR) 1.8 4.0 8.3 5.6Growth, % (158.1) 115.7 109.3 (32.4)Book NAV/share (INR) 41.9 45.9 54.2 59.8FDEPS (INR) 1.8 4.0 8.3 5.6CEPS (INR) 11.7 14.4 27.2 28.7CFPS (INR) 26.6 12.1 50.2 31.9Return ratios Return on assets (%) 6.5 6.6 7.0 6.4Return on equity (%) 4.4 8.6 15.3 9.4Return on capital employed (%) 10.3 10.9 11.2 9.7Turnover ratios Asset turnover (x) 1.2 1.1 1.0 1.1Sales/Total assets (x) 0.5 0.5 0.5 0.5Sales/Net FA (x) 0.7 0.7 0.7 0.7Working capital/Sales (x) (0.7) (0.5) (0.4) (0.4)Receivable days 42.8 60.9 55.0 55.0Inventory days 1.2 25.3 16.7 13.6Payable days 74.9 75.3 79.8 81.4Working capital days (243.7) (193.5) (154.1) (137.6)Liquidity ratios Current ratio (x) 1.1 0.6 0.8 1.0Quick ratio (x) 1.1 0.6 0.8 1.0Interest cover (x) 1.4 2.0 3.0 1.5Total debt/Equity (%) 87.0 92.8 151.4 164.8Net debt/Equity (%) (6.2) 72.0 102.7 91.2Valuation PER (x) 97.9 45.4 21.7 32.1PEG (x) ‐ y‐o‐y growth (0.6) 0.4 0.2 (1.0)Price/Book (x) 4.3 3.9 3.3 3.0EV/Net sales (x) 3.5 3.4 2.5 2.0EV/EBITDA (x) 10.1 10.5 6.9 5.4EV/EBIT (x) 23.1 21.5 15.3 11.4



Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition

BUY >= +15% Target price is equal to or more than 15% of current market price

NEUTRAL ‐15% > to < +15% Target price is less than +15% but more than ‐15%

SELL <= ‐15% Target price is less than or equal to ‐15%.

Contact Information (Regional Member Companies)

SINGAPORE: Phillip Securities Pte Ltd 250 North Bridge Road, #06‐00 Raffles City Tower,

Singapore 179101 Tel : (65) 6533 6001 Fax: (65) 6535 3834

www.phillip.com.sg

MALAYSIA: Phillip Capital Management Sdn Bhd B‐3‐6 Block B Level 3, Megan Avenue II,

No. 12, Jalan Yap Kwan Seng, 50450 Kuala Lumpur Tel (60) 3 2162 8841 Fax (60) 3 2166 5099

www.poems.com.my

HONG KONG: Phillip Securities (HK) Ltd 11/F United Centre 95 Queensway Hong Kong Tel (852) 2277 6600 Fax: (852) 2868 5307

www.phillip.com.hk

JAPAN: Phillip Securities Japan, Ltd 4‐2 Nihonbashi Kabutocho, Chuo‐ku

Tokyo 103‐0026 Tel: (81) 3 3666 2101 Fax: (81) 3 3664 0141

www.phillip.co.jp

INDONESIA: PT Phillip Securities Indonesia ANZ Tower Level 23B, Jl Jend Sudirman Kav 33A,

Jakarta 10220, Indonesia Tel (62) 21 5790 0800 Fax: (62) 21 5790 0809

www.phillip.co.id

CHINA: Phillip Financial Advisory (Shanghai) Co. Ltd. No 550 Yan An East Road, Ocean Tower Unit 2318

Shanghai 200 001 Tel (86) 21 5169 9200 Fax: (86) 21 6351 2940

www.phillip.com.cn

THAILAND: Phillip Securities (Thailand) Public Co. Ltd. 15th Floor, Vorawat Building, 849 Silom Road,

Silom, Bangrak, Bangkok 10500 Thailand Tel (66) 2 2268 0999 Fax: (66) 2 2268 0921

www.phillip.co.th

FRANCE: King & Shaxson Capital Ltd. 3rd Floor, 35 Rue de la Bienfaisance

75008 Paris France Tel (33) 1 4563 3100 Fax : (33) 1 4563 6017

www.kingandshaxson.com

UNITED KINGDOM: King & Shaxson Ltd. 6th Floor, Candlewick House, 120 Cannon Street

London, EC4N 6AS Tel (44) 20 7929 5300 Fax: (44) 20 7283 6835

www.kingandshaxson.com

UNITED STATES: Phillip Futures Inc. 141 W Jackson Blvd Ste 3050

The Chicago Board of Trade Building Chicago, IL 60604 USA

Tel (1) 312 356 9000 Fax: (1) 312 356 9005

AUSTRALIA: PhillipCapital Australia Level 37, 530 Collins Street

Melbourne, Victoria 3000, Australia Tel: (61) 3 9629 8380 Fax: (61) 3 9614 8309

www.phillipcapital.com.au

SRI LANKA: Asha Phillip Securities Limited Level 4, Millennium House, 46/58 Navam Mawatha,

Colombo 2, Sri Lanka Tel: (94) 11 2429 100 Fax: (94) 11 2429 199

www.ashaphillip.net/home.htm

INDIA: PhillipCapital (India) Private Limited No. 1, 18th Floor, Urmi Estate, 95 Ganpatrao Kadam Marg, Lower Parel West, Mumbai 400013

Tel: (9122) 2300 2999 Fax: (9122) 6667 9955 www.phillipcapital.in

Management(91 22) 2483 1919

Kinshuk Bharti Tiwari (Head – Institutional Equity) (91 22) 6667 9946(91 22) 6667 9735

Research IT Services Pharma & Speciality Chem

Dhawal Doshi (9122) 6667 9769 Vibhor Singhal (9122) 6667 9949 Surya Patra (9122) 6667 9768Nitesh Sharma, CFA (9122) 6667 9965 Shyamal Dhruve (9122) 6667 9992 Mehul Sheth (9122) 6667 9996Banking, NBFCs Infrastructure StrategyManish Agarwalla (9122) 6667 9962 Vibhor Singhal (9122) 6667 9949 Naveen Kulkarni, CFA, FRM (9122) 6667 9947Pradeep Agrawal (9122) 6667 9953 Deepak Agarwal (9122) 6667 9944 Anindya Bhowmik (9122) 6667 9764Paresh Jain (9122) 6667 9948 Logistics, Transportation & Midcap TelecomConsumer & Retail Vikram Suryavanshi (9122) 6667 9951 Naveen Kulkarni, CFA, FRM (9122) 6667 9947Naveen Kulkarni, CFA, FRM (9122) 6667 9947 Media Manoj Behera (9122) 6667 9973Jubil Jain (9122) 6667 9766 Manoj Behera (9122) 6667 9973 TechnicalsPreeyam Tolia (9122) 6667 9950 Metals Subodh Gupta, CMT (9122) 6667 9762Cement Dhawal Doshi (9122) 6667 9769 Production ManagerVaibhav Agarwal (9122) 6667 9967 Yash Doshi (9122) 6667 9987 Ganesh Deorukhkar (9122) 6667 9966Economics Midcap EditorAnjali Verma (9122) 6667 9969 Amol Rao (9122) 6667 9952 Roshan Sony 98199 72726Engineering, Capital Goods Mid‐Caps & Database Manager Sr. Manager – Equities SupportJonas Bhutta (9122) 6667 9759 Deepak Agarwal (9122) 6667 9944 Rosie Ferns (9122) 6667 9971

Oil & GasSabri Hazarika (9122) 6667 9756

Sales & Distribution Ashvin Patil (9122) 6667 9991 Sales Trader Zarine Damania (9122) 6667 9976Shubhangi Agrawal (9122) 6667 9964 Dilesh Doshi (9122) 6667 9747 Kishor Binwal (9122) 6667 9989 Suniil Pandit (9122) 6667 9745Bhavin Shah (9122) 6667 9974Ashka Mehta Gulati (9122) 6667 9934 ExecutionArchan Vyas (9122) 6667 9785 Mayur Shah (9122) 6667 9945

Corporate Communications

Vineet Bhatnagar (Managing Director)

Jignesh Shah (Head – Equity Derivatives)

Automobiles

http://www.phillip.com.sg/

http://www.poems.com.my/

http://www.phillip.com.hk/

http://www.phillip.co.jp/

http://www.phillip.co.id/

http://www.phillip.com.cn/

http://www.phillip.co.th/

http://www.kingandshaxson.com/

http://www.kingandshaxson.com/

http://www.phillipcapital.com.au/

http://www.ashaphillip.net/home.htm

http://www.phillipcapital.in/


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