Key Sectoral Takeaways:
- Global 5G rollout to accelerate digital transformation of enterprise in the current decade
- Telecom operators are expected to invest US$1.1tn in next five years, out of which 80% will be spent on 5G infrastructure
- Expect incremental spending on network softwarization via Network Function Virtualization (NFV)/Software Defined Networking (SDN) and Network Analytics
- Limited impact of COVID-19; operators maintain earlier mid-term 5G rollout plans
- TechM, which derives 40% revenue from telecom biz, is well-placed to benefit from IT modernization by the telecom operators
As 5G network will provide high-speed connectivity with ultra reliable low latency network, we believe rollout of 5G networks will be a game changing event of the current decade. It will revolutionize connectivity and accelerate industrialization of digital technologies in later part of decade.
Global telecom companies are expected to incur US$1.1tn capex, out of which 80% will be spent on 5G network services. While North America and Asia Pacific (APAC) will lead the rollout, Europe will see relatively slower rollout.
Whilst there was limited softwarization of network in 3G and 4G network environment, we expect the telecom operators to increasingly rely on technology/IT services companies for 5G networks to build and maintain software-based networks. We expect SDN revenue to grow in higher teens, going forward.
TechM derives ~40% of its revenue from telecom vertical, as it provides full spectrum services to telecom operators in network services, mobility, BPO and IT services. We expect TechM to be one of the key beneficiaries of network modernization given its diversified offerings i.e. NFV/SDN, network analytics and cloud native OSS/BSS coupled with its early experience in planned rollout of 5G network by Rakuten in Japan.
COVID-19 Impact: Telecom operators witnessed short-term disruptions in planned network rollout due to labour shortage and social distancing guidelines during 1HCY20. However, most global operators remain committed for medium-term 5G rollout trajectory. COVID-19 pandemic has accelerated remote working, which has resulted in higher demand for telecom and Internet connectivity. We are also seeing high political push, as nations consider 5G rollout as a hallmark of technology development. Commentary of the top US telecom operators suggests consistent improvement in plans for 5G rollout and monetization.
We Initiate Coverage on TechM
We expect healthy growth in TechM's both verticals i.e. telecom and enterprise on the back of step up in 5G capex and mid-term resiliency in technology demand. Robust deal wins in FY20 (2X YoY) suggests revenue and margin recovery in FY22-FY23E. At CMP, the stock trades at 30% discount to its peers vs. historical average discount of 20%+ owing to softness in telecom business. We forecast TechM to witness EPS CAGR of 20% over FY21-23E. The stock deserves multiple re-rating considering industry-leading EPS CAGR driven by sharp EBIT margin rebound and strong topline growth owning to uptick in global 5G rollout & acceleration in enterprise technology demand. We initiate coverage on TechM with BUY and a 2-Year Target Price of Rs1,100 (valuing the stock at 17x PE on FY23E earnings), which implies over 34% upside from the current level.
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