tulip_telecom_310310_01 - anand rathi initiating coverage

29
Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities India I Equities Tulip Telecom [TTSL IN]: Key financials and valuations Year end Mar, Rsm FY08 FY09 FY10e FY11e FY12e Reported PAT 1,871 2,498 2,654 2,894 3,731 Adj. PAT 1,848 2,398 2,330 2,894 3,731 Diluted EPS (Rs) 53.7 72.2 71.7 89.1 114.8 Revenue growth (%) 44.7 32.4 21.8 20.6 21.5 EBITDA growth (%) 84.9 37.1 53.7 27.7 25.0 EPS growth (%) 60.3 34.5 (0.7) 24.2 28.9 P/E (x) 15.5 11.5 11.6 9.4 7.3 EV/EBITDA (x) 11.1 9.5 6.9 5.5 4.3 Net-debt/Equity (x) 0.7 1.1 1.2 1.0 0.7 RoAE (%) 51.0 42.5 29.0 27.3 27.5 Source: Company, Anand Rathi Research. Share price as on the close of 29 March 2010. Telecommunications Initiating Coverage 29 March 2010 Tulip Telecom Bold growth agenda, but with increasing risk profile Initiate at Hold. Tulip is India’s biggest VPN (Virtual Private Network) connectivity provider, and 5 th largest player in NI (Network Integration) space. In the VPN segment, Tulip caters to low bandwidth requirements (typically 64-256 kbps) of businesses, primarily through wireless last mile access . We initiate at Hold with Dec-10 TP of Rs1,000, based on DCF. Pursuing a bold growth-agenda…Tulip is a dominant force (>90% market share) in Wireless VPN segment, but that accounts for <20% of the Enterprise Data Network (EDN) market. To eventually address 90% of the EDN market, Tulip is investing heavily in last mile fibre in top cities. The company also expects significant LT growth in its existing businesses from government-led initiatives such as: financial inclusion, e- governance, APDRP etc. We forecast 2-year revenue and EPS CAGR of 21% and 27% respectively, and RoAE of 27% for the period FY10-12. …but with a growing risk profile. (1) Tulip is entering EDN segments that have bigger and more entrenched competitors; (2) Fibre-ownership based business model entails front-ended capex but back-ended revenue growth ; and (3) Business is set to become more leveraged with increase in the proportion of fixed costs (i.e. depreciation and interest charges). Valuations. Our TP is DCF-based, but we also examine PER, given low revenue-visibility beyond 1-2 years, due to market-sizing related issues. Historically, Tulip stock has mostly traded at 11-15x forward 12-month PER, and because of the increase in risk profile, we believe a PER of 9- 10x is fair in the short-medium term, which also justifies our Hold rating. Key risks to our view. Tulip currently pays license fee on AGR, after deducting leased-bandwidth charges , which if disallowed by govt, would hit our EBITDA/EPS forecasts by 10%/18%, and TP by 27%. Other risks are regulatory changes requiring Tulip to pay for its ‘unlicensed’ spectrum, dependence on key management personnel, WiMAX auctions, and higher capex. Upside risk is higher-than-expected revenue growth. Key data TTSL IN/ TULP.BO 52-week high/low Rs1250 / Rs340 Sensex/Nifty 17711 / 5303 3-m avg. daily volume US$1.7m Market cap Rs24bn / US$537m Shares outstanding 29m Promoters (%) 69.0 Free float (%) 31.0 - Foreign institutions 24.7 - Domestic institutions 1.6 - Others 4.7 Relative price performance Tulip Sensex 300 600 900 1,200 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 Source: Anand Rathi Research. Rating: Hold Target Price: Rs1,000 Share Price: Rs833

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Page 1: Tulip_telecom_310310_01 - Anand Rathi Initiating Coverage

Anand Rathi Financial Services Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Disclosures and analyst certifications are located in Appendix 1 Anand Rathi Research India Equities

India I Equities

Tulip Telecom [TTSL IN]: Key financials and valuations Year end Mar, Rsm FY08 FY09 FY10e FY11e FY12e

Reported PAT 1,871 2,498 2,654 2,894 3,731

Adj. PAT 1,848 2,398 2,330 2,894 3,731

Diluted EPS (Rs) 53.7 72.2 71.7 89.1 114.8

Revenue growth (%) 44.7 32.4 21.8 20.6 21.5

EBITDA growth (%) 84.9 37.1 53.7 27.7 25.0

EPS growth (%) 60.3 34.5 (0.7) 24.2 28.9

P/E (x) 15.5 11.5 11.6 9.4 7.3

EV/EBITDA (x) 11.1 9.5 6.9 5.5 4.3

Net-debt/Equity (x) 0.7 1.1 1.2 1.0 0.7

RoAE (%) 51.0 42.5 29.0 27.3 27.5 Source: Company, Anand Rathi Research. Share price as on the close of 29 March 2010.

Telecommunications

Initiating Coverage

29 March 2010

Tulip Telecom

Bold growth agenda, but with increasing risk profile

Initiate at Hold. Tulip is India’s biggest VPN (Virtual Private Network) connectivity provider, and 5th largest player in NI (Network Integration) space. In the VPN segment, Tulip caters to low bandwidth requirements (typically 64-256 kbps) of businesses, primarily through wireless last mile access. We initiate at Hold with Dec-10 TP of Rs1,000, based on DCF.

Pursuing a bold growth-agenda…Tulip is a dominant force (>90% market share) in Wireless VPN segment, but that accounts for <20% of the Enterprise Data Network (EDN) market. To eventually address 90% of the EDN market, Tulip is investing heavily in last mile fibre in top cities. The company also expects significant LT growth in its existing businesses from government-led initiatives such as: financial inclusion, e-governance, APDRP etc. We forecast 2-year revenue and EPS CAGR of 21% and 27% respectively, and RoAE of 27% for the period FY10-12.

…but with a growing risk profile. (1) Tulip is entering EDN segments that have bigger and more entrenched competitors; (2) Fibre-ownership based business model entails front-ended capex but back-ended revenue growth; and (3) Business is set to become more leveraged with increase in the proportion of fixed costs (i.e. depreciation and interest charges).

Valuations. Our TP is DCF-based, but we also examine PER, given low revenue-visibility beyond 1-2 years, due to market-sizing related issues. Historically, Tulip stock has mostly traded at 11-15x forward 12-month PER, and because of the increase in risk profile, we believe a PER of 9-10x is fair in the short-medium term, which also justifies our Hold rating.

Key risks to our view. Tulip currently pays license fee on AGR, after deducting leased-bandwidth charges, which if disallowed by govt, would hit our EBITDA/EPS forecasts by 10%/18%, and TP by 27%. Other risks are regulatory changes requiring Tulip to pay for its ‘unlicensed’ spectrum, dependence on key management personnel, WiMAX auctions, and higher capex. Upside risk is higher-than-expected revenue growth.

Key data TTSL IN/ TULP.BO

52-week high/low Rs1250 / Rs340Sensex/Nifty 17711 / 53033-m avg. daily volume US$1.7mMarket cap Rs24bn / US$537mShares outstanding 29mPromoters (%) 69.0 Free float (%) 31.0 - Foreign institutions 24.7 - Domestic institutions 1.6 - Others 4.7

Relative price performance

Tulip

Sensex

300

600

900

1,200

Mar

-09

May

-09

Jul-0

9

Sep-

09

Nov

-09

Jan-

10

Mar

-10

Source: Anand Rathi Research.

Rating: Hold Target Price: Rs1,000

Share Price: Rs833

Page 2: Tulip_telecom_310310_01 - Anand Rathi Initiating Coverage

29 March 2010 Tulip Telecom – Bold growth agenda, but with increasing risk profile

Anand Rathi Research 2

Quick Glance – Financials and Valuations Fig 1 – Income statement (Rsm) Year end Mar FY08 FY09 FY10e FY11e FY12e

Revenues 12,190 16,144 19,668 23,720 28,810 EBITDA 2,456 3,367 5,174 6,610 8,259 EBITDA margin (%) 20.2 20.9 26.3 27.9 28.7 Depreciation (418) (414) (1,603) (2,021) (2,510)Other income 35 20 (67) 45 50 Net interest cost (89) (259) (632) (875) (889)PBT 2,009 2,827 3,273 3,758 4,910 Tax (138) (330) (619) (864) (1,178)Reported net income 1,871 2,498 2,654 2,894 3,731 Adj. net income 1,848 2,398 2,330 2,894 3,731 Diluted EPS (adj.) 53.7 72.2 71.7 89.1 114.8 DPS (Rs) 2.0 4.0 6.0 8.0 10.0 Revenue growth (%) 44.7 32.4 21.8 20.6 21.5 EBITDA growth (%) 84.9 37.1 53.7 27.7 25.0 EPS growth (%) 60.3 34.5 (0.7) 24.2 28.9 Source: Company, Anand Rathi Research

Fig 2 – Balance sheet (Rsm) Year end Mar FY08 FY09 FY10e FY11e FY12e

Share capital 290 290 290 290 290

Reserves & Surplus 4,164 6,529 8,980 11,603 14,995

Shareholders' funds 4,454 6,819 9,270 11,893 15,285

Debt 8,938 11,224 12,426 14,026 13,026

Deferred tax liability 9 9 9 9 58

Capital employed 13,401 18,053 21,706 25,928 28,369

Net fixed assets 5,197 12,148 15,976 18,739 20,102

Investments 0 0 0 0 0

Other non-current assets 1 4 4 4 4

Net working capital 2,265 2,431 4,693 5,571 6,629

Cash & cash equivalents 5,938 3,470 1,033 1,614 1,634

Capital deployed 13,401 18,053 21,706 25,928 28,369

No. of shares (m) 29.0 29.0 29.0 29.0 29.0

Net Debt/Equity (%) 67 114 123 104 75 Source: Company, Anand Rathi Research.

Fig 3 – Cash flow statement (Rsm) Year end Mar FY08 FY09 FY10e FY11e FY12e

Profits before tax 2,010 2,841 3,273 3,758 4,910 Depreciation and amortization 418 414 1,603 2,021 2,510 Other non-cash items (1) (129) (400) 0 0 Taxes paid (136) (330) (619) (864) (1,129)Chg in working capital (908) (166) (2,262) (878) (1,058)CF from operations 1,383 2,632 1,595 4,037 5,233 Capex (incl. entry fee) (3,118) (7,365) (5,431) (4,784) (3,873)Free cash flow (1,735) (4,733) (3,835) (747) 1,359 Investments/others (0) 1,858 0 0 0 Equity raised 0 0 0 0 0 Debt raised / (repaid) 7,375 543 1,602 1,600 (1,000)Dividends paid (68) (136) (204) (271) (339)Change in cash for year 5,572 (2,468) (2,437) 581 20 Beginning cash 366 5,938 3,470 1,033 1,614 Closing cash 5,938 3,470 1,033 1,614 1,634Source: Company, Anand Rathi Research

Fig 4 – Rolling 12-month forward P/E multiple Share p r i ce in Rs (LHS)

Tulip

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Source: Anand Rathi Research.

Fig 5 – Rolling 12-month forward EV/EBITDA multiple Share p r i ce in Rs (LHS)

Tulip

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8

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Source: Anand Rathi Research.

Fig 6 – Rolling 12-month forward P/BV multiple Share p r i ce in Rs (LHS)

1x

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06

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09

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9

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9

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-09

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10

Source: Anand Rathi Research.

Page 3: Tulip_telecom_310310_01 - Anand Rathi Initiating Coverage

29 March 2010 Tulip Telecom – Bold growth agenda, but with increasing risk profile

Anand Rathi Research 3

Investment Argument & Valuation Tulip Telecom (TTSL IN) is looking to transform itself, from a niche wireless VPN player, to an end-to-end, one-stop shop provider of enterprise connectivity solutions. While this strategy should drive medium-to-LT revenue growth, it is more capital intensive and entails higher risks than Tulip’s current business model, in our view.

We forecast EPS CAGR of 27% in FY10-12 and expect Tulip’s RoAE to stabilize at ~27% from FY11 onwards; however, we highlight that Tulip is yet to clearly demonstrate the benefits of its new growth strategy. At FY11e P/E of 9.4x, the stock is fairly valued in our view. We initiate at Hold, with a Dec-10 TP of Rs1,000, based on DCF.

Bold growth-agenda, but with increasing risk profile Investment positives

Strong and highly profitable VPN franchise

In FY09, Tulip had an estimated 30% revenue market share (RMS) in the VPN connectivity space, significantly ahead of the #2 (RCOM; 15% RMS) and #3 (Sify; 12%) players. The strength of Tulip’s VPN franchise is based on: (1) Network reach; (2) Pure wireless focus; (3) First mover advantage; (4) One-stop shop provider of Connectivity solution plus NI services; (5) High customer satisfaction levels, thanks to high uptime.

Tulip’s Return on Average Equity (RoAE) has historically been in the 40-50% range (although it has come down to 29% in FY10e). Key factors that have boosted RoAE are: (1) Higher supply/competition at the wholesale-end (i.e. inter-city bandwidth) versus demand at the retail-end (i.e. last mile access); (2) Capex has typically followed revenue/order visibility, which has resulted in higher utilization of ‘owned’, as well as ‘leased’ bandwidth capacity; and (3) Increase in financial leverage.

Additionally, Tulip has benefited from savings on account of license fee—Tulip deducts leased-bandwidth charges from its gross revenues, for computing the mandatory 6% revenue share (license fee) paid to the government. Although this practice potentially carries regulatory risk in our view, it has also aided Tulip’s profits and returns so far.

Big fish in a small pond; now moving to a bigger pond

Tulip has well over 90% RMS in wireless VPN segment. However, wireless VPN accounts for <20% of the EDN market (Fig 7).

Despite potential for LT growth in wireless VPN business, we believe the sustainability of high revenue growth rates (>20% p.a.) over the medium term is uncertain, given base effect. To maintain growth momentum, Tulip has embarked upon an ambitious strategy to address ~90% of the EDN market. To this end, Tulip has been investing in last-mile fibre in the Central Business Districts (CBDs) of Top 30-40 cities since early FY09. Tulip is aiming to become an end-to-end connectivity provider to enterprises, by meeting their high bandwidth requirements for VPN (in large cities) and for dedicated internet access, as well as providing them private leased circuits (IPLC/DLC) for point-to-point connectivity.

Tulip is India’s biggest VPN connectivity provider, and the 5th

largest player in the Network Integration (NI) space; VPN accounted for 86% of Tulip’s

9MFY10 revenues and an estimated 97% of its EBITDA.

The company is a niche provider of wireless data connectivity to

businesses, and has zero exposure to the retail/consumer space

By end-FY10, Tulip’s revenue and EBITDA will likely have grown

4x and 8x respectively, over a four-year period, thanks to the company’s

foray into the IP-VPN business

Thanks to its ‘low-bandwidth’ wireless data niche, and ‘voice focus’

of the bigger telcos, Tulip has managed to grow successfully below

the radar in VPN space

Tulip provides VPN over wireless last mile access, whereas its rivals rely on fibre/copper or VSATs

Tulip’s revenues from VPN connectivity will likely have grown

nearly 21-fold by end-FY10e to Rs17.0bn, from Rs0.8bn in FY06

Fig 7 – Segmental revenue breakdown of Enterprise Data Network market (FY10e)

VPN-Fibre26%

ILL23%

IPLC / DLC26%

VSAT / Others

8%

VPN-Wireless

17%

Source: Company presentation, Mar ’10

Page 4: Tulip_telecom_310310_01 - Anand Rathi Initiating Coverage

29 March 2010 Tulip Telecom – Bold growth agenda, but with increasing risk profile

Anand Rathi Research 4

Long-term upside from Government segment

We believe the Indian government’s thrust on promoting e-governance and inclusive growth will likely translate into significant demand for data connectivity in the coming years.

The e-Governance agenda includes: (1) Developing State Wide Area Network (SWAN) in each State; (2) Establishing National/State Data Centres; (3) Establishing Common Service Centres (CSCs) for delivery of public services; and (4) Unique ID (UID) project. The government’s inclusive growth agenda includes schemes such as, the National Rural Employment Guarantee Scheme (NREGS), as well as financial inclusion goals (connecting post offices, rural bank branches). Separately, given the ongoing thrust on Reforms and AT&C loss reduction in power sector, the APDRP is also a key emerging driver of connectivity demand.

Investment negatives

Weak revenue visibility

Tulip’s businesses inherently have low revenue visibility beyond 1-2 years, given difficulties in assessing the potential size of EDN and Managed Services markets, fragmented nature of the market (lack of industry wide data), and continuous erosion in bandwidth prices (although Tulip appears to be hedged, as it is a wholesale buyer of inter-city bandwidth).

Increasing risk profile

We believe Tulip’s new growth strategy entails higher risk vis-à-vis its existing business, as: (1) Unlike wireless domain, the fibre VPN segment already has entrenched competition in the form of RCOM, TCOM and BSNL; (2) Fibre strategy entails front-ended capex, but more back-ended revenue growth, compared to wireless, giving rise to the risk of RoAE dilution at least initially—this is already evident in Tulip’s financials; and (3) Tulip’s business is more leveraged than previously, because of higher capital intensity of the incremental business, and surge in debt levels.

Lack of adequate disclosures pertaining to new business segments

Although Tulip shares a decent amount of operating and financial data each quarter, we believe there is a need for more disclosures, especially in view of the company’s capital-intensive fibre strategy. In our opinion, additional details that would help investors appreciate the strengths and uniqueness of Tulip’s existing VPN business, as well as help investors track the benefits of new growth strategy in a transparent manner, are:

Average bandwidth per connect, and/or proportion of 64kbps connects in total connects, and/or proportion of total connects on fibre, and/or proportion of new connects on fibre

Details about the cost structure, especially the breakdown of ‘cost of services’, which includes bandwidth charges (the single biggest cost item: ~60% of total). Unlike other telecoms companies, Tulip does not disclose the regulatory expenses (i.e. license and spectrum fee)

Separately, it would also help if the management can provide proper guidance on capex, which has ballooned since FY09, and has significantly diluted the company’s RoAE.

Government segment potentially represents annual revenue

opportunity of at least Rs40bn in the medium-to-long term (3-5 years) for

providers of data connectivity

Additional disclosures on revenue metrics and cost breakdown, would provide better visibility, as well as help investors track the benefits of

fibre strategy

Net debt to Equity ratio is likely to end up at 1.23x in FY10e from

0.15x in FY06

Page 5: Tulip_telecom_310310_01 - Anand Rathi Initiating Coverage

29 March 2010 Tulip Telecom – Bold growth agenda, but with increasing risk profile

Anand Rathi Research 5

Financials

Earnings growth to resume in FY11

After growing nearly five-fold in three years ending FY09, Tulip’s EPS is likely to remain stagnant in FY10, because of higher depreciation, interest and taxes. However, we forecast 27% EPS CAGR from FY10-12, led by ~21% revenue CAGR, and ~240bps increase in EBITDA margin through FY12. Concurrently, we forecast RoAE to stabilize at 27-29% from FY10, after falling sharply from its peak of 51% in FY08. Finally, we forecast Tulip to become FCF-positive towards end FY11.

Risks to our view

Downside risks

Our earnings and cash flow forecasts would get significantly impacted, if the government disallows deduction of leased-bandwidth charges by Tulip, for computation of license fee on recurring VPN revenues. We note that an Aug ‘07 ruling of the TDSAT disallows such deduction, and an appeal against that same ruling is pending in the Supreme Court (Source: Form-20F filed by Tata Communications [TCOM IN; NC] with the SEC of USA). Tulip management is aware of the regulatory risk, but feels justified in its approach of license fee computation, as it avoids double incidence of license fee on the industry (we also agree with this view).

Other downside risks are:

Imposition of spectrum usage charges: Tulip and several other telecoms companies (TCOM, RCOM) currently provide wireless connectivity using a portion of ‘unlicensed’ spectrum in the 2.4/5.8 GHz frequency bands. Our TP would be negatively impacted, should the government impose regulatory charges for use of such spectrum

Higher-than-expected capex: Tulip’s gross fixed assets (including CWIP) have tripled in the last eight quarters, led by the company’s fibre-strategy. While we forecast capex to moderate after hitting a peak of Rs7.4bn in FY09, we note that Tulip’s FY10 capex is set to overshoot management’s initial guidance of Rs3-4bn, since actual 9MFY10 capex was already Rs4.0bn

Deployment of WiMAX networks post 2.3GHz auctions: The Indian government plans to auction a total of 20X2MHz of spectrum in the 2.3GHz band, for provision of Broadband Wireless Access (BWA). In our view, the winners are likely to use WiMAX technology (that yields data speed of over 20mbps per site), primarily for providing fixed broadband access to retail/consumer segments. However, should the winners of 2.3GHz spectrum target the enterprise customers too, Tulip would face increased competition

Dependence on key personnel: Tulip’s Chairman Col. HS Bedi and its Head of Sales have played a crucial role in the company’s success, in our view. Given this context, we believe the recent augmentation of senior management bandwidth is a step in the right direction

Upside risks

Strong execution in fibre-based enterprise connectivity business and/or front-loading of government-driven business may push revenue growth higher than our forecast of 21% CAGR in FY10-12. However, higher revenue need not result in higher FCF, if accompanied by higher capex.

We estimate 10%/18% impact on our EBITDA/EPS forecasts, and

27% impact on TP, if bandwidth cost deduction is disallowed for

computation of license fee

The robust 54% EBITDA growth in FY10e is likely to be offset by a

surge in depreciation, interest and taxes, resulting in zero EPS growth

RoAE could stabilize from FY10 onwards, as peak capex appears to

be behind us

Tulip employs MMDS technology (multiple microwave distribution

system) and uses spectrum in the 2.4-3.3GHz in its wireless network

WiMAX technology provides higher range (distance) for non line of sight

(NLOS) applications, as well as higher data speeds given superior quantity (10MHz) and quality

(2.3GHz) of spectrum to be awarded in the upcoming BWA

auctions

Recently an internal DoT committee has recommended that deduction of

bandwidth charges should be allowed for license fee payment [Source: The Economic Times, 16 March 2010]

Page 6: Tulip_telecom_310310_01 - Anand Rathi Initiating Coverage

29 March 2010 Tulip Telecom – Bold growth agenda, but with increasing risk profile

Anand Rathi Research 6

Valuations and share price analysis We have derived our Dec-10 Target Price of Rs1,000 using the DCF-method. Our DCF analysis captures the potential margin expansion driven by high bandwidth sales, and the long-term revenue upside from increased government spending on connectivity. However, we also examine P/E valuation to supplement DCF, given lack of revenue visibility in Tulip’s business beyond 1-2 years.

Dec-10 Target Price of Rs1,000 derived using DCF

We have used a WACC of 13.5% and terminal growth rate of 4.0% for Tulip. Our WACC assumption is higher than the WACC we have used for large-cap wireless telcos (12.0%/12.5%/13.0% for Bharti/Idea/RCOM); this reflects higher risk profile of Tulip owing to its smaller size, business model (only enterprise customers, lack of pricing power, higher operating and financial leverage), as well as low revenue visibility beyond 1-2 years.

Our assumptions yield a terminal EV/EBITDA multiple of 4.2x for Tulip, versus 4.6x-5.8x for the wireless telcos; this is mainly because of the higher WACC, and partly due to adverse working capital changes in Tulip’s business model (leading to lower conversion of EBITDA to FCFF).

Fig 8 – Tulip Telecom: DCF summary Rsm, Year end Mar FY10e FY11e FY12e FY13e FY14e FY15e FY16e FY17e FY18e FY19e FY20e

Key assumptions (%) Revenue growth 21.8 20.6 21.5 15.1 9.7 5.4 4.5 4.5 4.9 3.7 3.6 EBITDA growth 53.7 27.7 25.0 17.3 11.7 6.8 6.0 6.2 5.3 3.3 3.4 FCF growth NM NM NM 83.2 33.4 13.1 (10.1) 8.5 6.7 4.0 2.3 EBITDA margin 26.3 27.9 28.7 29.2 29.7 30.1 30.5 31.0 31.1 31.0 31.0 FCF margin (16.3) (0.9) 6.6 10.4 12.7 13.6 11.7 12.2 12.4 12.4 12.2 Capex / Sales 27.6 20.2 13.4 10.9 10.0 9.9 9.8 9.8 9.6 9.8 9.9 Net Debt / Capital 52.5 47.9 40.2 12.9 0.6 (11.3) (19.5) (27.0) (33.7) (39.6) (44.9)ROCE 13.7 13.1 14.5 16.0 16.8 16.7 14.8 14.5 14.1 13.4 12.9 EBIT X (1-tax rate) 2,842 3,568 4,465 5,244 5,934 6,429 6,038 6,396 6,718 6,902 7,122 Depreciation & Amortization 1,603 2,021 2,510 2,834 2,953 2,911 3,003 3,216 3,404 3,571 3,716 Change in net working capital (2,224) (1,012) (1,213) (991) (617) (302) (402) (420) (470) (373) (366)Operating FCF 2,221 4,577 5,763 7,087 8,271 9,039 8,639 9,192 9,652 10,100 10,472 Capital expenditure (5,431) (4,784) (3,873) (3,626) (3,653) (3,816) (3,946) (4,100) (4,221) (4,450) (4,691)Free cash flows (FCFF) (3,209) (207) 1,889 3,461 4,618 5,222 4,693 5,092 5,431 5,649 5,781 Sensitivity of Dec-10 TP to WACC and perpetual growth rate Dec-10 DCF calculation Dec-10 WACC (%) WACC (%) 13.5 13.00 13.25 13.50 13.75 14.00

Terminal growth (%) 4.0 3.00 1,003 966 930 896 864

Implied Exit EV/FCF multiple (X) 10.5 3.50 1,042 1,001 963 927 893

Implied Exit EV/EBITDA multiple (X) 4.2 4.00 1,084 1,041 1,000 962 925

NPV of cash flows 20,793 4.50 1,132 1,085 1,041 1,000 961

PV of terminal value 19,609 Perp

etua

l gro

wth

rate

(%

)

5.00 1,185 1,135 1,087 1,042 1,000

Enterprise value 40,402 Terminal value as % of EV 49% Sensitivity of exit EV/EBITDA multiple to WACC and perpetual growth

Net debt (Mar-10e) 11,393 WACC (%) Equity value 29,009 13.00 13.25 13.50 13.75 14.00

Equity value (US$m) 631 3.00 4.0 3.9 3.8 3.7 3.7

Equity shares outstanding (m) 29.0 3.50 4.2 4.1 4.0 3.9 3.8

Equity value/share (Rs) 1,000 4.00 4.5 4.3 4.2 4.1 4.0

Dec-10 Target Price (Rs) 1,000 4.50 4.7 4.6 4.5 4.3 4.2

Perp

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(%

)

5.00 5.0 4.9 4.7 4.6 4.5

Source: Anand Rathi Research

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Relative valuation analysis

P/E discount to historical trading multiples is justified

Since its listing in Jan-06, Tulip stock has mostly traded in the range of 11-15x forward P/E multiples.

Fig 9 – Tulip Telecom: One-year forward P/E multiple (x)

Average: 10.6x

0

2

4

6

8

10

12

14

16

18

Jan-

06

Apr-0

6

Jul-0

6

Oct

-06

Jan-

07

Apr-0

7

Jul-0

7

Oct

-07

Jan-

08

Apr-0

8

Jul-0

8

Oct

-08

Jan-

09

Apr-0

9

Jul-0

9

Oct

-09

Jan-

10

Source: Anand Rathi Research, Bloomberg

In view of the likely lower EPS growth and RoE outlook versus historical levels, as well as the increase in risk profile, we believe 9-10x is a fair P/E range for Tulip stock in the short-to-medium term.

Fig 10 – Tulip Telecom: EPS growth and RoAE Year end Mar

42 43

29 27 2751

100

60

34

(1)29

24

FY07 FY08 FY09 FY10e FY11e FY12e

RoAE (%) Diluted EPS growth (%)

Source: Company, Anand Rathi Research

Tulip stock is currently trading at 9.4x our FY11e EPS, which suggests limited room for upside in the near-term. Rolling over to Mar-11, a 9x forward P/E multiple would imply share price of Rs1,035 (24% upside potential).

In terms of relative valuations versus large-cap wireless telcos, Tulip stock is currently trading at a discount of 37% and 18% respectively, on FY11e P/E and EV/EBITDA.

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Earnings and Target Price sensitivity

As per the NLD license condition (which also covers the VPN service), Tulip is required to pay 6% of its adjusted gross revenues (AGR) from VPN business (recurring revenues) to the government as license fee. To derive the AGR, Tulip has been deducting the leased-bandwidth charges from gross VPN revenues (GR), which results in lower license fee. Should this deduction be disallowed, Tulip’s license fee expense would increase substantially (Rs500-600m p.a.), resulting in a significant negative impact on the company’s EBITDA/EPS as well as on our target price.

Fig 12 – Tulip Telecom: Sensitivity to change in the definition of AGR Year end Mar

FY11e FY12e FY13e

Base case

EBITDA (Rsm) 6,610 8,259 9,684

PAT (Rsm) 2,894 3,731 4,619

Diluted EPS (Rs) 89.1 114.8 142.1

If deduction of bandwidth cost disallowed

EBITDA (Rsm) 5,954 7,426 8,704

PAT (Rsm) 2,377 3,064 3,824

Diluted EPS (Rs) 73.2 94.3 117.7

Change vs. base case (%)

EBITDA (9.9) (10.1) (10.1)PAT (17.9) (17.9) (17.2)Diluted EPS (17.9) (17.9) (17.2) DCF (Rs/share)

Base case 1,000

Downside scenario 725

Impact (27.5)

Source: Anand Rathi Research.

We note that the TDSAT (Telecom Tribunal) had given its decision on this contentious issue in Aug-07, which resulted in a liability of Rs2,950m for TCOM in Jan-08 (TCOM was also deducting leased-bandwidth expense from the GR). TCOM has subsequently appealed in the Supreme Court, and if the Court upholds the TDSAT verdict, then this would have significant negative implications for Tulip as well, in our view.

Share price analysis

Since its stock market debut in Jan-06, Tulip shares have appreciated by 354%, versus 84% appreciation in the Sensex and 48% in the BSE mid-cap index. The stock fell by 75% from Sep-08 to Mar-09, but subsequently recovered by 340%, and hit its recent peak of Rs1,175 in Aug-09.

Fig 11 – India telecoms valuations Sh price Upside P/E (x) EPS CAGR P/E to EV/EBITDA (x) EBITDA CAGR EV/EBITDA

Year end Mar Rating (Rs) [a] TP (Rs) (%) FY11e FY12E FY11e-13e (%) Growth FY11e FY12E FY11e-13e (%) to-Growth

Bharti Sell 311 325 5 13.8 12.0 16.0 0.86 6.5 5.2 13.8 0.47

RCOM Sell 168 170 1 13.4 10.2 26.6 0.50 7.0 5.7 13.1 0.53

Idea Sell 67 65 (3) 34.3 21.7 56.6 0.60 7.5 6.1 23.1 0.33

Tulip Hold 833 1000 20 9.4 7.3 26.3 0.36 5.5 4.3 21.0 0.26

Average (Wireless) 14.8 12.3 20.9 0.71 6.8 5.5 14.9 0.45

Source: Anand Rathi Research [a] As on 29 Mar ’10

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Table 13 – Tulip Telecom: Share price performance since listing (rebased to 100)

0

100

200

300

400

500

600

700

Jan-

06

Apr-0

6

Jul-0

6

Oct

-06

Jan-

07

Apr-0

7

Jul-0

7

Oct

-07

Jan-

08

Apr-0

8

Jul-0

8

Oct

-08

Jan-

09

Apr-0

9

Jul-0

9

Oct

-09

Jan-

10

Tulip

Sensex

+354%

+84%

BSE midcap +48%

Source: Bloomberg.

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Pursuing a bold growth-agenda Tulip is a dominant leader in wireless VPN connectivity, having more than 90% share in this segment. However, wireless VPN accounts for <20% of the overall EDN market. To eventually address 90% of the EDN market, Tulip has embarked upon a bold strategy of deploying fibre in the CBDs of top cities. Furthermore, Tulip expects the Government to emerge as a significant driver of data connectivity demand over the medium-to-long term.

King of wireless VPN

In FY09, Tulip had an estimated 30% revenue market share (RMS) in the VPN connectivity space, significantly ahead of the #2 (RCOM; 15%) and #3 (Sify; 12%) players. Tulip provides VPN over wireless last mile access, whereas its rivals rely on fibre, copper and satellite (VSAT). In fact, the growth of wireless VPN space has been almost entirely driven by Tulip, and the company commands well over 90% RMS in this sub-segment.

Table 14: VPN market shares (Year ended Mar ’09)

RCOM15%

Sify12%

Bharti9%

BSNL12%

Others 14%

Tulip Telecom

29%

TCOM9%

Source: Company presentation, Mar ’10

We believe the strength of Tulip’s VPN franchise has been due to:

Reach—the company’s wireless last mile network is present in nearly 1,500 cities (Dec-09)

Wireless focus—has helped achieve quicker and cost-effective rollout, especially in smaller towns and remote areas. However, this also meant that Tulip could essentially cater to small bandwidth requirements (typically 64-256 kbps) of its enterprise customers

First move advantage—thanks also due to the ‘voice focus’ of bigger telcos in the country

One-stop shop—Tulip provides Connectivity solution along with NI services, which is unique vis-à-vis its competitors in the NI space

High uptime—Tulip can guarantee higher levels of uptime (>99%), as it has leased inter-city bandwidth from multiple provider. This results in higher customer satisfaction levels.

Despite a continuous decline (roughly 10-15% p.a.) in the bandwidth/ connectivity prices paid by customers, Tulip’s Return on Average Equity (RoAE) has historically been in the 40-50% range (although it has come down to 29% in FY10e). Key factors that have helped Tulip’s RoAE are:

Increase in volumes (bandwidth per link) sold to customers

Thanks to its ‘low-bandwidth’ wireless data niche, and the ‘voice

focus’ of bigger telcos, Tulip has managed to grow successfully below

the radar in VPN space

Tulip has a strong and highly profitable VPN franchise

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Significantly higher supply (competition) at the wholesale-end, versus demand at the retail-end: Tulip leases/buys inter-city bandwidth (a key raw material) on ‘bulk/wholesale’ basis from multiple providers, but sells the last mile bandwidth in smaller/retail quantities. The differential competitive intensity, combined with better utilization of leased capacity (>50%), result in high gross margins (30-40% of ‘recurring’ EDN revenue). Interestingly, Tulip buys inter-city bandwidth from national integrated carriers like Bharti, RCOM and BSNL, and in several instances Tulip has sold the same bandwidth capacity, at the retail level to their dealers or their enterprise customers located in smaller towns (last mile connectivity on wireless is outsourced to Tulip)

Capex linked to order/revenue visibility: Investment in new locations (City or POP) or purchase of additional inter-city bandwidth has typically happened after getting the VPN contracts. This has resulted in higher utilization of owned, as well as leased bandwidth capacity.

Other important factors are: (1) increase in financial leverage; and (2) savings on account of license fee—Tulip deducts leased-bandwidth charges from Gross Revenues, while paying the mandatory 6% revenue share (as license fee) to the government. Although this practice carries regulatory risk, it has aided Tulip’s profits and returns so far.

Big fish in a small pond; now moving to a bigger pond

Tulip’s focussed wireless strategy has paid-off handsomely so far, as evident from the 21x increase in its VPN revenues since FY06, and the fact that over 70% of the Economic Times-500 companies (by revenues) are Tulip’s customers. While there is potential for robust long-term growth in wireless VPN business from the emerging Government sector, we believe the sustainability of high overall revenue growth rates (>20% p.a.) over the medium term is uncertain, given base effect.

Fig 16 – Tulip Telecom: EDN revenues and revenue growth rates Year end Mar

21

26

7

11

17

23 25

108

74

49

322122

45

210

5

10

15

20

25

30

FY08 FY09 FY10e FY11e FY12e

0

20

40

60

80

100

120

EDN revenues (Rsbn, LHS) EDN revenue growth (%, RHS)

Total revenue growth (%, RHS)(Rsbn) (%)

Source: Company, Anand Rathi Research

To maintain the growth momentum, Tulip has embarked upon an ambitious strategy to address ~90% of the EDN market. To this end, Tulip has been investing in last-mile fibre in the Central Business Districts (CBDs) of the Top 30-40 cities since the beginning of FY09. Tulip is aiming to become an end-to-end connectivity provider to enterprises, by meeting their high bandwidth requirements for VPN (in major cities) and for dedicated internet access, as well as providing them private leased circuits (IPLC/DLC) for point-to-point connectivity. For a brief overview of the EDN market, please refer to Annexure I in this report.

Net debt to Equity ratio was 1.14x as of end-FY09 vs. 0.15x

in FY06

Tulip’s revenues from VPN connectivity will likely have grown

21-fold by end-FY10e to Rs17.0bn, from Rs0.8bn in FY06

Tulip has over 90% RMS in the wireless VPN segment. However,

wireless VPN accounts for less than 20% of the EDN market (Fig 16

below)

Fig 15 – EDN revenue distribution (FY10e)

VPN-Fibre26%

ILL23%

IPLC / DLC26%

VSAT / Others

8%

VPN-Wireless

17%

Source: Company presentation, Mar ’10

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Long term upside from Government segment

We believe the Indian government’s thrust on promoting e-governance and inclusive growth will likely translate into significant demand for connectivity in the coming years. The e-governance agenda includes:

Developing State Wide Area Network (SWAN) to connect all State government departments and offices in each State

Establishing National/State Data Centres for reliable and secured data

Establishing Common Service Centres (CSCs) for delivery of public services

Unique ID (UID) project for creating national ID cards

The government’s inclusive growth agenda includes schemes such as, the National Rural Employment Guarantee Scheme (NREGS), as well as financial inclusion goals (connecting post offices, regional rural banks and rural bank branches). Separately, given the ongoing thrust on Reforms and AT&C loss reduction in power sector, the APDRP is also a key emerging driver of connectivity demand.

In our view, these initiatives in the Government segment potentially represent annual revenue opportunity of at least Rs40bn over the medium-to-long term (3-5 years). Note that NI and other Managed Services (network and facility management) would constitute additional potential expenditure.

Fig 17 – Size of Government segment opportunity [Connectivity only] Rs bn per year Comments APDRP 6.0 Rs200-250m per SEB; Scaling up expected over next 2-3 years

SWAN 10.0 Connecting State Government departments and offices

CSCs 2.5

Police HQs and Stations 2.5

National Knowledge Network 6.0 All schools/colleges, libraries, R&D centres to be connected

UID project 6.0

Financial inclusion projects 10.0 Including Regional Rural Banks (RRBs)

Total 43.0

Source: Industry sources, Company, Anand Rathi estimates.

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29 March 2010 Tulip Telecom – Bold growth agenda, but with increasing risk profile

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Increasing risk profile Tulip’s new growth strategy entails higher risks vis-à-vis the risks in its existing low-bandwidth wireless connectivity business. The high-bandwidth business based on fibre ownership, has entrenched competitors. Furthermore, risk of RoE dilution in the short-term is greater, as capex is more front-loaded, while revenue growth is more back-ended. Finally, Tulip has become more leveraged—financially, as well as operationally.

We believe Tulip’s new growth strategy entails higher risk vis-à-vis its existing business:

More competition: While growth of Wireless VPN segment has been primarily driven by Tulip’s focus and effort, the Fibre VPN segment already has entrenched competition in the form of RCOM, BSNL, TCOM and Bharti. In our view, it would be very challenging for Tulip to wean away high-bandwidth connections, given the switching costs involved and the existing relationships between enterprise customers and incumbent connectivity providers.

At best, Tulip can hope to either become a provider of back-up connectivity (although the trend of having a backup line is on the decline), or capture a part of the additional/incremental bandwidth requirement of enterprise customers. Note that Tulip already has extant relationship with most of the customers, as it serves these same enterprise customers for their low-bandwidth requirements on wireless.

Table 18: EDN market shares (Year ended Mar ’09)

Bharti17%

RCOM14%

BSNL14%

Others24%

TCOM20%

Tulip11%

Source: Company presentation, Mar ’10

Longer gestation: Fibre strategy entails front-ended capex but more back-ended revenue growth, compared to wireless. Fibre deployment takes longer, and customers are unwilling to place firm orders unless the vendor already has infrastructure on the ground. This leads to lower incremental RoAE at least initially, and is already evident in Tulip’s financials, in our view.

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Fig 19 – Tulip Telecom: Net debt-to-Equity (%) and RoAE (%) Year end Mar

15

38

67

123

104

75

42 4229 27 27

114

51 43

FY06 FY07 FY08 FY09 FY10e FY11e FY12e

Net debt-to-Equity (%)

RoAE (%)

Source: Company, Anand Rathi Research

Higher leverage: Tulip’s financial leverage has increased significantly, ever since it started investing in owned-fibre in the top cities, as well as in the SWAN (NI) projects in the Government segment, which also require front-loaded capex. This, combined with higher capital intensity inherent in the fibre model, has increased the proportion of fixed (capital) costs like depreciation and interest, thus increasing overall leverage in the business.

Fig 20 – Capital charges as a % of total costs (excl. tax) Year end Mar

2

4

6 6

1415 14

FY06 FY07 FY08 FY09 FY10e FY11e FY12e

Source: Company, Anand Rathi Research.

Increase in financial leverage has been unable to prevent dilution in

RoAE

Share of depreciation and interest in overall costs has gone up significantly

in FY10

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29 March 2010 Tulip Telecom – Bold growth agenda, but with increasing risk profile

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Financials Tulip is likely to report zero profit growth in FY10, but we expect growth to resume in FY11, and forecast 2-yr EPS CAGR of 27%, led by 21% revenue CAGR and 240bps EBITDA margin expansion.

Tulip’s RoAE has come down to 29% in FY10e from its 51% peak in FY08; we forecast the RoAE to stabilize at ~27% in the medium term. Tulip is likely to turn FCF positive in FY12 on our forecasts. We believe the company is yet to clearly demonstrate the financial benefits of its capital intensive fibre-strategy.

Revenue growth to sustain above 20%

We forecast EDN revenue growth (primarily VPN) of 23% in FY11 and 25% FY12. However, NI revenues are likely to remain practically flat vs. FY10e levels, resulting in 21% overall revenue CAGR.

Fig 21 – Tulip Telecom: Total Connects and Average Revenue per connect Year end Mar

9,51351,376

117,176

200,641

286,442350,679

405,494

58,336

44,734 45,06849,928

54,986 57,24163,251

0

100,000

200,000

300,000

400,000

500,000

600,000

FY06 FY07 FY08 FY09 FY10e FY11e FY12e0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Connects (EOP #, LHS)ARPC (Rs p.a., RHS)

(#)(Rs)

Source: Company, Anand Rathi Research

Note that, we have factored some upside from Tulip’s new growth initiatives, although the company is yet to clearly demonstrate the revenue traction from its fibre-strategy. Tulip’s EDN (VPN) revenue growth (yoy) has declined in all but one quarter, since the company started investing in fibre. Furthermore, Tulip’s overall revenue growth was just 13% yoy in 3QFY10, and needs to pick up in FY11 to meet our forecasts.

Fig 22 – Tulip Telecom: YoY revenue growth (%) Year end Mar

11098

82

48

6659

32 35

5549

33

13

3328

13 14

1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10e

EDN [a]

Overall

Source: Company, Anand Rathi Research. Note: [a] Almost entirely VPN (>95%)

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Anand Rathi Research 16

Change in business mix has been a key driver of margins

Tulip’s business mix has changed dramatically over the past four years, as the share of NI in overall revenues has come down to 14% in FY10e from 84% in FY06. In fact, the NI business has shrunk in absolute terms, and FY10e revenues are likely to be less than 50% of their peak level, achieved in FY08. This has boosted Tulip’s overall margins, as NI business is a low margin (5-8% gross margin) and low return business, whereas gross margins in the EDN/VPN business are in the 35-40% range.

Fig 23 – Revenue mix and EBITDA margin Year end Mar

4 613 16

20 2126 28 29

0

20

40

60

80

100

FY04 FY05 FY06 FY07 FY08 FY09 FY10e FY11e FY12e

Share of EDN revenue [a] Share of NI revenueEBITDA margin(%)

Source: Company, Anand Rathi Research [a] Almost entirely VPN (>95%)

Margin expansion to continue thanks to scale economies

NI revenues were just 12% of total revenues in 3QFY10, and once SWAN related NI revenues start rolling in from FY11, we forecast NI share to remain around 10% in the medium term. However, we still forecast EBITDA margins to expand from their 3QFY10 level of 27% and peak out at 30-31% over the long term. This will primarily be driven by scale benefits in the purchase of bandwidth, as well as higher utilization of leased bandwidth.

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Fig 24 – Tulip Telecom – Consolidated income statement Year end Mar, Rsm FY07 FY08 FY09 FY10e FY11e FY12e

Revenues Enterprise data network [EDN] 3,155 6,575 11,440 16,995 20,933 26,107 Network integration [NI] 5,270 5,615 4,704 2,673 2,787 2,703 Total revenues 8,426 12,190 16,144 19,668 23,720 28,810 Operating costs (Increase)/decrease in stock-in-trade (57) 497 215 0 0 0 Cost of goods & services (6,514) (9,503) (11,774) (13,141) (15,524) (18,750)Staff cost (307) (396) (712) (812) (938) (1,052)Selling and distribution expenses (36) (40) (42) (45) (59) (72)G&A (184) (291) (464) (497) (588) (677)Total operating costs (7,097) (9,733) (12,777) (14,494) (17,110) (20,551)EBITDA 1,328 2,456 3,367 5,174 6,610 8,259 EBITDA margin (%) 15.8 20.2 20.9 26.3 27.9 28.7 Depreciation (159) (418) (414) (1,603) (2,021) (2,510)EBIT 1,170 2,038 2,953 3,571 4,589 5,749 EBIT margin (%) 13.9 16.7 18.3 18.2 19.3 20.0 Other income 6 35 20 (67) 45 50 Interest income 18 169 204 101 60 73 Finance expenses (131) (258) (462) (733) (935) (963)Extra-ordinaries, Prior period items 27 25 113 400 0 0 PBT 1,090 2,009 2,827 3,273 3,758 4,910 Current tax (incl. FBT) (87) (136) (330) (619) (864) (1,129)Deferred tax (6) (1) 0 0 0 (49)Reported PAT 997 1,871 2,498 2,654 2,894 3,731 Adjusted PAT 972 1,848 2,398 2,330 2,894 3,731 Adj. PAT margin (%) 11.5 15.2 14.9 11.8 12.2 13.0 Adjusted EPS (Rs) Primary EPS 33.5 63.7 82.7 80.3 99.8 128.7 Diluted EPS 33.5 53.7 72.2 71.7 89.1 114.8 Shares outstanding (m) Shares outstanding (m) 29.0 29.0 29.0 29.0 29.0 29.0 Diluted shares (m) 29.0 34.4 33.2 32.5 32.5 32.5 Growth rates (%) Revenue 65.8 44.7 32.4 21.8 20.6 21.5 EBITDA 101.2 84.9 37.1 53.7 27.7 25.0 EBIT 89.6 74.2 44.9 21.0 28.5 25.3 Net profits 99.8 90.1 29.8 (2.8) 24.2 28.9 Diluted EPS 99.8 60.3 34.5 (0.7) 24.2 28.9 2-year forward Revenue CAGR (%) 38.4 27.0 21.2 21.0 18.3 12.4 2-year forward EBITDA CAGR (%) 59.2 45.1 40.1 26.3 21.0 14.4 2-year forward EBIT CAGR (%) 58.9 32.4 24.7 26.9 22.2 16.9 2-year forward Profit CAGR (%) 57.1 12.3 9.9 26.6 26.3 21.0 2-year forward EPS CAGR (%) 46.8 15.5 11.0 26.6 26.3 21.0 Margins (%) Gross profit margin 22.0 26.1 28.4 33.2 34.6 34.9 EBITDA 15.8 20.2 20.9 26.3 27.9 28.7 EBIT 13.9 16.7 18.3 18.2 19.3 20.0 PBT 12.9 16.5 17.5 16.6 15.8 17.0 Net profits 11.5 15.2 14.9 11.8 12.2 13.0 Current tax rate (%) 7.9 6.8 11.7 18.9 23.0 23.0 Effective tax rate (%) 8.5 6.9 11.7 18.9 23.0 24.0 Source: Company, Anand Rathi Research.

After rising dramatically in FY10, we forecast depreciation and interest expenses to remain stable as a % of

revenues

Tax rate has increased in FY10 because of increase in the MAT rate. Since FY10 is the 5th and the final year of 100% tax exemption under Section 80-IA, Tulip’s tax rate is

set to increase further in FY11

Rs400m estimated gains on FCCB buyback and FX translation

gains/losses on FCCBs, ECB debt and others

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Fig 25 – Tulip Telecom: Comparison with consensus estimates Year end Mar, Rsm FY10e FY11e FY12e

Revenues Consensus 20,200 24,002 28,883 AR 19,668 23,720 28,810 Diff (%) (2.6) (1.2) (0.3)EBITDA Consensus 5,114 6,316 7,924 AR 5,174 6,610 8,259 Diff (%) 1.2 4.7 4.2 Reported net profit Consensus 2,689 3,211 3,757

AR 2,654 2,894 3,731

Diff (%) (1.3) (9.9) (0.7)Source: Anand Rathi Research, Bloomberg [29 Mar ’10]

Balance sheet

We forecast Tulip’s net debt (incl. outstanding FCCBs) to peak at Rs12.4bn in FY11, but the net debt-to-equity ratio is likely to start declining in FY11, after peaking at 1.23x in Mar-10e. The net debt-to-EBITDA ratio has been around 2x in recent quarters, and should start winding down towards the end of FY11, with generation of FCF.

FCCB conversion assumed

Tulip had issued FCCBs worth US$150m face value in Aug-07, of which it has bought back bonds worth US$53m FV over the last four quarters. We do not assume any further buyback, as bonds prices have recently recovered to 5-10% premium over FV from a 40-60% discount. The bonds are convertible to equity shares at a price of Rs1137/share. We have assume conversion in FY13 (Aug-12), which would result in issue of 3.5m new shares (11% dilution).

It is important to note that Tulip’s outstanding FCCBs are appearing on the balance sheet at their FV of US$97m (FY10e). If we were to add the redemption premium for 2.5 years (Aug-07 to Feb-10), then Tulip’s current net debt would increase by roughly Rs900m (US$20m).

Fig 26 – Tulip Telecom: Details of FCCBs US$m, Year end Mar FY08 [a] FY09 FY10 [b]

Face Value of outstanding bonds 150.0 116.6 97.0 FV of FCCBs bought back during the year 0.0 33.4 19.6Shares to be issued upon conversion (m) 5.4 4.2 3.5 Potential dilution post-issue (%) 15.7 12.6 10.8 Source: Company, Exchange filings. Notes: [[a] FCCBs were issued in Aug-07 [b] Based on buybacks completed till 9MFY10.

Our revenue forecasts are in line with the consensus, but EBITDA is 4-5% higher, reflecting our view that margins should continue to expand

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29 March 2010 Tulip Telecom – Bold growth agenda, but with increasing risk profile

Anand Rathi Research 19

Fig 27 – Tulip Telecom: Consolidated balance sheet Year end Mar, Rsm FY07 FY08 FY09 FY10e FY11e FY12e

Equity Equity share capital 290 290 290 290 290 290 Reserves & Surplus 1,051 1,044 1,416 1,416 1,416 1,416 Profit & Loss account 1,457 3,120 5,113 7,564 10,186 13,578 Total shareholder equity 2,797 4,454 6,819 9,270 11,893 15,285 Deferred tax liability 8 9 9 9 9 58 Liabilities 0 0 0 0 0 0 Secured debt 1,416 1,943 5,141 7,750 9,350 8,350 Unsecured debt 0 6,996 6,083 4,676 4,676 4,676 Total debt 1,416 8,938 11,224 12,426 14,026 13,026 Total Invested capital 4,221 13,401 18,053 21,706 25,928 28,369 Assets Cash & cash equivalents 366 5,938 3,470 1,033 1,614 1,634 Current assets 1,970 2,994 5,252 6,503 7,413 8,551 Current liabilities & provisions 613 729 2,821 1,810 1,843 1,922Net working capital (excl. cash) 1,357 2,265 2,431 4,693 5,571 6,629 Gross block 2,500 4,447 9,437 16,639 21,829 26,071 Less: accumulated depr/amort (229) (647) (1,061) (2,664) (4,685) (7,195)Net fixed assets 2,271 3,799 8,376 13,976 17,144 18,875Capital work-in-progress 226 1,398 3,772 2,000 1,595 1,227 Net fixed assets (incl. CWIP) 2,497 5,197 12,148 15,976 18,739 20,102 Investments 0 0 0 0 0 0 Misc. expenditure (not w/o) 1 1 4 4 4 4 Total assets 4,221 13,401 18,053 21,706 25,928 28,369 Gearing and profitability ratios (%) Net-debt incl. FCCBs 1,050 3,000 7,755 11,393 12,412 11,392 Net-debt incl. FCCBs (US$m) 24 75 152 248 270 248 Debt/Equity 51 201 165 134 118 85Debt/capital 34 67 62 57 54 46 Net-debt/Equity 38 67 114 123 104 75 Net-debt/capital 25 22 43 52 48 40 Net-debt/EBITDA (x) 0.8 1.2 2.3 2.2 1.9 1.4 Net interest coverage (x) [a] 10.2 9.5 7.3 7.1 7.1 8.6 RoAE 41.7 51.0 42.5 29.0 27.3 27.5 RoACE (excl. CWIP) 29.4 23.1 18.2 13.7 13.1 14.5

Source: Company, Anand Rathi Research. Notes: [a] Interest coverage defined as EBITDA/interest cost.

Fig 28 – Tulip Telecom: Capex and net debt Year end Mar

0.6 1.93.1

7.4

5.44.8

0.3 1.13.0

7.8

11.412.4

0.1 0.1

4

11

2326

20

46

28

0

2

4

6

8

10

12

14

FY05 FY06 FY07 FY08 FY09 FY10e FY11e0

10

20

30

40

50

Capex (Rsbn, LHS) Net debt (Rsbn, LHS)Capex to sales (RHS,%)

(Rsbn) (%)

Source: Company, Anand Rathi Research

Capex surge since FY09 has boosted the debt levels

Outstanding FCCBs are appearing at their face value of US$97m, i.e. without accrual of any redemption

premium

Rapid increase in current assets led by debtors, is a concern, especially in

view of declining revenue growth rates

Gross fixed assets are up 3.75x in the last two financial years

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Fig 29 – Tulip Telecom: Consolidated cash flow statement Year end Mar, Rsm FY07 FY08 FY09 FY10e FY11e FY12eProfits before tax 1,063 2,010 2,841 3,273 3,758 4,910 Depr & amort 158 418 414 1,603 2,021 2,510 Other non-cash items 25 (1) (129) (400) 0 0 Taxes paid (87) (136) (330) (619) (864) (1,129)Chg in working capital 52 (908) (166) (2,262) (878) (1,058)CF from Operations 1,211 1,383 2,632 1,595 4,037 5,233 Capex (1,930) (3,118) (7,365) (5,431) (4,784) (3,873)(Purchase)/Sale of assets/investments 24 (0) 1,858 0 0 0 CF from investments (1,906) (3,118) (5,507) (5,431) (4,784) (3,873) Equity raised 0 0 0 0 0 0 Debt raised / (repaid) 660 7,375 543 1,602 1,600 (1,000)Dividends paid (68) (68) (136) (204) (271) (339)CF from financing 592 7,308 407 1,398 1,329 (1,339) Change in cash for year (102) 5,572 (2,468) (2,437) 581 20 Beginning cash 468 366 5,938 3,470 1,033 1,614 Closing cash 366 5,938 3,470 1,033 1,614 1,634 Free cash flow (CF from operations less capex) (719) (1,735) (4,733) (3,835) (747) 1,359 Source: Company, Anand Rathi Research. [a] Free cash flow = CF from operations less capex

Gain on buyback and cancellation of FCCBs, MTM forex

gains/losses on FCCBs, ECBs, others

Surge in working capital levels in FY10 is

a concern

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Fig 30 – Tulip Telecom: Quarterly results Year end Mar, Rsm 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10e YoY (%) QoQ (%)

EDN revenues 3,350 3,486 3,687 4,177 4,422 4,709 32.0 5.9

Installation (one-time) 975 1,046 761 913 1,005 924 3.1 10.0

Recurring 2,375 2,440 2,926 3,264 3,418 3,785 43.9 4.7

Network Integration revenues 1,068 1,191 742 734 586 611 (45.1) (20.1)

Total revenues 4,418 4,677 4,429 4,910 5,009 5,320 13.4 2.0

Operating costs

Cost of goods/services (3,138) (3,346) (3,037) (3,309) (3,307) (3,488) 5.4 (0.1)

Employee costs (171) (199) (185) (211) (205) (210) 19.6 (2.8)

G&A costs (185) (129) (121) (123) (147) (145) (20.2) 20.2

Total operating costs (3,494) (3,675) (3,343) (3,642) (3,659) (3,843) 4.7 0.5

EBITDA 924 1,002 1,086 1,269 1,350 1,477 46.1 6.4

EBITDA margin (%) 20.9 21.4 24.5 25.8 27.0 27.8 603bps 112bps

Depreciation (94) (136) (353) (436) (409) (405) 333.7 (6.1)

EBIT 830 866 733 833 941 1,072 13.4 13.0

Other income (incl. int income) 89 67 (32) 222 104 19

Gross interest expenses (98) (143) (158) (187) (186) (200) 90.5 (0.5)

Exceptional items (290) 512 304 (186) 0 0

PBT 531 1,302 846 682 858 892 61.6 25.8

Taxes (35) (235) (96) (164) (172) (187) 397.3 4.8

PAT 496 1,067 750 518 686 705 38.2 32.5

Adjusted PAT 767 647 481 659 686 705 (10.6) 4.1

Shares outstanding (m) 29.0 29.0 29.0 29.0 29.0 29.0

Diluted shares (m) 34.0 34.0 34.0 34.0 32.5 32.5

Adj. EPS (diluted) 22.57 19.04 14.15 19.37 21.11 21.69 (6.5) 9.0

Effective tax rate (%) 6.5 18.0 11.3 24.1 20.1 21.0 1354bps -403bps

Capex 826 1,131 2,020 1,450

Capex-to-sales (%) 19 23 40 27

YoY changes (%)

EDN revenues 82 48 66 59 32 35

NI revenues (28) (34) (33) (40) (45) (49)

Total revenues 33 13 33 28 13 14

EBITDA 34 22 66 57 46 47

EBIT 47 22 33 14 13 24

PAT 42 (3) 5 11 (11) 9

Operating data

Cities covered (#) 1,370 1,393 1,415 1,455 1,495 1,535 15.0 5.7

POPs (#) 3,711 3,923 4,035 4,247 4,447 4,622 29.0 10.2

Clients (#) 1,188 1,367 1,472 1,500 1,571 1,696 52.1 6.7

Total connects (#) 175,463 200,641 218,763 240,510 264,429 286,442 73.6 20.9

Recurring ARPU (Rs; annualized) 57,958 51,898 55,813 56,848 54,151 54,963 8.1 (3.0)

Installation ARPU (Rs) 42,199 41,536 41,999 41,997 42,000 42,000 (0.5) 0.0

Balance Sheet data

Gross debt 11,225 11,026 11,210 12,139

Cash and cash equivalents 3,459 2,460 1,748 1,100

Net debt 7,766 8,567 9,462 11,039

Networth 6,804 7,554 8,074 8,759

Net debt-to-EBITDA (x) 1.9 2.0 1.9 2.0

Net debt-to-Equity (%) 114 113 117 126

Source: Company, Anand Rathi Research

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Tulip Telecom: Company Profile Tulip is a niche provider of wireless data connectivity to businesses. The company also has a presence in the Network Integration (NI) space. Unlike bigger rivals (TCOM, RCOM, Bharti) that cater to ‘high bandwidth’ needs of enterprise customers in major cities, Tulip is a leader in the provision of ‘small bandwidth’ connectivity (typically 16kbps to 256kbps) to large and medium enterprises.

Since FY09, the company has stepped up investments in last mile fibre-optic, to address the high bandwidth market through various connectivity solutions (VPN, ILL, IPLC, DLC). Tulip is also aiming to participate in the large opportunities emerging in the Government sector, in the areas of e-governance and financial inclusion.

Background Tulip started off as a reseller of software products in 1992. Over the next 12 years, the company ventured into the supply of computer and network hardware, system integration and network integration. In 2005, Tulip began offering VPN connectivity using wireless last mile to enterprise customers. In fact, Tulip pioneered the wireless-access based VPN connectivity in India, which has helped the company become the leading VPN provider in the country (~30% market share in FY09). In the broader space of enterprise data network (EDN) connectivity, Tulip had a market share of ~11% in FY09.

Shareholding

To fund the growth in its VPN business, Tulip raised Rs1.0bn in Jan-06 through an IPO of its equity shares (31% dilution). As of end-Dec’09, the promoters of Tulip (Col. H S Bedi & family) held 69% equity interest in the company.

Fig 31 – Tulip Telecom: Business transformation over the years

1991

2000

2010

Floppy DisksSoftware products / packages

Hardware products (PCs)

Hardware products(Networking equipment)

Network Integration

VPN connectivity on wireless

Data Centres

VPN connectivity on fibreInternet leased lines (ILL)

FutureIPLC/DLCManaged servicesVASGovernment projects

1992

1995

1999

2001

2005

2007

2009

Source: Company IPO/FCCB prospectus, Anand Rathi research.

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Fig 32 – Tulip Telecom: Shareholding pattern (Dec-09) # of shares (m) (%)Promoter Group 20.0 69.0FIIs 7.2 24.7 Lehman Brothers Investment Management Company Ltd 0.9 3.0

Citigroup Global Markets Mauritius Private Limited [a] 1.5 5.0

Merrill Lynch Capital Markets Espana S.A. S. V. 1.6 5.4

Swiss Finance Corp. (Mauritius) Ltd [a] 1.1 3.9

Others 2.1 7.3

Domestic Institutions (MFs, UTI) 0.5 1.6Indian Public 0.8 2.9Others (corporate bodies, clearing members, NRIs, foreign nationals) 0.5 1.8Total 29.0 100.0

Source: NSE website, Anand Rathi Research. [a] After accounting for the recent sale of 2% stake by Swiss Finance Corp. to Citigroup Global

Management Lt. Col. Hardeep Singh Bedi, Chairman and Managing Director

Col. Bedi has served in the Indian Army for 22 years, during which he worked as an instructor in the Army’s Faculty of Computer Technology, worked with the Chief of Army Staff, and at the Army Headquarters to coordinate the Army’s automation. He was awarded the ‘Vishisht Seva Medal’ (VSM) by the President of India for his role in the computerization of the Army. After retiring early from the Army in 1993, Col. Bedi joined Tulip as a Director, and bought out the original founders in 1997.

Deepinder Singh Bedi (son of Col. Bedi), Executive Director

Deepinder Singh has a Bachelors degree in Electronics and has done his Masters in Business Administration from Boston University, USA. Since 2001, he has been actively involved in running the company. At present, he is handling the Sales and Marketing function in Tulip.

Business profile Within the broader scope of Enterprise Data Market (EDM; See Annexure I), Tulip Telecom has presence in the Connectivity space (through wireless VPN) and in the Managed Services space (through NI). Tulip has four telecom licenses for participating in the connectivity business: NLD (covers DLC, VPN services), ILD (for IPLC), ISP (for ILL) and VSAT. For NI (equipment re-sale, installation) or other managed services, no telecom license is required.

Network integration—low priority, legacy business

Network Integration (NI) business involves designing and developing networks for enterprises. The revenue primarily comes from resale of equipment (mostly imported), hence it is a low margin business. Furthermore, the receivable cycle is fairly long (3-6 months), especially in the government segment.

This is a low priority business for Tulip, and its contribution to overall revenues has been declining. According to the management, Tulip would prefer to take up NI projects, where:

NI is required to maintain key customer relationships

NI is required to support Tulip’s enterprise VPN business

NI would help in generating leads for VPN business especially in the

Tulip’s Board comprises seven directors, of which five are

independent

In VPN segment, Tulip caters to small bandwidth requirements of

large and medium enterprises

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government segment (e.g. SWAN NI projects)

Dominant leader in the small bandwidth, wireless-VPN market

Tulip has a dominant (>90%) market share in the wireless VPN space, thanks to its first mover advantage, focus and execution. Tulip’s key advantage is ‘reach’—the company’s wireless network is present in over 1,500 cities. In fact, its bigger rivals (Bharti, RCOM) in a bid to provide their enterprise customers end-to-end connectivity, tend to outsource low bandwidth connects/links to Tulip.

Tulip uses wireless media for last-mile access using microwave spectrum, to profitably serve its niche segment. For inter-city links, Tulip leases bandwidth capacity on fibre from other companies (e.g. Bharti, RCOM, TCOM, Railtel). Effectively, Tulip buys inter-city bandwidth on wholesale basis (>2mbps) and sells the same in the last-mile on retail basis (64kbps-256kbps).

While the average tariff per 64k connect is Rs35K-40K per year, the average cost of inter-city bandwidth per 64k connect basis, typically comes to less than Rs18K-19K (@50% utilization), if an E1 link (2mbps) is bought. The gross margin clearly depends on the relative size of bandwidth purchased to bandwidth sold, and the utilization level. Note that these relatively higher margins (>40%) are needed to cover fixed capital costs as well (depreciation + interest).

Fig 34 – Bandwidth costs per 64Kbps user (based on BSNL tariffs) E-1 DS-3 STM-1 STM-16Inter-city bandwidth (mbps) 2.0 44.7 155.0 2,480.0 Annual leasing cost (Rsm p.a.) 0.30 2.10 5.70 48.8

# of 64kbps users [100% utilization] 32 699 2,422 38,750

Annual cost per 64k user (Rs) 9,375 3,004 2,354 1,259

Source: BSNL website, Anand Rathi Research

Small bandwidth requirements are more common in smaller towns and cities. These links typically connect

the remote branches to the Regional/Head Office or dealers to

a company’s network

Fig 33 – Tulip Telecom: Metrics in wireless VPN business

City coverage (#)

350

800

1,1751,393

1,543

FY06 FY07 FY08 FY09 FY10e

Number of POPs

1,565

2,7313,206

3,9234,628

FY06 FY07 FY08 FY09 FY10e

Number of clients

239

536

855

1,367

1,695

FY06 FY07 FY08 FY09 FY10e

Source: Company, Anand Rathi Research. Note: PoP is a Point of Presence

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Fig 35 – Tulip Telecom: Gross margin on sale of intercity connectivity (%)

50

40

30

6760

53

81 7773

62

17

45

84

47403942

60606165

75828587

89

64 kbps 128 kbps 256 kbps 512 kbps 1,024kbps

2,048kbps

4,096kbps

6,144kbps

8,192kbps

Capacity sold in units of

(E-1, 50%)

(E-1, 75%)(DS-3, 50%)

(DS-3, 75%)

Gross margins % under different scenarios (Capacity purchased, Capacity utilisation)

Source: BSNL website, Tulip Telecom, Anand Rathi Research. Note: Tariffs used in this illustration are based on 40% discount to headline tariffs published by Tulip in March-09

Government business

Tulip is currently implementing SWAN (NI) projects in four States: Assam, Haryana, MP and West Bengal. The project comprises installation and maintenance of networking equipments for five years under a Build-Own-Operate-Transfer (BOOT) contract.

These BOOT projects are not a focus area for the company, because of low profitability (largely a trading business). However, the management believes these projects are important to establish Tulip’s name in the government sector; this would help the company qualify and win, some of the more lucrative contracts for provision of Connectivity (under SWAN).

In 2QFY10, Tulip was successful in winning a 5-year fixed rate contract, for supply of connectivity/bandwidth to the Maharashtra SWAN project. We estimate annual revenue potential of Rs500-800m from Maharashtra SWAN contract. However, winning such bandwidth contracts in other States may be difficult, as BSNL is the default bandwidth vendor in most cases. BSNL also has the right of first refusal (RoFR) for such contracts.

Tulip has also been selected to provide bandwidth for APDRP projects by State Electricity Boards (SEBs) in nine Indian States. The company has tie-ups/alliances with IT vendors (Infosys, TCS, L&T, HCL), who generally bid for IT implementation and NI portion, but outsource the Connectivity to third-party vendors like Tulip.

Tulip expects such APDRP related contracts to be awarded by 15 more States over the next few months. Our industry sources indicate that annual connectivity revenues per State in the APDRP can potentially ramp up to Rs150-250m.

Tulip has won the connectivity contract for Maharashtra SWAN

project, thanks to its coverage/reach, high uptime (high perceived

reliability) and competitive pricing

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Annexure I: Enterprise data market The enterprise data market has essentially two components:

Connectivity or bandwidth sale (typically annual contracts, except capacity sale based on IRU, which are multi-year infrastructure deals)

Services, incl. managed services as well as Value added services

Within the EDN segment, several connectivity solutions are available, and their selection depends on several considerations such as: bandwidth, cost, uptime/reliability etc. The table below ranks various VPN connectivity solutions for low bandwidth (16-256kbps) applications, on key parameters, using a score of 1 (Worst) to 5 (Best).

Fig 37 – Comparison of VPN connectivity solutions for low bandwidth applications MPLS Wireless [a] Broadband V-SAT GPRS/CDMA-1X Ethernet

1) Latency 4 3 2 1 5

2) Uptime 3 2 4 1 5

3) Cost [b] 3 4 2 5 1

4) Scalability 3 4 1 2 5

5) Security 3 2 4 1 5

6) Time to deploy 4 2 3 5 1

Total score [c] 20 17 16 15 22

Comments Costs are

coming down

Initial cost high; Recurring is

lowest

Variable speeds, since not dedicated

Source: Industry, Tulip Telecom, Anand Rathi research. [a] Wireless last mile access assumed. Fibre access is more suitable for high bandwidth (>2mbps) applications. [b] Initial cost + recurring cost + maintenance cost

[c] Assuming same weightage for each factor.

Fig 36 – Enterprise data market: Key segments 1. Enterprise Data Connectivity/Network [EDN] MPLS-VPN, Internet Lease Lines, International and Domestic Private Leased Circuits, VSAT/Others2. Capacity sale IRUs (Long term sale of dark and lit fibre)

3. Managed services NI [a], Network management, Data Centres, Hosting, ASP, Security, Disaster recovery 4. Value Added Services (VAS) Push e-mail, corporate internet, bandwidth on demand, video conferencing, VoIP

Source: Anand Rathi Research.

Wireless MPLS-VPN has emerged as the best solution for low

bandwidth applications, especially when cost and time to market are

also key considerations

Tulip has presence in the Connectivity space through VPN, and in the Managed Services space

through NI

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Annexure II: Government sector The Indian Government is likely to emerge as a big spender on IT and data connectivity in the coming years, thanks to its initiatives on e-governance and financial inclusion. The e-Governance initiatives include projects like SWAN and UID, whereas financial inclusion measures include NREGS, rural branch banking. Separately, the APDRP in the power sector is also a key emerging driver of data connectivity demand.

National e-Governance programme

Over the past decade, several isolated e-Governance projects have been undertaken in the country at the National, State, District and even Block level. However, to speed up the spread of e-Governance and save costs (common infrastructure, interoperable standards), National e-Governance plan (NeGP) was formulated by the central government in 2006.

Mission mode projects

Under the NeGP, the government plans to implement several initiatives, called mission mode projects (MMPs); these include deployment of information and communications technologies in various departments such as taxation, passport, immigration and visa issuance, employment exchange etc. While these projects are being promoted as Central government initiative, the implementation of various MMPs would be decentralized.

Core and support infrastructure

To support the MMPs, the government is developing common core and support infrastructure, consisting of Common Service Centres (CSCs), State Wide Area Networks (SWANs) and State Data Centres (SDCs).

CSC: The government intends to establish 100,000 CSCs in 600,000 villages of India through a Public-Private Partnership model. The CSCs would be designed as ICT-enabled Kiosks having a PC (along with basic support equipment like Printer, Scanner, UPS) and additional equipment for providing common citizen services, such as edutainment, telemedicine and projection systems. The CSCs would be connected to SWAN networks through the use of wireless technologies. The CSC scheme has been approved at a total cost of Rs57bn over four years

SWAN: The objective is to create a secure Closed User Group (CUG) government network for delivering G-to-G and G-to-C services. The total outlay on SWAN implementation in twenty-eight States and seven union territories (UTs) has been estimated at Rs33bn (cost of network installation). Implementation is progressing well—SWAN is already established in 17 States and implementation is at an advanced stage in four more States

SDC: SDCs are to be set up to consolidate services, applications and infrastructure to provide efficient electronic delivery of G2G, G2C and G2B services. Estimated outlay on SDCs has been estimated at Rs16bn over a period of five years. The government expects SDCs to become operational across different States and UTs by 2011

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Other government led initiatives

R-APDRP

Restructured Accelerated Power Development and Reform Programme (R-APDRP) is a central government initiative to reduce Aggregate Technical & Commercial (AT&C) losses in power distribution in the States. The programme proposes to cover towns and cities with at least 30,000 pops, and is expected to involve investments of Rs500bn (>$10bn), to be funded by the central government in the form of loans and grants.

Apart from strengthening and up-gradation of sub-transmission and distribution network, R-APDRP would also focus on adoption of IT. Under the programme, the State governments would award contracts to IT and NI vendors. These vendors are expected to obtain Connectivity from bandwidth providers, such as Tulip.

Department of Post

The DoP has ~155,000 post offices across the country. It is the most widely distributed post office system in the world. The department also serves as a financial institution offering various small savings/investment schemes. Given its wide reach, Indian postal service is potentially an important instrument for achieving financial inclusion goals of the government.

India Post plans to invest 50% of the proposed Rs120bn (US$2.6bn) expenditure earmarked for the 11th five year plan, for technology upgrade and modernization. Under the Technology Induction Plan, India Post plans to undertake computerization and networking of all post offices using a Central Server based system.

Unique Identification project

Through the UID project, the Indian government intends to assign an unique identity number to every resident of the country. A central ID data repository (CIDR) would be created to store data about the ID number holders. The data include basic information such as name, gender, photo, date of birth, family details, address and bio-metrics such as finger prints.

National knowledge network

In January this year, the Central government gave in-principle approval for the establishment of an NKN to connect various knowledge institutions (e.g. universities, research centres, libraries) spread across the country. The NKN will likely have 25 core Points of Presence (PoPs) and 600 secondary PoPs. It is expected to connect around 1500 institutions.

The NKN architecture would be scalable, with initial bandwidth requirement of 100mbps in the last mile for a typical institution. The network would also consist of an ultra-high speed core (multiples of 10Gbps and upwards), to provide a nation-wide ultra high-speed data-network highway. The physical infrastructure (setting up of core network) is expected to be completed in the next 24 months. (Source: Press Information bureau, 21 Jan ’10)

UID would help reduce ‘KYC’ costs through online authentication of

identity

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Appendix 1 Analyst Certification The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. The research analysts, strategists, or research associates principally responsible for the preparation of Anand Rathi Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.

Anand Rathi Ratings Definitions

Analysts’ ratings and the corresponding expected returns take into account our definitions of Large Caps (>US$1bn) and Mid/Small Caps (<US$1bn) as described in the Ratings Table below.

Ratings Guide Buy Hold Sell Large Caps (>US$1bn) >20% 5-20% <5% Mid/Small Caps (<US$1bn) >30% 10-30% <10%

Anand Rathi Research Ratings Distribution (as of 12 Jan 10) Buy Hold Sell Anand Rathi Research stock coverage (116) 61% 10% 29% % who are investment banking clients 4% 0% 0% Other Disclosures This report has been issued by Anand Rathi Financial Services Limited (ARFSL), which is regulated by SEBI.

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