AGC Networks Ltd (AGC) Techno-Fundamental Pick

(CMP Rs. 191.25)

April 18, 2012
Target Rs. 235 Stoploss Rs. 159 Time Horizon 1-2 quarters

Industry CMP Recommended Action Communication Buy at CMP and average in the Networks Rs. 165-176 band TATTELEQNR Rs. 191.25

HDFCSec Scrip ID

Company Background
AGC Networks Ltd. (AGC) is Indias Leading Solutions Integrator in Unified communications, Audio video solutions, Collaboration, Network infrastructure, Information security and Consulting & PSO. AGC delivers customized business solutions that help organizations accelerate revenue growth, increase market penetration, optimise operating costs and improve employee productivity, by embedding communication in their business processes. AGC has been voted the No.1 Company in Enterprise Communications in India consecutively for 8 years. Today it has over 2,500 customers, 22 offices spread across India with a strong distribution network comprising of more than 50 System Integrators, Channel Partners and Dealers. Besides India, AGC is present in 20 countries in Middle East, Africa, ANZ, UK and USA. AGC Networks was formed as Tata Telecom Ltd in 1986 to cater to the emerging EPABX market in India. Lucent Technologies later invested in the company, spun off its enterprise business into another company namely Avaya Inc and subsequently acquired Tatas stake. In FY11 Avaya sold AGC to the Essar Group, who now hold 75% stake through Aegis Ltd. AGC had one wholly owned subsidiary at the end of FY11, GlobalConnect Australia Pty Ltd (GCA). GCA is a solution integrator focusing on mid-market Data & Wireless space. In FY12, AGC added two subsidiaries, AGC Networks Pte Ltd in Singapore (100% stake for $12.5 mn) and AGC Networks Inc in the USA with a $0.5 mn investment from AGC Singapore. These subsidiaries will expand activities in the regions and further relations with existing and prospective clients. Some of AGCs clients include global leaders like Avaya, Juniper, NICE Systems, Aspect, Verint, HP, Polycom, Cisco, NEC, Sony, Plantronics, EMC, Dialogic, NetApp, Checkpoint and Jabra. While AGC manufactures a little portion of goods sold (mainly EPABX capacity utilisation ~20%, sales value Rs.20 cr in FY11), all other products are purchased from outside and installed as a package in customers premises. Data on trading purchases by AGC networks is as under: Converged Comm Sol Sep-10 Mar-11 Purchase Quantity Purchase Value (Rs. Cr) Sales Quantity Sales Value (Rs. Cr) 216.8 238.3 142.9 195.1 Telephone Instruments Sep-10 Mar-11 47053 28.1 46783 62.9 5392 12.7 2937 2.4 Teleconferencing Sol Sep-10 Mar-11 578 12.6 559 28.2 53 6.7 60 1.6

Businesses

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Industry Solutions: AGC offers leading solutions, which are tailor made for each industry and have scope of getting further customized for individual organizations needs. Some of the industries that AGC caters to are: Healthcare Hospitality Manufacturing Government BFSI ITES/BPO Small/Medium Business Solutions Legal Advertising Real Estate Retail Service Provider Customer Relations Management Services

Shareholding Pattern
Particulars Promoters Foreign Institutions & Individuals Indian Institutions Non Promoter Corporate Holding Public & Others Total No. of shares 31/12/2011 106.7 7.8 1.5 3.7 22.5 142.3 % Shareholding 31/12/2011 75.0 5.5 1.1 2.6 15.8 100

Among institutions, India Opportunities Growth Fund Ltd holds 4.4% as on 31st December 2011.

Triggers
Change in parent has led to sharp jump in sales momentum: Aegis Ltd, the parent company of AGC and a part of the Essar group, is a global Business Process and Experience Management company with a presence in 12 countries and ~50 locations. Nasscom rated Aegis the No. 4 BPO player in India. AGC partners with Aegis to provide its services to Aegis. AGC can take advantage of Aegiss established network and client base in global markets. Aegis has close to 300 clients and 55,000 employees. Aegis specializes in tailor-made solutions that cover the entire spectrum of customer and business experiences across business processing, technology, shared services, analytics and consulting and offers customized engagement models to further facilitate the ease of doing business. Aegis strong foothold in US, Australia, South Africa and Europe give AGC a good opportunity to expand in those markets. AGC might have benefited from Aegis network in overseas markets and now Outside India sales account for over 50% of the companys total revenue. We believe new products, new clients in global markets and shift toward a complete communications service provider have led to a stellar performance since Aegis acquisition of AGC. Though the change in ownership is 6 quarters old, growth in sales started from Q4FY11 quarter and has continued till Q3FY12. As contract for work typically is on an annual basis, one could expect some more new clients coming into AGCs fold in the quarters to come and sales growth momentum to continue (though at a slower rate than 75% y-o-y growth in 9MFY12 sales). Spread of geographical and product revenues could contribute to topline growth and risk containment: AGC has a wide range of products and services and the company is not largely dependent on any one. AGC obtains just over 50% of its revenue from the domestic market however, with expansion plans in global markets, the mix is likely to change. Outside India revenue has grown significantly in FY12 from Rs. 6.8 cr in the quarter ended Dec-10 to Rs. 113.4 cr in Q3FY12 and from Rs. 29.2 cr in 9MFY11 to Rs. 255.3 cr in 9MFY12. AGC also set up subsidiaries in Singapore and USA to penetrate the respective markets. The integrated network solutions market has great potential. As the global economy grows and companies expand their operations, integrated communication will be required across firms to ensure efficiency. The domestic market for products that AGC is present in is ~Rs. 18,300 cr and grew over 20% in FY11. The global market for enterprise solutions was estimated at $793 bn in 2010 and ~$852 bn in 2011 and is expected to grow at a CAGR of ~5% till 2015. Latin America, Asia Pacific and Middle East and Africa comprise the fastest growing global markets. AGCs presence and growth plans in these markets (except Latin America) reflect the growth possibilities.

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Global Industry Size

1100 1000 (USD bn) 900 800 700 2008 2009 2010 2011E 2012P 2013P 2014P 2015P 400 300 200 100 0

Industry - Geography

(USD bn)

Canada

Mid. Ea & Afr

Cent & E. Eur

Lat Am

W. Eur

2010

(Source: Company, HDFC Sec Research)

Stellar performance in 9MFY12 and excellent financial raitos: Net sales grew 75.3% in 9MFY12 vs 9MFY11. EBITDA and PAT grew 73.8% and 83.2% in the same period. OPM increased from 8.5% to 9.3% and NPM increased from 5.5% to 5.7%. PAT grew by 83.2%. Staff cost reduced significantly in FY12 while cost of traded goods increased a little. It would be feasible to say the increase in earnings has come from an increase in revenue, which has been rising since Aegis took over the company. AGCs annualised RONW and ROA for FY12 is 17.4% and 18.7% respectively. With a BV of Rs. 213.5, the P/BV is 0.9. With a fixed Asset turnover of 42.7 and Total Asset turnover of 3.3, AGC is poised to do well in the current financial year. Virtually debt-free: AGC is virtually a debt-free company. In FY10 and FY11 the reported debt was 0 however, in H1FY12, the company reported a debt of Rs. 24.3 cr. While this is negligible and keeps the gearing ration below 0.1, it does cause an interest expense (Rs. 3.3 in 9MFY12), which was negligible previously. Given the fast-paced environment that the company is operating in presently, the debt of Rs.24.3 cr doesnt raise much concern as the cash balance on hand is Rs. 55.3 cr (as per the H1FY12 balance sheet). Strong customer base and long-term relationships: AGC partners with leading OEM providers such as Avaya, Juniper, NICE Systems, Aspect, Verint, HP, Polycom, Cisco, NEC, Sony, Plantronics, EMC, Dialogic, NetApp, Checkpoint and Jabra. Moreover, AGC partners with its parent, Aegis, a leading BPO. AGC will continue to leverage its relations with Aegis to acquire additional clients in the global market. AGC also earns some revenue from government owned organizations and the company is trying to expand its presence in PSUs. AGC maintains excellent relationships with its customers, providing world-class services at competitive rates. Moreover, the difficulty in switching communication systems is very high as with equipment cost, there is the cost of training and accustoming to the new system. Hence the chances of AGCs clients easily switching to other suppliers are very low. The long-term relationships provide visibility for annuity revenues from each client. Vice-versa, it would be difficult for AGC to steal existing clients with competitors.

Concerns
Technological obsolescence: AGC operates in an industry where technology is imperative for success. While the company takes pride in its present technology standards, obsolescence of the same in the future due to it not keeping pace with technology changes could diminish the value of the firm. Forex risk: Until FY11, AGC had limited foreign operations with only ~5% of the companys revenue being earned in other currencies. However now, close to 50% of AGCs sales come from non-Indian markets. Forex exposure has increased significantly and could increase further going ahead as AGC expands its customer base in foreign markets. Any major forex fluctuation or lack of appropriate hedging strategies could result in non-operating losses. In FY11 it spent Rs.140 cr in forex on impart of goods. This could also result in a possibility of volatility in margins though with rising exports, it has achieved a certain natural hedge. Competition: AGC is in a competitive industry. While the number of large players is limited, acquiring competitors market share is extremely difficult. Competitors include 3i Infotech, HCL Tech, Tulip Telecom, Wipro, Blackbox, Dimension Data and Xeta. Most competitors belong to strong groups and hence have the ability to leverage their networks to their advantage. Very high sundry debtors: AGC has very high debtors (Rs. 206.2 cr in FY11 including Rs.35.2 cr due for more than 6 months - and Rs. 369.7 cr in H1FY12). Debtor days in FY11 stood at 97.4 and in 9MFY12 stood at 113.9 (based on half yearly balance sheet). This indicates a slow recovery of receivables, affecting the cash conversion cycle and locking up of funds. Besides just a slow recovery, risk of bad debts also remains highlighted.
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Asia Pacific

2015E

Japan

USA

High pledged shares: ~96% of the promoters holding is pledged, which is equivalent to ~72% of total shareholding. Any defaults of payments to respective lenders could lead to a sell-off of shares in the secondary market resulting in a sharp fall in market prices. Investment in Aegis: AGC has invested Rs. 80 cr in Aegis Ltd (57.14 lakh shares for Rs. 140 each) in FY11. While the company expects good returns from the investment from its parent company, it has temporarily resulted in locking up of funds in avenues that may not bring in any return in the near term. AGC declares dividend with payouts ranging from 19% to 25% of its PAT over the last two years. Given the fact that the capex requirements of AGC are limited, it could afford to pay higher payout of dividends. Essar group needs to improve on its image for being shareholder friendly and hence its companies do not get the valuation that they may otherwise deserve.

Conclusion
AGC is an integrated communications provider with a strong presence in India and expanding operations in the world. Since Aegiss acquisition of the company, business momentum has increased as AGC now leverages with Aegiss global network. This benefit is expected to continue for a few quarters as AGC establishes global offices to increase penetration in other markets. AGC has a strong customer base and good financials with a healthy balance sheet (except sundry debtors, which are very high and remain a raise a concern of recoverability). Technological obsolescence, forex fluctuation, high competition and high pledged shares are some concerns. To sum up, we expect domestic business to improve with new products and services, international business to improve with new clients due to Aegis network, and overall business to improve by maintaining good relationships with vendors and moving up the value chain by providing end-to-end solutions. Though the fact that the business of AGC consists largely of trading (and implementing solutions) resulting in possibility of getting a low P/E, the fact that such businesses generate consistent annuity cashflows (due to the reluctance of clients to change vendors) is a positive and needs to be adequately discounted. AGC is currently trading at 4.1x FY13 (QE) EPS of Rs. 47.0. We recommend buying at the CMP of Rs. 191.25 and adding on dips to the Rs. 165 to Rs. 176 (3.5-3.75x FY13 (QE) EPS) band for a target of Rs. 235 (5x FY13 (QE) EPS).

Consolidated Financials
Profit & Loss: Particulars (Rs. Cr) Net Sales Other Operating Income Other Income Total Income Operating Expense Operating Profit OPM (%) Interest Depreciation PBT Exceptional Items Tax PAT NPM (%) EPS P/E (annualised) Quick Estimates: Particulars (Rs. Cr) Net Sales Total Income EBITDA FY12 (QE) 932.1 937.1 94.5 FY13 (QE) 1118.5 1125.5 110.6
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FY10 (Sep) FY11 (Mar) 538.3 323.1 0.0 0.0 10.3 3.1 548.6 326.2 488.5 302.6 60.1 23.6 9.3% 6.3% 0.9 7.8 51.4 1.0 17.8 34.6 6.4% 24.4 7.8 0.6 3.8 19.2 0.0 6.0 13.2 4.1% 9.3 10.3

% Change 66.6% N/A 232.3% 68.2% 61.4% 154.7% 50.0% 105.3% 167.7% N/A 196.7% 162.1% 162.1% -

9MFY12 692.1 7.2 1.8 701.1 634.5 66.5 9.3% 5.2 8.5 52.8 -2.0 11.2 39.6 5.7% 27.9 5.1

9MFY11 394.7 1.8 4.6 401.2 362.9 38.3 8.5% 0.9 5.6 31.7 1.0 11.1 21.6 5.5% 15.2 9.4

% Change -43.0% -74.2% 153.4% -42.8% -42.8% -42.5% -82.1% -33.7% -39.9% -148.0% -1.0% -45.4% -45.4% -

(Source: Company Reports, HDFC Sec Research)

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PAT EPS P/E Balance Sheet: Particulars (Rs. Cr) Capital Reserves Total Loan Funds Deferred Tax Liability Total Fixed Assets Investments Inventory Sundry Debtors Cash Loans & Advances Total Liabilities & Provisions Net Current Assets Total

57.1 40.2 4.8

66.8 47.0 4.1

(Source: Company Reports, HDFC Sec Research)

Sep-10 (12) Mar-11 (6) Sep-11 (6) 14.2 14.2 14.2 238.8 248.5 289.0 253.0 262.7 303.2 0.0 -12.2 240.8 21.7 0.0 46.6 138.6 153.4 57.6 396.2 177.1 219.1 240.8 0.0 -13.8 248.9 22.1 80.5 42.0 206.2 21.8 80.5 350.5 204.2 146.3 248.9 24.3 -12.4 315.1 43.3 80.5 44.1 369.7 55.3 105.2 574.4 383.1 191.3 315.1

(Source: Company Reports, HDFC Sec Research)

Technical Outlook

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After touching an intermediate bottom of Rs. 102 during early Sept 2011, AGC Networks has been consistently rising and making higher bottoms and higher tops in the process. An intermediate uptrend was confirmed during the week ended 23rd March 2012 when the stock took out its previous intermediate highs of Rs. 168.7. Intermediate technical indicators are healthy. The stock trades above the 13-week simple moving average and the 14-week RSI is rising. The momentum reading is also not overbought, which is encouraging. The Intermediate ADX readings too are rising from lower levels and are currently around 22. This indicates that the current uptrend is strengthening and there is scope for further upsides in the intermediate term. We recommend a positional buy at current levels of Rs. 191.25 and average on any declines between Rs. 176 and the immediate lows of Rs. 166. Stop loss can be placed at the unfilled upgap of Rs. 159 made on Mar 22, 2012. Our intermediate upside targets are at the next resistances of Rs. 240 and Rs. 264.

Analyst: Kushal Sanghrajka (kushal.sanghrajka@hdfcsec.com) RETAIL RESEARCH Fax: (022) 30753435 Corporate Office: HDFC Securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station,
Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone: (022) 30753435 Website: www.hdfcsec.com Email: hdfcsecretailresearch@hdfcsec.com
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