Tata Communications Neotel sale a high probability

Neotel BroadbandVodacom has entered into exclusive discussions to acquire a 100% stake in Tata Communications subsidiary, Neotel. Neotel is the second fixed-line operator in the South African market and caters to carrier and enterprise demand with a 7% market share in FY13. TCom owns a 67.3% stake in Neotel as at FY3/13. Vodacom, which is majority-owned by Vodafone Plc, is a mobile operator in South Africa and four other African countries.

Neotel has the assets that would interest Vodacom’s extant wireless business as well as aid its enterprise segment ambitions. Vodafone’s stated intent to grow its enterprise business globally; company’s cable and wireless undersea cable buyout was a step in this direction and we have seen a sharp increase in the company’s enterprise focus in India as well in recent times

The value of the deal has not been disclosed by the company. However, as per media reports, the equity value of the deal could be ~US$500m, which implies Rs70 per TCom share. In our SOP-based valuation for TCom, we ascribe a negative value of Rs15/share; hence, the deal could potentially increase TCom’s fair value by Rs85 per share.

We believe stake sale in Neotel could be a significant positive for TCom, as it would lead to substantial deleveraging. Neotel’s net debt as at 1QFY14 stood at US$519m, which is 25% of TCom’s consolidated net debt of US$2bn. In addition, if the enterprise value of Neotel is higher than US$520m, it will contribute to a further reduction in TCom’s debt.