Kaufman Bros. Remains Bearish On Sify Following Earnings

Following is an excerpt from the note Sameet Sinha, Senior Equity Research Analyst, at Kaufman Bros., sent to clients following Sify's (SIFY) latest earnings:

FISCAL 1Q08 RESULTS IN LINE BUT CAPEX TO INCREASE IN 2008

• Results generally in line. Sify reported fiscal 1Q08 revenue of $34.6 million in line with our estimate of $34.5 million. Gross margins came in at 46.5%, slightly below our estimate of 47%; adjusted EBITDA was $2.9 million (8.5% margin) versus our expectation of $3.0 million. Adjusted EBITDA was in line as higher-than-expected SG&A was offset by a lower-than-anticipated incremental bad debt expense. Our estimate of $2.9 million in adjusted EBITDA nets out $780,000 in incremental bad debt expense (out of a total of $1.28 million) and forex losses of approximately $480,000. Management indicated that the provision for doubtful debts will likely abate and normalize after fiscal 2Q08.
• Corporate services drives growth. The Corporate services business exhibited strong growth, up 33% Y/Y and 12.3% Q/Q to $21.9 million (versus our estimate of $20.3 million). Management has seen efficiencies from the realignment of the sales force to sell multiple products and expects the benefits to gain momentum over the next few quarters.
• Access Media declined Q/Q. The Access Media business was flat Y/Y and declined 4% Q/Q to $10.18 million (versus our estimate of $10.95 million). SIFY announced a new model for its cyber cafes offering enhanced services, and being built in 250-, 300-, and 500-square-foot sizes. The new layout will offer ATMs, a coffee and snack counter, flat screen televisions, and displays for advertising. The capital expenditure for the new cafes will be incurred by the franchisee and will take place both for new and existing cafes. The ISP business declined sequentially, losing 7,000 subs to end the quarter with 208,000 subscribers as consumers disconnected going into summer vacation months.
• Interactive services suffered. This business was down 24% Y/Y and declined 37.5% Q/Q to $1.09 million (versus our estimate of $1.9 million). The slowdown was caused by the failure in its previous strategy to outsource ad sales to Big Bang Media. Management has pulled back and is rebuilding its internal sales team.
• Capex for the quarter was $6.7 million; spending to continue. The $6.7 million in investments was primarily used to cover network expansion, new office space, equipment, and the expansion of the data center in Mumbai. Management indicated that full year fiscal 2008 capex will be close to $36 million, compared to just over $14 million in fiscal 2007. According to management, it is seeing significant increases in demand from Enterprises and wants to build to capitalize on this demand. Additionally, SIFY plans to ramp its spending in sales and marketing with the hiring of 300 to 400 employees domestically and internationally.
• Changes to our estimates. We are lowering our 2008 revenues estimate to $145.5 million from $148.4 million. Our Adjusted EBITDA estimate declines to $12.4 million from $18.7 million.
• Our price target comes down to $7 from $8. This utilizes a 10-year forecast of the company’s estimated unlevered free cash flow discounted at the cost of equity of 13.4%.
• Bottom line. Looking at Chairman and CEO Raju Vegesna’s past experience, it makes sense SIFY is going after the Enterprise market with additional capex layout and hiring of sales people. While the company has the cash balance to support an expanded capex program, it increases the risk profile. The legacy bad debt has been flushed out, which is good news, and we can hope for continued growth in demand and management execution. Until we see traction, we will stay on the sidelines.

SIFY 1-yr chart:

Disclosure: author doesn't have a position in SIFY.