The Hindu Business Line : Tata Elxsi: Buy

Investors can buy the stock of Tata Elxsi, given its robust business prospects and reasonable valuations. At Rs 208, the stock trades at 12.5 times its FY08 earnings and 10 times its likely current year earnings.

Strong presence in the product design and engineering segment, emerging opportunities in developing full-length animation films, which Tata Elxsi appears well placed to tap, and an expanding presence in lucrative markets may drive growth for the company.

Tata Elxsi broadly operates under two divisions — software development services (85 per cent of revenues) and a systems integration. The software development division comprises two high growth areas. Product design services catering to clients in consumer electronics, multimedia, wireless communication and automotive electronics. The visual computing division develops graphics and special effects and creates animation films.

Product design services

This segment has driven strong deal wins for Tata Elxsi from original equipment manufacturers (OEMs) of office automation and consumer electronics products. The company works with these OEMs to design embedded solutions for game consoles, digital cameras, home appliances and a whole host of other electronic products.

These are high growth segments in India as well as in the US, the UK and Japan, where the company has a footprint. With strong partnerships with principals, the company appears well placed to garner service revenues as well as annuity revenues for further software/hardware upgrades or updates. A similar model of working also exists with office automation products manufacturers.

Visual Computing labs

This segment has already tasted success, developing special effects for films such as Dhoom2 and Salaam Namaste. The success of animation films such as Hanuman has triggered a series of animation ventures in India.

Tata Elxsi has now designed and developed a 90-minute animation film for a Yashraj Films and Disney Studios venture, Roadside Romeo. The company has taken a fixed-price contract for this deal. If the film becomes a success, it could result in more such deal wins from the US, where animation is a $10 billion industry, according to KPMG estimates. The Indian animation industry is also expected to touch $1 billion by 2010. This represents tremendous opportunity for Tata Elxsi.

On the realisation front, the success of such films at the box-office could help in two ways. One, it could prompt the company to take up a revenue-share model, which provides an upside if an in-house produced film is a success. Alternatively, the billing levels could also be increased substantially in case a fixed-price contract is taken. The company hopes to see this segment contribute Rs 100 crore over the next three years.

Telecom segment

The company works with telecom network manufacturers and phone companies in the wireline, wireless as well as wireless-broadband space. Tata Elxsi develops applications and software components that are built into telecom infrastructure.

The company develops solutions value-added services such as MMS and Mobile TV to be integrated to mobile phones. Wimax is another focus area for the company and has deal wins in the US in this segment.

In the US, new 3G spectrum and licences were issued recently. The 3G policy is also on the anvil in India. Europe represents the largest VAS (value-added services) market in the world and, along with the US, is expected to expand Wimax services soon.

Operators around the world are seeking to offer VAS as a means to stem the tide in falling ARPUs and are expanding the scope of such offerings. Even media broadcasters are looking to package content tailored to mobile phones.

All these factors represent strong opportunities for Tata Elxsi, which it is well placed to tap, thanks to its existing working relationships in the design engineering space such as Tensilica, ARM, Altera and Xilinx.

Other Positives

The company has a reasonable geographic spread with the US, the UK and Japan contributing 30 per cent each to overall revenues. The rest comes from India. This reduces concentration risks. This apart, the appreciation of the dollar, pound and the yen against the rupee may also improve realisations.

Risks

Technology obsolescence and delay in project executions (which has happened in the past) leading to a gridlock for starting on further projects are key risks. Debtor days have increased to 90 days from 70 earlier, which may expand working capital requirements.

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