Key points from Kaufman Bros. analyst Sameet Sinha's recent note to clients on Sify Ltd. (SIFY):
• Higher SG&A affects EBITDA. Sify reported fiscal 4Q07 revenue of $33 million versus our estimate of $32.2 million. Gross margins came in at 46.7%, above our estimate of 46.5%; adjusted EBITDA was $2.4 million (7% margin) versus our expectation of $4 million. The $2.4 million in EBITDA nets out about $1.8 million in incremental bad debt expense (out of a total of $2.39 million) and forex losses of about $400,000. Net of these extraordinary expenses, the variance versus our estimate was primarily due to an increase in SG&A caused by additional hiring and incremental marketing.
• Corporate services drives growth. The Corporate services business exhibited strong growth, up 20% Y/Y and 4% Q/Q to $19.5 million (versus our estimate of $19.3 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. The Access Media business declined 5% Y/Y and was flat Q/Q to $10.6 million (versus our estimate of $10.2 million). Most of the decline is at the cyber cafe business as the management team is focused on turning around the underperforming cafes and has slowed down the pace of new cafe openings. These cafes are being positioned as e-stores providing travel bookings, bill payments and money transfer services. The roll out of these services should be completed in the next 2-3 quarters. The ISP business continues to grow adding 7,000 new subs to end the quarter with 215,000 subscribers. Management indicated that they are already seeing a benefit to gross margins and EBITDA margins due to the restructuring.
• Growth at interactive services declined. This business grew 23% Y/Y and declined 11% Q/Q to $1.6 million (versus our estimate of $1.8 million). The slowdown was caused by the departure of some ad sales personnel and tough comps created by a large corporate order in FY3Q07. The company has announced that it will be outsourcing its ad sales to Big Bang Media, which should give it access to agencies who handle most of the marketing dollars.
• Changes to our estimates. We are increasing our 2008 revenues from $145 million to $148.4 million, primarily at the Corporate business, offset by reductions at the Access Media business. Our Adjusted EBITDA estimate declines from $20.5 million to $18.7 million to account for higher SG&A costs.
• Our price target remains $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%, down from 13.6% due to a lower risk free rate (10-year note) in our CAPM model.
Bottom line. As expected, the bad debt write offs continue at SIFY and smaller amounts should be expected for the next 2 quarters. While the turnaround seems to show some traction, it is still in its early stages. Maintain HOLD.