Sterlite Technologies Ltd (STLTECH) Q3 FY23 Earnings Concall Transcript

Sterlite Technologies Ltd (NSE: STLTECH) Q3 FY23 Earnings Concall dated Jan. 27, 2023

Corporate Participants:

Pankaj Dhawan — Investor Relations

Ankit Agarwal — Managing Director

Tushar Shroff — Group Chief Financial Officer

Analysts:

Mukul Garg — Motilal Oswal Financial Services — Analyst

Mohit Motwani — KPMG India — Analyst

Bhupendra Tiwari — ICICI Direct — Analyst

Krish Mehta — Enam Holdings — Analyst

Saket Kapoor, — Kapoor & Company — Analyst

Tejas Sheth — Nippon India Mutual Fund — Analyst

Sunny Gosar — MK Ventures — Analyst

Pritesh Chheda — Lucky Investment — Analyst

Subrata Sarkar — Mount Intra Finance — Analyst

Presentation:

Pankaj Dhawan — Investor Relations

Ladies and gentlemen, good day, and welcome to the STL Quarter Three FY’23 Earnings Conference Call. I am Pankaj Dhawan, Head, Investor Relations at STL. To take us through the Q3 results and to answer your questions, we have Ankit Agarwal, Managing Director, STL; and Tushar Shroff, Group CFO, STL.

Please note that all participant lines are in the listen-only mode as of now. There will be an opportunity for you to ask questions after the presentation concludes. Please note that this call is being recorded. You can also download a copy of the presentation from our website at www.stl.tech.

Before we proceed with this call, I would like to add that some elements of today’s presentation may be forward-looking in nature and must be viewed in relation to the risk pertaining to the business. The safe harbor clause indicated in the presentation also applies to this conference call.

For opening remarks, I now hand over the call to Ankit Agarwal. Over to you, Ankit.

Ankit Agarwal — Managing Director

Thanks, Pankaj. Good day to everyone. Thank you for joining us for our Q3 FY’23 and also wishing all of you a very Happy Republic Day. I look forward to our conversation and discussions and your questions as well at the end.

In line with our expectations, strong investment momentum is continuing in 5G, fiber-to-the-home, fiber-to-the-x, datacenter and citizen network deployments. 5G is becoming the fastest growing technology in the world today. Operators are expected to invest more than $500 billion in 5G from 2022 to 2025. As even recently Mr. Sunil Mittal, Chairman of Bharti Enterprises also indicated that the industry will also be spending this quantum of money.

As per Ericsson, 228 service providers have now launched 5G commercial services globally and the number of subscribers of 5G are expected to go up from 870 million to 5 billion by 2028. Leading the 5G deployments is China, which plans to increase its base stations from 2.2 million to 3.7 million by 2025. FTTX is also becoming all pervasive. In the U.S., for example, Frontier has reached halfway to reach its target of 10 million homes, home pass locations. Similarly Windstream is targeting 3 million homes by 2030. In the U.K., BT Openreach plans to reach 25 million fiber-to-the-home locations by 2026. Deutsche Telekom is building FTTB networks to pass 2.5 million to 3 million premises in 2023 and similarly Open Fiber in Italy is targeting to reach 24 million homes by 2031.

Datacenter deployments are also increasing. Datacenter capex is set to actually increase from $263 billion globally to $377 billion by 2026. Particularly in India, the datacenter investments are expected to surpass over $20 billion by 2025. As an example, NTT India has earmarked $2 billion for next three to five years for IT and communication infrastructure in India.

Lastly, on the Citizen Network side, we’re seeing significant investments by the governments globally. For example, the U.S. is investing $97 billion in broadband through multiple programs like RDOF, BEAD, Middle Mile programs etc. Similarly, U.K., Germany, France, Austria are countries where cumulatively about $8 billion, $14 billion, $24 billion, and $2 billion respectively under various programs are being utilized to build digital programs to connect the unconnected. The Indian government similarly is looking to move forward on the Phase III of BharatNet to connect all the villages and over $10 billion is expected to be invested.

As we listen to the leadership of the leading global telecom companies, they are unequivocal on the importance of fiber investments in the overall network buildout. In this regard as an example AT&T has recently signed definitive agreement to form a joint venture with BlackRock that will operate commercial fiber platform. The JV plans to deploy a multigig fiber network to 1.5 million customer locations across the nation. It’s important to note that these customer locations will be outside of AT&T’s traditional 21 states service footprint and in addition to the 25 million, 30 million home passes that already AT&T has targeted by 2025.

All of these deployments is leading to a sustainable growth of OFC volumes and Optical Interconnect. As per CRU, the leading research house in this space, the global OFC demand is expected to reach 624 million fiber kilometers by 2025 from 534 million fiber kilometers in 2022 last year.

The Optical Interconnect demand in the global market, ex-China is also expected to grow from $7.5 billion in 2021 to close to $10 billion by 2025, and STL has a strong presence in its key focus markets, which are North America, Europe and in India.

Coming specifically to India, 5G deployments are clearly picking up pace. The top two telecom operators are rolling approximately 3,500 sites per week cumulatively. Bharti Airtel, for example, launched 5G services in more than 30 cities and Jio has launched 5G services in more than 130 cities. Both the operators have aggressive plans to cover India broadly between now and March 2024. Telecom operators are expected to invest between $18 billion to $22 billion and non-spectrum capex between now and 2025. And out of this, we expect operators to spend between $1.5 billion to $2 billion for fiber rollout specifically in the next two to three years and preparation of the 5G.

As we shared before, we broadly believe the tower connectivity has to grow from about 30% to close to 70% and this is where significant fiber will also be required. In terms of cable kilometers, we expect telcos to deploy more than 2 lakh cable kilometers in the next 18 to 24 months.

With favorable industry tailwinds, we have deployed a focused strategy to propel us forward. In the following section, we will talk about our strategy in detail. Essentially, our strategy is straightforward and includes two levers. Firstly, we focus on growing the optical business. Secondly, we look to consolidate our services business. We are allocating capital to tap into strategic growth opportunities offered by these levers and we shall talk about our progress and each of these in detail in the subsequent slides.

If you look at the optical business, particularly optical fiber cable business, as you can see from the chart, we are consistently gaining market share. In nine months FY’23, we had reached an estimated 12% market share globally. If we subtract the China share, which is up from just 5% in FY’20. We’re also very pleased to announce that we have received additional orders in the multiyear multimillion dollar contract with a leading North American broadband connectivity company. Our intent is to increase the long-term contracts and order books and we’re moving forward in that direction.

In line with expectation, commercial production has started in our optical fiber facility in China in Q3 FY’23. In the U.S., commercial production shall start in the current quarter, Q4 FY’23. We are working hard to reach to full utilization by first half of FY’24.

We have increased our Optical Interconnect attach rate from 3% in FY’21 to 10% in the nine months of FY’23. The first step we have taken to grow this business is to offer Optical Interconnect Solutions to our existing accounts, particularly in the European market. As a next step, we are also going through a product approval cycle in new markets such as the Middle East and APAC. We expect to continue to increase our rate of attach — rate of optical interconnect products and plan to reach the attach rate to 40% by Q4 of FY’25.

Coming to the Services business. We are focused on building a profitable order book by picking up order — by picking up projects in our India Private segment. If you look at the Services revenue split, revenue from India Private has gone up from 31% in FY’22 to 42% in nine months FY’23. We’re looking to build sustainable revenue streams, including O&M as well. Moving forward in the Services business, our focus is on cash and profitability rather than chasing revenue growth.

As you can see, our product execution is on track. Among India Public projects, our BharatNet projects in the state of Telangana is 61% complete, including all packages and the network modernization project for Indian PSU is 63% complete. For the Indian Private sector — private side fiber rollout for a large Indian telco operator is 100% completed for Phase 1 and 99% completed for Phase II, Phase III is yet to start. Fiber rollout for a modern optical network for a yet another private operator is 29% complete and specifically in the U.K., fiber-to-the-home rollout for all our U.K. projects combined is 6% complete.

As you would recall, we had entered the network software business in FY’16 through acquisition of Elitecore. We continue to remain a niche player in this business. Moving forward, we are working to pivot from this telecom software business to digital business. The strategy is still in works and we shall come back to you in Q4 with some more detail plans. In line with what we shared last quarter, we have ramped down the Wireless business with no further investments in capital and manpower from Q4 of FY’23. In the last quarter, we enabled specialized engineering talent of the Wireless business to move on to other relevant organizations. We expect STL EBITDA to go up on account of ramp down of the Wireless business from Q4 FY’23 onwards.

In terms of capital allocation, our clear priority is investments in the optical business. We are investing in the optical fiber cable capacity expansion, Optical Interconnect expansion and new product development. We have improved margins and working capital cycle in the Optical Business. We are working to improve margins and working capital cycle also in the Services business. We have ramped down the Wireless business as I mentioned, and we shall help in improving the cash flow from operations.

We should also continue to divest sub-scale assets. We have divested IDS in the current year. As you would recall, in FY’22, we sold our interest in Metis Eduventures and MTCIL. Through all of these actions as we start to generate higher cash from operations, our priority will be to reduce net debt and bring to along with adequate investments in the optical business.

STL’s endeavor is to be a responsible leader in ensuring a connected and inclusive world. This focus reflects in the way we have designed and implemented our ESG agenda. We have diverted over two lakh plus metric tons waste away from landfills from FY’19 to November ’22. We have reduced emissions of 21,000 tons of carbon dioxide emissions through various initiatives in the plants from FY’21 to Q3 FY’23. We have also announced the commitment to become a carbon-neutral company by 2030 and we have recycled six lakh metric cube of water from FY’19 to November ’22.

We’re also very happy to announce that we have become the world’s first optic fiber manufacturer to be zero liquid discharge certified. Through our various initiatives in education and women empowerment, more than 790,000 lives have been positively impacted from FY’19 to Q3 FY’23. We have also positively impacted 2.15 million lives through our various initiatives in healthcare from FY’19 to Q3 FY’23. In our work, we have won 84 ESG awards. I’m very proud of the team for their achievements from FY’20 to Q3 FY’23.

At this juncture, I’m delighted to introduce Tushar, who has joined us as Group CFO. Just to give you some brief on Tushar. He is a qualified chartered accountant and a cost accountant with an experience of close to three decades in the fund-raising capital structure, mergers and acquisition, strategy management, taxation, financial accounting and planning, investor relations and business partnering. So all the facets of finance function. As a CFO of STL, he will work closely with me and the leadership team to bolster the company strategy to deliver consistent shareholder value and profitable growth.

I’ll now hand over to Tushar to discuss the company’s financials with you.

Tushar Shroff — Group Chief Financial Officer

Thanks, Ankit, for your kind introduction. Good day, ladies and gentlemen. Our financial continue to improve. We shall now discuss this in detail. Before discussing on this financials, I would like to state that in accordance with Indian Accounting Standard, Ind AS 105, non-current asset held for sale and discontinued operation, which is related to IDS, wireless business, and telecom software business are reported as discontinued operations, and accordingly for like-to-like comparatives respective period financials are restated. For further details, you can also refer note four to the financial result.

Our open order book, that is order backlog at the end of Q3 FY’23 has gone up to INR12,054 crores. This is a reflection of strong demand in the industry and our dominant position and focus particularly on Optical Fiber business. Our order book is well diversified across customer segments also across our business areas. We also have a significant O&M order book, which is already yielding revenue from this year.

Our revenue mix is shifting to customer segment and geographies of our choice. We are increasing our share in Telco segments. In terms of geographies, we are increasing our shares in America and European markets. In line with our strategy, as compared to last year, we have increased the revenue share in American market from 11% to 37%. Again, this is a reflection of our product innovation and reward of investment in R&D over the years.

In terms of notable order wins in this quarter, apart from the additional order in the multimillion dollar contracts for cables in North America, we have secured a multimillion dollar order for optical fiber cable and Optical Interconnect solutions from European customers. On the service side, we have secured new orders for Pan India fiber rollout from leading Indian Telcos.

In line with our expectation, quarterly revenue grew 12% quarter-on-quarter to INR1,882 crores. EBITDA from continued operation went up by 8% on quarter-on-quarter basis to INR252 crores. Net profit grew by 17% on quarter-on-quarter basis to INR77 crores for Q3 FY’23. Revenue growth was driven strongly, strong growth in Optical business, margin improvement mostly on the back of improvement in margins in optical business.

For nine months FY’23, revenue grew by 28% on year-on-year basis to INR5,050 crores and EBITDA from continued operations went up by 17% on year-on-year basis to INR651 crores. Net profit from continued operation is at INR162 crores for nine months period FY’23.

In order to increase the transparency, we have started reporting segmental financials from last quarter. Starting with Optical business, we delivered revenue from continued operations of INR1,486 crores, which is 13% higher on quarter-on-quarter basis. This is due to increase in our volume and better price realization and the favorable prospects. We delivered EBITDA from the continued operations of INR302 crores, which is 15% higher on quarter-on-quarter basis. Key drivers for margin improvements were a product mix shift to higher margin products and reduction in logistics cost, while increased raw material, particularly helium, has dragged the margin relatively.

In Global Services business, we had delivered revenue from continued operations of INR380 crores, which is 8% lower on a quarter-on-quarter basis. As we have said initially that we are focused on a cash and a profitability over a revenue growth, we are being selective in new projects intake. Despite lower revenue, EBITDA is relatively flat due to better project management and focused execution. As we said earlier that we are working to ramp up U.K. revenue to be profitable by H1 FY’24.

Coming to Digital Technology Solution, revenue from continued operations grew 380% to INR24 crores in Q3 FY’23. As we have spoken earlier that we are building a new business in this segment and we shall come back to you in Q4 to explain the business in detail. We have placed a bridged version of quarterly reported numbers for your perusal.

In summary, I would like to say that our profitable growth journey in optical business continues. We continue to gain the market share across the focused markets, increase the Optical Interconnect attach rate and improve the margins. We are consolidating towards the strategic segments and service business. We are working to build profitable order book from Indian private telcos and aim to reduce the capital deployed in this segment.

In line with the status strategy, we have discontinued the wireless business and exited from IDS and other sub-scale businesses. We aim to reduce our debt as we move forward. The debt has peaked and, going forward, it shall be progressively — we see the progressive reduction in our debt over a period of time.

Now if there are any specific questions, we would be happy to take your questions.

Questions and Answers:

Pankaj Dhawan — Investor Relations

Yes. Thanks, Tushar. [Operator Instructions] So we’ll take the first question from the line of Mukul Garg. Mukul, you can ask your question.

Mukul Garg — Motilal Oswal Financial Services — Analyst

Yes, thank you. I hope I’m audible. Hi, Ankit. Two questions from my side. First on the Americas business, the pace of growth in that market is extremely sharp, and I think it has become your largest region this quarter. How should we think about Americas going forward? Will it be more of a case that Americas will take the sales away from your other segments or how are you kind of looking at tradeoffs between different regions? And second, on the profitability side, your margins at least the optical margins are flattish compared to last quarter whereas the raw material prices including helium have corrected very meaningful. So how should we think about given that the volumes also were higher this quarter and operating leverage benefit should also started flowing off?

Ankit Agarwal — Managing Director

Yes, thanks. So I think one broadly on the U.S. market, I think we’re generally quite bullish on the market demand. We continue to see pretty strong investment both by large operators, players as well as a very large investments from the government. As I called out, just one project, which is the $40 billion program of BEAD is expected to come in by mid of this calendar year as an example. So we fundamentally see fairly strong demand over the next three to five years. I think our own position in that market has been strengthened in terms of our team, product, portfolio and now with the facility coming up our overall brand and positioning in the market has improved quite positively. We are under stage of commissioning the factory, setting up our processes, systems and getting certain technical approvals, which will enable us to serve that market better. I think macro level, the way to think about it is that, yes, it will continue to be either our number one or number two market going forward. We also see that this is a future growth area for our Interconnect Solutions as well over the next two to three years. And I think the way we are looking at it is that we would serve that market both from the operations that we would have locally as well as from our operations in India. So that’s how we look to serve the market.

In terms of the profitability of the optical business, I think, we have guided that we will be north of 20% and that’s something that we continue to be committed towards. We will see broadly over the next between now and H1 of next year improvements coming in into the numbers because of the volume. We are talking about going from 33 million to 42 million. So that will come in. The China fiber factory has restarted and as we scale that up, those benefits of volume will come in.

We largely believe the realizations have peaked, largely will peak between now and Q4. So the upsides will now come from the volume on the cable part as well as growth of our Optical Interconnect. We’ve talked about going from 10% attach rate to 40% attach rate by Q4 FY’25. So that’s really priority and focus for us.

Just one comment, one different view, Mukul, on the raw materials. So while I think we’ve seen some kind of now flat lining or benefit of polyethylene and container, the helium prices are still very high, I would say exceptionally high. Both availability and pricing has been a challenge and at least our current visibility is that it will continue for probably next six months.

Mukul Garg — Motilal Oswal Financial Services — Analyst

Sure. And then just one follow-up on the U.S. market. Will that business kind of operate at a different profitability levels versus India and Europe or net-net higher prices will be compensated by higher operating cost due to transportation and other expenses?

Ankit Agarwal — Managing Director

Yes. So I don’t want to comment on the realization in that market for competitive reasons, but I think broadly, as I said, it’s a very important market for us, it’s a fast-growing market. We have invested a lot in R&D, innovation and intellectual property to serve that market and we’ll continue to do that. And so for us it’s definitely an important market. And going forward, we will address that market, both through our operations there as well as a good portion of sale will come from our Indian operations into that market.

Mukul Garg — Motilal Oswal Financial Services — Analyst

Sure. Thank you so much for answering my questions. I’ll get back into the queue.

Ankit Agarwal — Managing Director

Thank you.

Pankaj Dhawan — Investor Relations

Thanks, Mukul. We’ll take the next question from the line of Mr. Mohit Motwani. Mohit, you can ask your question now.

Mohit Motwani — KPMG India — Analyst

Hi. Thanks for the opportunity. I wanted to understand the jump in the other expenses quarter-on-quarter. I think this is a reflection of the fact that you stated container costs continue to remain high. Is this completely driven by that or there is something else also to it?

Tushar Shroff — Group Chief Financial Officer

Yes. So I’ll respond to this particular question. If you see Q3 FY ’22, other expenses were about 32.55% of the overall revenue. Q2, I think it went down to 23.8%. And currently, this quarter, we are at 24.9%, which is in line with the increase in the revenue that we have seen for this particular quarter, largely on account of the variable cost in terms of a transport cost, transportation and logistic costs that we have. And the second part is there are a couple of expenses like one-time expenses on professional and legal services that we have taken as well as the plant operation in U.S., which is related to operating expenses, which is a time cost, which is impacting other expenses for this particular quarter. But however, our guidance is — in terms of this operating expenses or other expenses should be in the range of 23% to 25% going forward.

Mohit Motwani — KPMG India — Analyst

And thank you for that and one other question would be around the Wireless business ramp down. So are the effect — is the effect — benefit of that completely done in Q3 or there we could expect some incremental benefit in Q4 as well?

Ankit Agarwal — Managing Director

No. So in fact, we had the costs for that business in Q3, so the benefit will actually come in Q4. There’s two parts to it. Largely, the people cost that we had — we really put a lot of effort to ensure that they were placed with partner companies, and we’re so very happy with that outcome. And so we don’t expect those costs to be there in Q4 onwards, so that benefit will start coming in Q4. There are certain assets that are there with STL in terms of R&D equipment, etc. Those, we will run probably a sale process or something to ensure that we maximize the value from that.

Mohit Motwani — KPMG India — Analyst

Understood. So actually, I just meant that above EBITDA, there’s no wireless business cost. Everything is flowing through profit from discontinuing operations, right?

Ankit Agarwal — Managing Director

That’s correct. That’s correct.

Mohit Motwani — KPMG India — Analyst

Got it. Thank you so much.

Pankaj Dhawan — Investor Relations

Thanks, Mohit. We’ll take the next question from the line of Mr. Bhupendra Tiwary. Bhupendra, you can ask your question now.

Bhupendra Tiwari — ICICI Direct — Analyst

Yes. Hi, Ankit. Congratulations on good set of numbers. I hope I’m audible.

Ankit Agarwal — Managing Director

Yes, yes.

Bhupendra Tiwari — ICICI Direct — Analyst

Yes. So my question is more on the — we thought about raising fund of right issue in all this out, but I just wanted to understand the focus behind this issue. I mean is it a growth driven kind of a fund raise for — or in terms of the capacities that maybe we would like to add in the product thing or is it basically for deleveraging? So just wanted your thoughts around that first.

Ankit Agarwal — Managing Director

Yes. So I think Bhupendra, it’s really in line with our conversations we’ve had and we’ve been sharing the market fundamentally. On the one hand, we’re clearly positive about the growth of the business. But I think more important for us to really make sure our capital structure is in the right place. So that’s really the core of the fundraise through the rights issue. The total capital amount will be up to INR500 crores and further details will be decided with the committee. So I think that’s — the intent is really to use the capital to get the capital structure in a better place and really in line with our previous discussion on capital allocation and make sure that the balance sheet improves essentially.

Bhupendra Tiwari — ICICI Direct — Analyst

Thank you. That was very, very useful. And the second question was largely on the services thing. And I think you alluded to that saying that you’re focusing more on the private side of the services and that was seen also in the nine months revenues that we have. So when we say private side of the business and the opportunity that we talked about was 2 lakh fiber kilometers of fiber that will come around in India because of the 5G, how much is your sense or rather what has been your historical kind of a market share of fiber layout in India? And how — just wondered you to throw some light there.

Ankit Agarwal — Managing Director

Yes. So maybe some context here. Historically, the fiber rollout was done by a lot of local companies was a very local way of running the business. And our whole premise for SGL was that, A, we can consolidate and be a large Tier 1 professional company in this space. We can bring in innovation and technology. We can use apps, tools and other means to improve both the service quality as well as operational maintenance. So that’s been the efforts we worked with the two large operators in the country. I won’t be able to share market share, but I can share that certainly with both operators, we’re probably one of the largest partners in the country. And there’s a real interest to — from both sides to see how we can further support them both for their 5G as well as for their fiber-to-the-home rollout. But as I said, what’s important for us at the same time is not to grow the revenue for sake of it. We are really focusing on getting any of these opportunities, whether government or private, at the right margins and in the right fund involvement structure. So that’s really the focus for this business.

Bhupendra Tiwari — ICICI Direct — Analyst

Thank you, Ankit. Thanks a lot.

Ankit Agarwal — Managing Director

Thank you.

Pankaj Dhawan — Investor Relations

Yes. Thanks, Bhupendra. We’ll take the next question from the line of Mr. Krish Mehta. Krish, you ask your question now.

Krish Mehta — Enam Holdings — Analyst

Yes, hi. Thanks for taking my question. I just wanted to ask on what the loss for this quarter was for OSS and BSS as well as for Q2 FY’23?

Tushar Shroff — Group Chief Financial Officer

The loss for the OSS and BSS. Please give us a minute.

Krish Mehta — Enam Holdings — Analyst

Sure.

Tushar Shroff — Group Chief Financial Officer

So nine months period, it was about INR53 crores.

Krish Mehta — Enam Holdings — Analyst

And what was it for this quarter specifically and last quarter?

Tushar Shroff — Group Chief Financial Officer

So I’m talking about the EBITDA impact of OSS and BSS business to the extent of INR53 crores. This quarter was about INR15 crores. The previous quarter was about INR26 crores.

Krish Mehta — Enam Holdings — Analyst

Okay. Thank you so much.

Pankaj Dhawan — Investor Relations

Thanks, Krish. We’ll take the next question from the line of Mr. Madan. Madan, you can ask your question now. Okay. So we’ll take the next question from the line of Mr. Saket Kapoor. Saket, you can ask your question now.

Saket Kapoor, — Kapoor & Company — Analyst

Namaskar, sir

Ankit Agarwal — Managing Director

Namaskar.

Saket Kapoor, — Kapoor & Company — Analyst

Firstly, as you mentioned that the Chinese entity would be now contributing since now the utilization levels have gone up. So if you could give us the trajectory, what kind of contribution will be there from the Chinese for the remaining half and for the full year as a whole going ahead?

Ankit Agarwal — Managing Director

Actually, Saket, we are not disclosing volumes by facility for competitive reasons. What I can share is that, as you would have seen in the pictures and some of the data, we do have the team there. The operations have started. It’s actually a world-class asset. So we do believe the fiber manufactured from there will both be competitive as well as able to serve our global requirements. At a macro level, what’s important to understand is that a large portion of our fiber will now be utilized for our own cable operations, especially as we are expanding from 33 million to 42 million. So similarly a good portion of the fiber made from our China factory will be utilized for our global cable operations. By and large we believe that quarter-on-quarter, we will see volumes scale up. And we do believe that these will be made competitively. And whatever investment we require — we’ve made to acquire the balance, 25%, that will be a positive investment. As well as one of the areas that’s also positive is now targeting to — because it’s a R&D facility, we will be targeting to run this at 15% tax rate, which will also be beneficial for the company.

Saket Kapoor, — Kapoor & Company — Analyst

So sir, how much more we need to spend to ramp up the production there? And I was just trying to understand that last year, I think, so there was negative impact of around INR80 crores, INR90 crores from the Chinese subsidiary. So going ahead, what would be the run rate? How will that go down? And how will, yes, that’s the understanding. And what was the price we paid for the balance acquisition, sir? How much have we spent?

Ankit Agarwal — Managing Director

I think a ballpark in the range of INR50 crores, INR60 crores. You can come back with the specific number. I think the main message was that essentially, while during COVID, we were negotiating with our JV partner on the terms, and the operations weren’t running at that time. Since then, we have acquired the 25% successfully. The transaction is closed. We’ve also successfully got the business license to operate and so we are quite well set up now. Quarter-on-quarter, we’ll see the improvement in the production. And we can probably update you more into next quarter on how that’s scaling up.

Saket Kapoor, — Kapoor & Company — Analyst

Sir, when you mentioned it as an R&D, it is an operating asset. I did not —

Ankit Agarwal — Managing Director

Yes. Yes, sorry. What I meant was that it’s from the government perspective, if you are doing technology manufacturing, you are given a special tax rate of 15%. I didn’t mean R&D in that sense.

Saket Kapoor, — Kapoor & Company — Analyst

Right, sir. So more update will get in the fourth quarter. Sir, in terms of the net debt level, and I think so the road map ahead for reduction, rights issue has been, as you earlier commented. So what’s the road ahead in terms of how the net debt is going to look like, whether we have peaked out and just more thoughts on the same sir?

Tushar Shroff — Group Chief Financial Officer

So the right issue proceeds that we are expecting, maybe in the FY’24 because of the documentations and everything that procedural part that we’ll have to complete, so the right issue proceeds will come in next year. However, for this particular year-end, what we are targeting is that we will be at a net debt of about INR3,200 crores based on the earlier guidance Ankit had given. So all our efforts are moving towards INR3,200 crores at year-end debt levels.

Saket Kapoor, — Kapoor & Company — Analyst

INR3,200 will be the closing for March ’22?

Tushar Shroff — Group Chief Financial Officer

That’s the target, yes.

Saket Kapoor, — Kapoor & Company — Analyst

Okay. I’ll come in the queue, sir. That would be my questions. Thank you, sir.

Pankaj Dhawan — Investor Relations

Thank you so much. Thank you. We’ll take the next question from Mr. Tejas Sheth. Tejas, you can ask your question now.

Tejas Sheth — Nippon India Mutual Fund — Analyst

Yes. Hi, Ankit.

Ankit Agarwal — Managing Director

Yes. Hi, Tejas.

Tejas Sheth — Nippon India Mutual Fund — Analyst

On the Optotec side, when you said the attach rate of 10%, is it on the cable and fiber combined revenue it is only on the cable side?

Ankit Agarwal — Managing Director

Yes, this is the attach rate of interconnects. So that’s what I was sharing last time also for $1 of cable sold. Today, we sell $0.10 of interconnect at a company level. And just to be clear, it is a combination of the Optotec that we have, we have a setup in Dadra as well and so it’s a combination of everything in the interconnect business that we have.

Tejas Sheth — Nippon India Mutual Fund — Analyst

Got it. Got it. On the — is there any element of INR depreciation towards the increase in the order book level?

Tushar Shroff — Group Chief Financial Officer

So FX impact, if you see this quarter, like-to-like basis is about 2% to 3% in a dollar terms, right? However, the very specific number in terms of what were the adjustment due to the FX rate, which is somewhere from quarter Q2 to Q3, which I’ll provide you separately. Ankit will provide you separately.

Ankit Agarwal — Managing Director

I don’t see it being meaningful. I mean these are — that’s where we’ve been sharing some of the details. These are some of the contracts in the U.S., there’s some contracts in India, etc. So it’s a mix from a geography perspective.

Tejas Sheth — Nippon India Mutual Fund — Analyst

Okay. Because when I see your optical order book, in a way, obviously, it has been executed well on the quarterly basis. But at the quarter end basis, it’s more or less quite flat over last four, five quarters.

Ankit Agarwal — Managing Director

Yes. So that’s said, I mean directionally, we’ve been in this range overall of open order book in this range of, say, 11,000 to 11,500 or so. And I think what’s also important is that to measure that versus our revenue run rate, right? So we’ve been at say 1500, 1600 and now it’s going up. At the same time, we are booking over INR2,700 crores per quarter. So that’s an important measure for us in terms of what is our order booking vis-a-vis our quarterly revenue, which will then help us and place us well for next year growth onwards.

Tejas Sheth — Nippon India Mutual Fund — Analyst

Got it. Got it. Just last question. On the digital side where we are burning capital, how you see that trajectory changing as well as on the global services side, where the margins are very, very low — much lower single-digit. How you see the margin trajectory there also, not from a quarter basis, but more so from, let’s say, FY’24 or FY’25 basis?

Ankit Agarwal — Managing Director

Yes, I think, good question. So maybe on the — so the U.K. services is on the back of the acquisition we are done for comp. And so I think the intent that clearly when we look at the model, we need to scale up that business and execute on a quarter-on-quarter basis. We believe that probably by end of H1 of next year we should at least get to a breakeven level versus the losses right now and then we see how to improve the EBITDA probably to that 10% range. So that’s really the focus for the services business and the U.K. team out there.

On the digital business, one part of it, we have called out that these are assets held for sale. And then we have Raman, who’s come in, and he’s really relooking at our business, our portfolio and seeing how do we scale it up and write profitable segments. So there, I would say, give us about three to six months, he will come back with more details of how we want to drive the business. But it looks exciting. We’re definitely seeing positive trends in that.

Tejas Sheth — Nippon India Mutual Fund — Analyst

Okay. Just one last bookkeeping question. Are we capitalizing any of the finance cost considering that the interest cost is quite steady despite our debt increasing as well as the interest rate increasing at the global level as well as in India?

Tushar Shroff — Group Chief Financial Officer

Yes. So for our U.S. plant, which is under construction and which is under WIP, which is whatever the borrowing cost that — borrowing that we have to the extent of the capital employed for that particular plant, we are capitalizing it, which is required as per the accounting standard.

Tejas Sheth — Nippon India Mutual Fund — Analyst

Sure. Sure. Yes, it is, yes. Thank you very much for answering.

Pankaj Dhawan — Investor Relations

Thanks, Tejas. We’ll take the next question from the line of Sunny Gosar. Sunny, you can ask your query now.

Sunny Gosar — MK Ventures — Analyst

Yes. Thanks for taking my question and congratulations on an improvement in your financial performance. My first question is, if you can highlight what is the net debt levels of the company currently? And in terms of the guidance, what’s the net debt that either net debt-to-EBITDA or some ratio or some guidance you can give of net debt in the next 18 to 24 months?

Tushar Shroff — Group Chief Financial Officer

So currently, we are at about INR2,400 crores in terms of net debt at the close of the Q3. We are expected that we should be able to close this particular financial year with INR3,200 crores. So this — so we will be able to generate lot of cash. As we discussed in Ankit’s presentation that the way we are looking at the services business, we want to run this particular business in a disciplinary manner. And that’s why we are looking at targeting debt-to-EBITDA level of 2.5 to EBITDA. So that’s the journey that we’ll be embarking on over a period of next six to 12 months.

Sunny Gosar — MK Ventures — Analyst

Got it. Got it. And in terms of the capex, so any guidance on capex for next two years? So this year, I believe, it’s INR500 crores overall — with the capex per annum for next year.

Ankit Agarwal — Managing Director

Broadly, we are looking at around INR350 crores for next year. We’re still kind of in the finalization of our business plan. But it will be largely focused on the cable and, to some extent, the interconnect.

Sunny Gosar — MK Ventures — Analyst

Sure. My next question is on the system integration business. So we are doing about like about 1% margin on the system integration business currently. So how should we look at the business going forward? So you mentioned about the focus on the private side and not — and focusing on orders which are profitable and have a working capital, which is under control. So whether the current revenue base on a quarterly basis is the base or it can go down further? And how should we look at margins for this business at least for the next few quarters and then maybe in the medium term?

Ankit Agarwal — Managing Director

Yes, good question, Sunny. So I think at a macro level, one is just at a fundamental level, we believe one of the drags on the profitability is the U.K. business, what we just spoke about. So I think that’s quite critical for us to turn that around, get it to at least breakeven and then grow that. And that — so that’s something we’re looking to execute. The orders are there. The market is positive. I think it’s for us to execute and build that right model to get it to breakeven and profitable. So I would say that’s one directionally that we are looking to do.

In India, as I said, directionally, we are not chasing revenues per se. We are focused on whatever orders we pick up going forward, both from private and government to both look at very closely the right profitability margins as well as the right fund involvement. And then I think the third part clearly is on projects, where we’re either executing or have executed like Maharashtra, Telangana and other projects is to make sure that we complete execution, complete the milestones and then collect the cash. So that’s really the priority of the system integration business. We do expect the profitability to improve, but it will take time to get the new projects on one side in India with the right margins. And second is this six, nine month period will take to get these U.K. services into the right profitability level.

Sunny Gosar — MK Ventures — Analyst

So if I can conclude, is the current quarter profitability in that sense, the way and things improve from here on or there could be a couple of quarters where you have remained at breakeven or even have some kind of losses, small losses in this segment?

Ankit Agarwal — Managing Director

Yes. So again, it’s going to be — touch and go is really a function of how do we make the shift happen, as I said, in both the U.K. and in India. So I wouldn’t comment. I think directionally, as I said, we are — as you can already see, quarter-on-quarter, probably some of the revenues have started coming down for services. So we’re really not even setting very specific targets on revenue going forward. It’s just whatever we have on our plate, execute in the best way possible. And anything new we pick up, we do it at better margins. So I think it will just take some time, but it will probably — it will take us that period of six to nine months to improve the business performance.

Sunny Gosar — MK Ventures — Analyst

Sure. And if I may, I have one last question. So on the new digital business that you’re focusing on, so say in this quarter, you had EBITDA losses of, say, about INR30 crores, INR35 crores. So going forward till the business stabilizes and breaks even, is this the peak level of loss on a quarterly basis or there could be, again, a period where on a — for a few quarters these losses go up?

Ankit Agarwal — Managing Director

So I think directionally, at least, as I said, we’ll give more details of the business, what we’re looking to do, customers, etc., probably in a quarter’s time. But directionally, we are excited about the business. We have a global leader, Raman Venkatraman, who’s coming from TCS, who leads this business. So I think we are really working with him to see how do we scale this business up, how do we do it profitably, etc., and with the right customers. So I would just leave it at that to say that give us another quarter to share more details. Broadly, we are investing in this, but we are also conscious of making sure that at the right point of time, this business also start generating profit and cash for the company.

Sunny Gosar — MK Ventures — Analyst

Got it. Got it. Thanks and all the best for the future.

Ankit Agarwal — Managing Director

Thank you. Thank you, Sunny.

Pankaj Dhawan — Investor Relations

Thanks, Sunny. Due to the paucity of time, we’ll take maybe last few questions. So the next question we’ll take from the line of Mr. Pritesh Chheda. Pritesh, you can ask your question now.

Pritesh Chheda — Lucky Investment — Analyst

Hello? Am I audible?

Pankaj Dhawan — Investor Relations

Yes.

Pritesh Chheda — Lucky Investment — Analyst

Yes, sorry. Just a few questions. When you say that from here, it is largely volume. So I want to know what is the headroom in volumes that you have from the current levels, is it 20%, 30%, if you could share that. My second question is, we have a interconnect rate today of 10%, right, that we aspire to reach to about 50% in some years times.

Ankit Agarwal — Managing Director

40%, 40%.

Pritesh Chheda — Lucky Investment — Analyst

40%. What is the value addition on account of the interconnect rate on your overall business run rate that you have today, when you reach that 40%? And what are the margins in that incremental business? These are my two broader questions.

Ankit Agarwal — Managing Director

What was the first question?

Pritesh Chheda — Lucky Investment — Analyst

First question was what is the headroom?

Ankit Agarwal — Managing Director

So I think broadly, what we shared is that the cable capacity is what will come on stream, right? So broadly from 33 million to 42 million, about a 9 million addition of volume will come through broadly in the next six to nine months. So I think that’s the major volume trigger. As a subpart —

Pritesh Chheda — Lucky Investment — Analyst

What is it in the percentage terms of the current, that 9 million, that’s 30% extra?

Ankit Agarwal — Managing Director

Yes, broadly over 9 million over 33 million, so about 30% odd. So that’s on the cable essentially. On the interconnect, basically, what we see, so just to give you a perspective, globally, the cable market is about $8 billion, $9 billion. And the interconnect is similar, $8 billion, $9 billion, right? So the global benchmark for us when we see at a macro level is 1:1, which means 100% attach rate. So that’s where we are already in conversations with customers. But there’s a typical longer time cycle to build the products, get intellectual property approved, get the customer approval and also to supply. So this is where there is some period of time, probably even more than what it takes for cable supply to really scale this up. But once you’re in there, typically, customers really like to depend on you for long-term directionally because this is much more solution-oriented than even cable. The typical EBITDA margins on interconnect are 30% compared to cable being at 20%. So that’s really what we are driving in terms of growth. And also, this is typically less capex investment or capex intensive than what’s required for cable. So that’s really where our focus is. We do have global teams. We do have global customer connects. So the focus is now to build the product portfolio and get this moving over the next two years.

Pritesh Chheda — Lucky Investment — Analyst

And how much business do you add from moving 10% to 40% on your current quarterly revenues that we see?

Ankit Agarwal — Managing Director

So at least directionally — I won’t be able to share exact number. But directionally at least INR1,000 crores to INR1,500 crores can be an addition over the next two to three years.

Pritesh Chheda — Lucky Investment — Analyst

Okay. Thank you.

Pankaj Dhawan — Investor Relations

Yes, thanks, Pritesh. So we’ll take one more question from the line of Mr. Subrata Sarkar. Subrata, you can ask your query now.

Subrata Sarkar — Mount Intra Finance — Analyst

Yes. First on the India side of the business. Like, apparently, it’s appearing like we are more on the external market than India. So can I try to understand the reason behind that? Is Indian market is too competitive? Like what is the business? Is it because of margin? Is it because of like operational difficulty implementation or is it because of like working capital issue? This is first question from my side.

Ankit Agarwal — Managing Director

Yes. So I think, Subrata, I think, one, just at a macro level, I don’t think we have a negative view on India.

Subrata Sarkar — Mount Intra Finance — Analyst

So relatively, we are muted. That’s what I mean.

Ankit Agarwal — Managing Director

I’ll come to that. So I think fundamentally, I think, India will have a 10-year digital network build-out, right, whether it’s from government side, from defense side, data center side, etc. So I think it’s a great opportunity, and STL has built strong capability over the last seven, 10 years. So we are quite well placed to take it on. I think what we’re simply saying is that this is where we look at the business today. We are largely doing a lot of services today both to private sector and government sector. So based on our experiences, particularly on some of our execution challenges for government projects or cash collection, which would have — or fund involvement, which has been longer on government side. Based on some of those experiences, we’re saying we want to pivot more to private sector in India. So we’re still committed to the India market and we want to make sure that we support the growth especially at this time of 5G deployment in India.

The other part we are looking at very closely is that there’s probably a $10 billion investment funded by the government on fiber rollout to the villages as part of Phase 3 of BharatNet. That’s obviously a very, very exciting and national project, which would be great for STL to be part of. Having said that, we have to ensure that if and when we look at any of these projects, it has to be at the right terms, right norms, so that there’s complete visibility on both profitability as well as the fund involvement. So these are the parts that we are just taking lessons from our past experiences. And I would say being more mindful of which projects we are part of, which projects do we say yes to and sometimes we have to say no to.

Subrata Sarkar — Mount Intra Finance — Analyst

Perfect. My second question is on the capital structure side. Like as you announced like this year, we will have a INR500 crore capex. Next year, we will have INR350 crores of capex. And our operation is also growing, which will require higher working capital. So given all this context, whatever debt reduction or rationalization that we are planning for, is it mainly from the external source like funding through right issue or like whatever source or like we are, I think, internally from operational cash flow also, we are planning to reduce the debt to that? What’s the strategy?

Tushar Shroff — Group Chief Financial Officer

Very good question. I think if you would have looked at the service business, which is working capital heavy, and as we continue to execute some of the projects, we tend to release a lot of retention money, which gets involved in this kind of a tender business. So as we execute better and better, the opportunity of releasing cash is much, much more. So we are more focused in terms of ensuring that we are able to generate more on operational side of cash flow as well.

Subrata Sarkar — Mount Intra Finance — Analyst

Sir, last a small question. Like, in the optical fiber side, more or less that we are high above 20% margin, which is more or less the peak margin. So in this context like major margin expansion, so vis-a-vis our overall company level margin, we are operating 13% only. So my point is like a service level like that’s also a strategic decision like how much we want to penetrate on the debt at the service level because service is a much lower kind of a business. You are guiding for 10% margin. So like what will be — from a strategic point of view, what kind of overall company level margin we are targeting given the mix of like optical fiber interconnect as well as service?

Ankit Agarwal — Managing Director

Yes. So good question I think the way I would put it is the optical today is at 20%. We’re confident of that. I think it’s important, as we talked about, there will be improvement coming from the volume increase. There is also both a focus on volume as well as profitability improvement coming from the interconnect, right? As I said, the margins in interconnect are closer to 30% typically. So it’s important for us to keep pushing that forward, getting all the technology, getting the innovation and pushing that to the customers. So I think that’s something that we are positive about, and that’s work cut out for us.

In terms of the services part, as we stated in our last results as well, directionally, we want to improve the profitability or EBITDA level of the services business, take it at least to 10% levels from very low levels currently. One big part of that is to sort out the U.K. services margin so that overall services improves. As well as in India focus more on the private sector going forward so that we have both good margins as well as better fund involvement. That combination of these two, we believe it should help us improve the EBITDA margin. But as I said, this is probably a six to nine month process.

Subrata Sarkar — Mount Intra Finance — Analyst

Okay. But are we targeting any optimal level of mix like the way our intention is to reach 40% in interconnect? So service to optical fiber interconnect mix, are we targeting anything? Do you have any optimal mix in our mind?

Ankit Agarwal — Managing Director

Nothing specific. I mean already, as you can see, directionally, we are broadly at, say, 70% of optical business. 25%, 27% of services. And then balance is the digital business. So as I said, we’re not consciously driving any top line growth in services. We’re much more focused on taking select projects at the right profit and cash level. So I’m comfortable at the split. More than the split for me is making sure whatever business we are in is coming at the right terms. So I think it’s — we are positive when we look at the market trends of optical. So we are fully committed on that. Services require some sort of change in improvement from where it is. That’s the second part. And in digital, as I said, we’ll share more details by next quarter. But clearly, a lot of opportunity here for us to improve from here.

Subrata Sarkar — Mount Intra Finance — Analyst

Thanks. Thanks a lot.

Pankaj Dhawan — Investor Relations

Thanks, Subrata. So with this, we come to the end of Q&A session, and I now give it back to Ankit Agarwal for closing remarks.

Ankit Agarwal — Managing Director

I’d like to thank everyone for attending this call and showing your interest in our company. I hope we were able to address and clarify all your queries and comments. For any further questions and discussions, please feel free to contact Investor Relations team, which includes myself and Tushar. We really look forward to continuing the conversation with you in the future. Thank you. Jai Hind.

Tushar Shroff — Group Chief Financial Officer

Jai Hind.