L&T Technology Services Ltd

Transcription

1 IPO Review Rating matrix Rating : Avoid Issue Details Issue Opens 12-Sep-16 Issue Closes 15-Sep-16 Issue Size ( Crore) Price Band ( ) No of Shares on Offer (crore) 1.04 QIB (%) 50 Non-Institutional (%) 15 Retail (%) 35 Minimum lot size (No. of shares) 16 Objects of issue Objects of the Issue Proceeds to the promoters Amount crore Shareholding Pattern Pre-Issue Post-Issue Promoter & promoter group 100.0% 89.8% Public/others 0.0% 10.2% Financial Summary Crore FY15 FY16 FY17E FY18E Revenue from operations EBITDA EBITDA Margin (%) EPS RoCE Valuation Summary (at 860; upper price band) (x) FY15 FY16 FY17E FY18E EV/EBITDA(L) EV/EBITDA(U) P/E(L) P/E(U) Research Analyst Deepak Purswani, CFA deepak.purswani@icicisecurities.com Tushar Wavhal tushar.wavhal@icicisecurities.com Deepti Tayal deepti.tayal@icicisecurities.com September 12, 2016 Incorporated in 2012, L&T Technology Services (LTS) is a leading global pure-play in the growing ER&D services company. The company leverages the strengths and heritage of Larsen & Toubro, a leading Indian conglomerate with strong global engineering capabilities providing it deep domain expertise in product and process engineering. LTS operates in five diverse industry segments viz. transportation, industrial products, telecom and hi-tech, process industry and medical devices. In FY16, the company derived ~50% of revenues from the three segments of industrial products, process industry and medical devices. The company aims to raise ~ 894 crore through an offer for sale of shares (at a price band of per share). Investment Rationale Pure-play on ER&D services with strong heritage L&T Technology Services (LTS) is a focused player in the growing ER&D space. Furthermore, LTS have been also recognised by Zinnov in the leadership zone, its highest ranking category in eight industry verticals. With the leadership position, the company is likely to be a key beneficiary of the growing ER&D market. According to Zinnov, the Indian market contributed revenue of $20 billion in FY15 and is expected to grow at CAGR of 13.7% to $38 billion during FY15-20E. Well-diversified across verticals with focus on growth LTS had diversified very well across five verticals viz. transportation, industrial products, telecom and hi-tech, process industry and medical devices. Furthermore, the company has long-standing relationships with customers, including more than 50 leading Fortune 500 companies. Also, 43 of LTS customers are among the top 100 global ER&D spenders. Top 20 customers contribute ~54% to revenues while ~95% business was from repeat customers in FY16. Going ahead, the company will focus on driving growth through our T30:A3 model, whereby LTS is looking to prioritise T30 accounts that are in the range of $5-$30 million and are scalable to $50 million over the next few years. Concerns L&T Technology Services Ltd Price band Loss of any major client could have a material impact on financials High dependence on North America and Europe Foreign exchange rate fluctuations could adversely impact business operations Leading player in ER&D Space; recommend AVOID on valuation LTS is a one of the leading players in the growing ER&D space. However, LTS is available at 15.5x FY18E EPS, which is at premium to other IT players who have a presence in the ER&D space such as HCL Tech (12.3x FY18E EPS) and Cyient Technologies (11.9x FY18E EPS). Hence, we believe current valuations leave limited upside. We recommend that investors AVOID the issue.

2 Company Background Incorporated in 2012, L&T Technology Services (LTS) is a leading global pure-play ER&D services company. The company leverages the strengths and heritage of L&T, a leading Indian conglomerate with strong global engineering capabilities, quality of service and reliability. Prior to January 2014, the company s business was conducted as a division integrated engineering services (IES) of L&T and as a sub-segment product engineering services (PES) of L&T's subsidiary, LTIL. As part of a business restructuring exercise, the PES business from LTIL, (except its unit in Germany, which was transferred with effect from September, 2014) and the IES business from L&T that was transferred to the company. As of March 31, 2016, the company has an employee base of 9406, of which more than 8,000 are engineers across multiple engineering disciplines. In terms of verticals, LTS operates in five diverse industry segments viz. transportation (30% of revenues), industrial products (25% of revenues), telecom and hi-tech (20% of revenues), process industry (18% of revenues) and medical devices (6% of revenues). Among geographies, North America and Europe have been the largest contributor to revenue contributing 60.4% and 19.8% in FY16 while India and Rest of the world contributed 8% and 12%, respectively. Exhibit 1: Geographical revenue trend during FY15-FY16 100% % contributuion to revenue 80% 60% 40% 20% 60.4% 56.1% 20.4% 19.8% 10.0% 8.3% 13.5% 11.5% 0% North America Europe India ROW FY15 FY16 In terms of revenues mix, it derives 52.9% of revenue in FY16 through onsite locations and 47.1% of revenue in FY16 through offshore locations as it has an integrated global delivery model. Exhibit 2: Revenue contribution - onsite and offshore % % contribution to revenues 80.00% 60.00% 40.00% 20.00% 52.50% 47.10% 47.50% 52.90% 0.00% FY15 FY16 Onsite Offshore Source: RHP, ICICIdirect.com Research Page 2

3 Industry Dynamics Given IoT is gaining momentum, regulatory and growing customer demand for innovation to increase energy efficiency & lower emission, personalised product experience, engineering R&D is witnessing strong momentum in spending. According to Zinnov, $1007 billion was spent by corporations on ER&D activities in FY15 According to Nasscom, global ER&D spend grew at a CAGR of over 7% since Out of $1007 billion, the addressable engineering outsourcing market is $365 billion. However, only $67 billion outsourcing market has been addressed so far. Even out of $67 billion, the ER&D market addressed by India was only $20 billion indicating huge opportunities to be tapped in future. Exhibit 3: ER&D spend According to Zinnov, revenue from the India addressed market may grow at a CAGR of 13.7% to $38 billion in FY15-20E. Out of this, while in-house ER&D centres are expected to grow at a CAGR of 13.3% to $22.9 billion, revenues from third-party ER&D service are anticipated to grow at a CAGR of ~14% to $14.9 in FY15-20E. In 2015, in-house & third party ER&D market size was $12.2 billion & $7.8 billion, respectively. Exhibit 4: ER&D market from India to grow at 13.7% CAGR in FY15-20E Page 3

4 In 2015, segments of telecom & hi-tech and transportation contributed 26.9% and 22.5% to G500 ER&D spend, respectively, while process industry contributed 21.3%, industrial products (7.0%) and medical devices (5.0%). Exhibit 5: Global 500 ER&D spend in business segments Page 4

5 Key strength Pure-play on ER&D services with strong heritage L&T Technology Services (LTS) focuses on the ER&D space and acts as a one-stop shop for customers in ER&D space, covering phases from conceptualisation to implementation within the product and manufacturing engineering life cycles. LTS also leverages strengths and heritages of L&T, providing it deep domain expertise in product and process engineering. Furthermore, LTS have been also recognised by Zinnov in the leadership zone, its highest ranking category in eight industry verticals. With the leadership position, company is likely to be key beneficiary from growing ER&D market. According to Zinnov, Indian market contributed revenue of $20 billion in FY15 and is expected to grow at CAGR of 13.7% to $38 billion during FY15-20E. Exhibit 6: LTS in leadership zone, highest ranking category by Zinnov Well-diversified across verticals with focus on growth LTS had diversified very well across five verticals viz. transportation, industrial products, telecom and hi-tech, process industry and medical devices. The company have long-standing relationships with customers, which includes more than 50 leading Fortune 500 companies and 43 of company s customers are amongst the top 100 global ER&D spenders. Top 20 customers contribute ~ 54% to revenues and ~ 95% business was from repeat customers in FY16. Exhibit 7: Revenue contribution by business segments % of revenue FY15 FY16 Q1FY17 Transportation Industrial Products Telecom and Hi-Tech Process Industry Medical Devices Page 5

6 Strategy Driving higher growth in key segments, verticals and geographies LTS is pursuing growth strategies to expand market share across key segments, verticals and geographies. Vertical wise, the company s key priority areas are currently automotive, industrial products segment, consumer electronics and product software (both of which forms part of our telecom and hi-tech segment). In the automotive vertical, LTS aim to focus on software-based engineering solutions, which will supplement traditional strengths in auto-mechanics. In the industrial products segment, the company intends to expand its offerings in IoT-enabled smart products and the renewable energy. In the customer electronics vertical, LTS tend to focus on wearables, smart homes and camera and security devices. The company intend to pursue both organic and inorganic strategies to enhance its service offerings in the product software space. Geography wise, the company will continue to focus on North America and Europe, particularly by setting up labs or development centres in close proximity to customers' offices. The company also intends to focus on Austria, Switzerland, Japan and establishing delivery centres in Eastern Europe. Maintain existing & acquire new customer relationships LTS record of delivering an extensive range of solutions through integrated global delivery model, industry specific expertise have led to strong client relationships over the years. Top 20 customers contributed 53.8% of revenues in FY16 (vs. 56.3% in FY15). Total 43 of the top 100 global ER&D spenders are the company s key global customers. According to the management, these top 100 ER&D spending represents a large market opportunity for the company to grow and develop. The company will focus on driving the growth through our T30:A3 model, whereby LTS is looking to prioritise T30 accounts that are in the range of $5-30 million and are scalable to $50 million over the next few years. Exhibit 8: Number of million dollar clients contribution to revenue Revenues FY15 FY16 > $ 1-5 million > $ 5-10 million > $ million 8 8 > $ 20 million 2 3 Delivering solutions-oriented engineering applicable across verticals Digitisation would increasingly become systematically critical in near future, for which LTS plans to focus on key technology areas as digital engineering, mobile internet, internet-of-things (IoT), advanced robotics, automation of knowledge, autonomous and near-autonomous vehicles, energy efficiency and imaging and video. To bring business process efficiency to clients, company is building cross-domain solutions that can be applied to the businesses of existing and prospective customers across verticals. Company is also building and strengthening alliances with technology companies. Increased investment in emerging technology & innovation labs Currently, the company has 31 labs in India. The company will continue to drive growth by focusing towards digital transformation and have invested significantly in smart manufacturing infrastructure to align its existing areas of expertise with new business trends. Page 6

7 Expanding footprint through selective acquisitions LTS plans to expand organic growth by pursuing selective acquisitions and strategic alliances to expand vertical offerings and customer base. The company also plans to pursue acquisitions of companies outside India to expand global footprint by leveraging low cost offshore delivery model to move a greater portion of the work offshore to India. Attract, develop and retain highly-skilled employees Employees are one of the important assets for the company. Thus, the company has certain talent development strategies and training framework which aid company to deliver quality services to customers. Financial Performance At the consolidated level, LTS revenue grew 17.1% YoY to 3,066.5 crore in FY16. During FY16, EBITDA margins expanded 180 bps to 17.0% while PAT grew ~34% YoY in FY16 to crore. On a rough cut basis, we expect revenue, PAT to grow at a CAGR of 14.5%, 22%, respectively, in FY15-18E, assuming EBITDA margin of ~19% (LTS EBITDA margin expanded ~200 bps to 19% in Q1FY17 from 17% in FY16). Exhibit 9: Revenue may grow at CAGR 14.5% during FY15-18E Exhibit 10: EBITDA and EBITDA margin trend 5,000 20% crore 4,000 3,000 2,000 1,000-2, , , ,926.6 FY15 FY16 FY17E FY18E 15% 10% 5% 0% crore FY15 FY16 FY17E FY18E (%) Net Sales Growth (%) EBITDA EBITDA Margin (%) Exhibit 11: PAT may grow at CAGR ~22% during FY15-18E Exhibit 12: Return ratios crore % FY15 FY16 FY17E FY18E - FY15 FY16 FY17E FY18E RoCE RoE Page 7

8 Key risks and concerns Loss of any major client could have material impact on financials During the financial year ended March 31, 2016, LTS derived 36.2% of revenues from top 10 clients and 53.8% of revenues from its top 20 clients. Downsizing of volume of work by any or loss of any one or more of clients could have a material adverse effect on its business. Revenue contribution from new customers is typically small for the first year. New customers contributed 5.4% and 1.3% to revenue in FY16 and FY15 respectively. Also, the company derives ~80% of revenues from North America and Europe and any uncertainty in these markets may lead to reduced spending on ER&D services which may lower the demand for services and negatively affect revenues and profitability. Exhibit 13: Concentration of revenue among top clients Revenue Concentration FY15 FY16 Top 5 client 22.2% 22.8% Top 10 client 37.0% 36.2% Top 20 client 56.3% 53.8% Challenges relating to immigrations laws may impact business model In December 2015, the US substantially increased visa fees on H1-B and L-1 visas, thereby increasing visa cost and would increase cost in the future. Due to increased scrutiny in visa applications and work petitions in US, industry is witnessing decreased number of grant of visas, thereby affecting company s ability to compete and provide services to clients in the US. Besides US, immigration laws in other countries, in which company seek visa or work permits may require to meet legal requirements such as maintaining a defined ratio of local to foreign employees. Inability of project personnel to obtain visas or work permits could delay or hamper growth and cause revenue or profits to decline. Business risk and limited operating history Incorporated in 2012, the company has a limited operating and financial history making it difficult to evaluate its current and future prospects Engineering expertise along with creating innovative service offerings and execution of projects is one of the critical factors for success of the company and inability to evolve on these grounds can impact the profitability of the company One of the vital factors of ER&D industry is the ER&D budgets of the customers. Reduction in client s budgets due to macroeconomic factors or shift in corporate priorities could impact company s revenues and profitability Acquisitions may not yield intended benefits L&T Technology services may undertake acquisitions in line with its growth strategy. However, successful implementation of acquisitions depends on a range of factors, including change in competition laws in India and abroad, funding arrangements, and integration. Failure to successfully integrate acquisitions with the company s existing business or acquisition not delivering intended results could negatively affect company s financial performance. Adverse ruling in outstanding litigation could have adverse impact... Adverse ruling on outstanding proceedings at different levels of adjudication before various courts, tribunals and appellate authorities could have material impact on L&T Technology Services performance. Page 8

9 Exhibit 14: Valuation comparison with peers Valuation LTS is one of the leading players in the growing ER&D space. However, the stock is available at 15.5x FY18E EPS, which is at a premium to other IT players who has presence in ER&D space such as HCL Tech (12.3x FY18E EPS) and Cyient Technologies (11.9x FY18E EPS). Hence, we believe current valuations leaves limited upside. We recommend that investors AVOID the issue. CMP M Cap EPS ( ) P/E (x) EV/EBITDA (x) RoCE(%) RoE (%) ( ) ( Cr) FY16 FY17E FY18E FY15 FY16 FY17E FY18E FY15 FY16 FY17E FY18E FY15 FY16 FY17E FY18E FY15 FY16 FY17E FY18E L&T Tech Services (L) 850 8, L&T Tech Services (U) 860 8, HCL Technology , Cyient 461 5, Page 9

10 Financial Summary Exhibit 15: Profit and Loss Statement ( Crore) FY15 FY16 FY17E FY18E Net Sales 2, , , ,926.6 Growth (%) % 12.5% 13.8% Employee benefits expense 1, , , ,195.0 Operating expenses Other expenses Total Operating Expenditure 2, , , ,172.7 EBITDA Growth (%) % 25.9% 15.0% Depreciation & Ammortization EBIT Growth (%) % 27.1% 14.5% Finance Cost Other Income PBT Tax PAT Growth (%) % 20.9% 11.7% EPS Growth (%) % 20.9% 11.7% Exhibit 16: Cash Flow Statement (Year-end March) FY15 FY16 FY17E FY18E Profit before Tax Depreciation Interest (net) 2.2 (0.7) (1.2) (1.2) (Profit)/Loss on sale of fixed assets (0.2) Cash Flow before WC changes (Increase)/Decrease in Trade Receivables (93.1) (11.9) (90.7) (113.2) (Increase)/Decrease in Other Receivables (96.4) 89.9 (56.5) (60.6) (Increase)/Decrease in Trade & other Payables Cash generated from operations Direct Taxes Paid (67.0) (144.8) (177.0) (208.1) Net CF from Operating Activities (Purchase)/Sale of Fixed Assets (52.7) (126.9) (100.0) (100.0) (Purchase)/Sale in current Investments - (55.5) - - Consideration paid towards businesses purchased (609.6) Interest Received Net CF from Investing Activities (667.1) (179.3) (96.8) (96.8) Share Capital Issued Proceeds from/(repayment of) borrowings (23.3) (25.0) (25.0) Interest Paid (3.4) (2.5) (2.0) (2.0) Dividend Paid (219.9) (302.0) (201.5) (225.1) Dividend Tax (30.0) (55.6) (50.4) (56.3) Net CF from Financing activites (383.4) (278.9) (308.3) Net increase in cash & cash equivalents 85.8 (28.9) Cash & Cash equivalents at beginning of year Cash & Cash equivalents at end of year Page 10

11 Exhibit 17: Balance Sheet ( Crore) FY15 FY16 FY17E FY18E Equity Capital 1, , , ,050.0 Reserve and Surplus Total Shareholders funds 1, , , ,625.8 Short term borrowings Other long term liabilities Long term provisions Total Liabilities 1, , , ,794.2 Fixed Assets Tangible Intangible Capital WIP Goodwill on consolidatiom Deferred tax asset Long term loans & advances Total Non Current Assets Current investments Trade receivables Unbilled revenue Cash and Bank Short term loans & advances Total Current Assets 1, , , ,807.2 Trade Payables Other current liabilities Short term provisions Total Current Liabilities Net Current Assets ,020.8 Total Assets 1, , , ,794.2 Exhibit 18: Key Ratios (Year-end March) FY15 FY16 FY17E FY18E Per share data ( ) EPS BV DPS Cash Per Share Operating Ratios (%) EBIT Margin PBT Margin PAT Margin Debtor days Creditor days Return Ratios (%) RoE RoCE Valuation Ratios (x) P/E EV / EBITDA EV / Net Sales Market Cap / Sales Price to Book Value Solvency Ratios Debt/EBITDA Debt / Equity Current Ratio Page 11

12 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction; Buy: >10%/15% for large caps/midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more; Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai research@icicidirect.com Page 12

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