VA Tech Wabag Limited

VA Tech Wabag Limited E q u ity Re s e a r c h D e s k IPO Note Sector - Engineering 23 rd September, 2010 Highlights of the Issue Recommendation: NEUTRAL Issue Snapshot Issue Open: 22-Sep-10 Issue Close: 27-Sep-10 Price Band ` 1,230-` 1,310 Issue Size ` 4,514 mn - ` 4,726 mn Market Cap ` 12,985mn - ` 13,748mn @ ` 1,230 @ ` 1,310 Issue Size (No. of Shares) 3,607,581 3,669,643 QIB: 1,834,822 1,803,791 Non-Institutional: 550,446 541,137 Retail: 1,284,375 1,262,654 Face Value (`) 5 Book Value as of FY10 (`) 420 Capital Structure: Pre Issue Equity Post Issue Equity @ `.1230 Post Issue Equity @ `.1310 Shareholding Pattern Pre Issue (%) Post issue (%) @ `1250 ` 47.7 mn ` 52.8mn ` 52.5mn Post issue (%) @ `1310 Promoter & Promoter Groups 34.3% 31.0% 31.2% MF,FII & Others 58.5% 27.8% 27.9% Public 7.1% 41.2% 40.9% Total 100.0% 100.0% 100.0% Total Shares 9,540,813 10,557,073 10,495,011 Sr. No. Particulars ` Mn. 1 Working capital requirement 645.1 2 Construction of corporate office 347.4 3 Implementation of global systems 110.5 4 General Corporate Purposes [.] Total [.] Means of Finance Sr. No. Particulars ` Mn. 1 Proceeds from Initial Public Offer [.] Less: Issue related expenses [.] Less: Proceeds of the offer for sale [.] Total [.] Sumit Duseja sumit.duseja@spagroupindia.com VA Tech Wabag Ltd (Wabag), headquartered in Chennai, is a multinational company in the water treatment industry with market presence in India, Middle East, North Africa, Europe and South East Asia. The company provide a range of EPC and O&M solutions for sewage treatment, processed and drinking water treatment, effluents treatment, sludge treatment, desalination and reuse for institutional clients like municipal corporations and companies in the infrastructure sector. Investment Rationale Key challenges of cleaning, desalination, waste water treatment amid growing environmental concerns increases demand of technology driven solutions which augur well for Wabag. Wabag is a complete water solutions provider. Being a global player with the dual advantage of global brand/technological competence and a local setup, Wabag gains prominence and is expected to grab larger share of the industry pie. Technology and R&D driven business model. Company owns 157 products and process patents and has applied for 51 patents that are pending. The company has recorded high topline cumulative growth of 26.06% and cumulative bottomline growth of 108.74% in last three years. With increased government focus towards water treatment, there is a huge opportunity of growth and expansion through BOOT and TOT models. Key concerns include higher debtor days leading to negative cash flows, lower margins and dependence on fewer clients. Valuation & Recommendation At the upper band of ` 1,310, the stock is available at a P/E of 29.2x FY10 on post issue EPS of ` 44.9. As compared to its peers, we believe Wabag is fairly valued. Although company has a strong presence in the fast growing water treatment industry, there are concerns regarding higher debtor days and lower margins. Hence, we rate this issue as Neutral and recommend a re-look in the future when company showcases better operational efficiency. I n s t. D e a l i n g D e s k : S P A H o u s e, N y a y s a g a r, N e a r G u r u n a n a k H o s p i t a l, K a l a n a g a r, B a n d r a ( E ), M u m b a i 5 1 T e l. N o. : 022-42895000, F a x N o. 2 6 5 7 3 7 0 8 / 9 E m a i l : r e s e a r c h @ s p a s e c u r i t i e s. c o m Page 1 of 6

Investment Rationale Integrated Operations Limited presence of safe drinking water along with key challenges of cleaning, desalination, waste water treatment amid growing environmental concerns increases demand of technology driven solutions which augur well for the companies having presence in this segment. Wabag with many decades of experience and technological expertise along with presence in countries with higher industry growth is well equipped and placed appropriately to gain from high growth opportunities in this sector. Complete water solutions provider Wabag provide engineering solutions in the water industry for sewage treatment, processed and drinking water treatment, effluents treatment, sludge treatment, desalination and reuse and offer a comprehensive range of services throughout the entire life cycle of water including conceptualization, project design, installation, construction and O&M support. Currently the water industry is highly fragmented industry with very few global players. Being a global player with the dual advantage of global brand/technological competence and a local setup, Wabag gain prominence and is expected to grab larger share of the total industry pie. The clients of the company are institutional, both municipal corporations and industries. The projects are executed on a turnkey basis. The principal expertise of the company is technology and they subcontract the civil works which reduces higher fixed asset requirements. Strong execution track record and strong order book Company has a project reference in more than 19 countries globally and project list of more than 2,250 projects over last three decades. Out of 113 projects completed by the Company, 83 were turnkey projects, where the civil works, construction and erection works were outsourced. Consolidated Order Book of the company as on June 30, 2010 was ` 27,796 Mn which is equal to 2.27 times FY10 revenues of ` 12,237.4 Mn. This indicates good visibility of high growth rate in topline and bottomline numbers. Technology and R&D driven business model Company strive to continuously upgrade its technology to latest technologies in the market to stay competitive. Company owns 157 products and process patents and has applied for 51 patents that are pending. In India, company has used several technologies such as dual media filter, ultra filtration and reverse osmosis and mixed bed filter at the refinery in Panipat where the effluent is recycled after treatment for its industrial purpose like boiler feed water and process water. The company has research and development (R&D) centres located in Chennai (India), Vienna (Austria) and Winterthur (Switzerland). At the end of July 31, 2010, on a consolidated basis, the company had a workforce of 1,469 persons including 757 qualified engineers while the Indian operations had a workforce of 754 persons including 588 qualified engineers. Increased government focus towards water treatment As water and wastewater treatment reaches national prominence in more and more countries, governments across the world are inviting private participation to meet the funding requirements of the sector. Company intend to bid for available and future opportunities and expand its presence in BOOT and TOT projects. As BOOT projects require substantial capital commitment, company is intending to enter into partnerships with other companies to bid and develop the same. High Topline and Bottomline Growth Revenue has increased from ` 6,108.9 Mn in FY08 to ` 12,237.4 Mn in FY10 at a CAGR of 26.06% whereas bottomline numbers increased from ` 54.3 Mn in FY08 to ` 493.9 Mn in FY10 recording a robust CAGR of 108.74%. Higher growth rate is expected to maintain in the future owing to higher demand with growing population and environmental concerns. Top Investors Institutional investors both domestic and international hold 39.5% of the pre-issue capital. Through this issue two funds are making a complete exit, while ICICI Ventures (India Advantage Fund I) and Dynamic India Fund are making a part-exit from the company. Some of the top institutional investors are: Shareholding as on 15-Sep-10 % Holding Dynamic India Fund I, Mauritius 14.2 India Advantage Fund I 12.7 Passport Capital LLC 8.7 GLG Emerging Markets Fund 8.3 Govt of Singapore Investment Corptn. 5.2 IDFC Investments Advisors Limited 4.3 Source: RHP 2 S P A S e c u r i t i e s L i m i t e d

Investment Concerns Higher working capital needs & long receivable days For FY10, on revenues of ` 12,337.6 Mn, the company has outstanding debtors of ` 6,353 Mn, as on 31st March 2010 and ` 5,743.8 Mn as on 31st March 2009, representing a average collection period of 180 days. Though most of the revenues are generated in the last quarter, still a debtors balance of 6 months sales is very high, compared to the industry standards. In the last two financial years company reported negative cash flows from operations. Lower margins indicate high competition in the sector Its EBITDA and PAT margins are below average at 9.9% and 3.9% respectively, which reflects poorly on the technology edge and operational efficiency. Company Background Wabag is a multinational player in the water treatment field. Wabag provide engineering solutions in the water industry for sewage treatment, processed and drinking water treatment, effluents treatment, sludge treatment, desalination and reuse and offer a comprehensive range of services throughout the entire life cycle of water including conceptualization, project design, installation, construction and O&M support. Wabag s key competences, which are based on over 80 years of plant building experience, lie in the planning, completion and operation of drinking water and wastewater plants for both the municipal and industrial sectors. The operations of Wabag India have been divided into four strategic business units namely municipal business, industrial water, operations business (O&M) and international businesses. On a stand- alone basis, Wabag India s revenues include 64% from the municipal business, 11% from the industrial business, 5% from the O&M business and 20% from the international business. Source: Company, SPA Research Large dependence on fewer clients It has large dependence on few clients as 66% of revenues in FY10 came from top 5 clients, while 82% of order book as on 31st March 2010, are from top 5 clients. Around 88% of company s latest order book comes from State and Central government controlled municipal corporations while the rest attributable to industrial clients. Since company s revenues are highly dependent on municipal clients which have not so good record of making payments on time, there could be extended period of receivables and low cash flow affecting the operations. Further any delays, termination or cancellation of projects would affect its cash flows and business operations. 3 S P A S e c u r i t i e s L i m i t e d

Industry Overview With finite amount of fresh water on earth the supply of clean, potable water and sanitation are the key challenges in the coming future. Water/waste water treatment processes involves the removal of solids, bacteria, algae, plants, inorganic and organic compounds. Also certain industrial processes need more intensive or advanced filtration for applications such as semiconductors, pharmaceuticals etc. After water is used it has to be collected and treated in a waste water treatment plant before discharge. Water recycling is also undertaken so that the waste water can be reused again in some of the industrial applications. The water utilities and industrial global market is about USD 350 billion in 2007 and expected to grow to USD 530 billion by 2016 at an approximate CAGR of 5.00% as per Global Water Markets 2008. pharmaceutical industries. Overall, however, the industrial water market is considered to be smaller than the municipal water market. The industrial water market is less homogenous than the municipal water treatment market. Although the same water treatment technologies (reverse osmosis, ultrafiltration, ion exchange, and membrane degasification) are used across many different industries, each application will be specific to the industrial process in which it is used. Opportunity in India The commencement of Jawaharlal Nehru National Urban Renewal Mission indicates increased government focus over urban development. As of 29 th May, 2009, 463 projects requiring an investment of ` 497.43 billion have been sanctioned, over 76% of the projects sanctioned, aim at improving basic urban services like water supply sewerage and storm-water drainage. JNNURM is designed to encourage private investment as this sector is high capital intensive. As per the planning commission data, plan expenditure is to grow from ` 192.08 billion in 2007-08 to ` 410.63 billion in 2011-2012. Indian water market size is expected to grow at a CAGR of 12% from ` 120 billion in 2007 to ` 320 billion in 2016 according to Global Water Markets 2008. The water treatment industry is gaining increasing focus of governments around the world and due to the capital intensive nature coupled with inadequate funding sources, lot of private participation is being sought to develop the water infrastructure in many countries. Considering the momentum at which the sector is opening up for private players, this should provide significant growth impetus to the industry for next several years. Source: RHP Municipal Water and Waste Water Treatment Market In general, local public entities are responsible for organizing both drinking water distribution and wastewater treatment services. According to Global Market Report 2008, the total expenditure on Municipal water and waste water is estimated to be USD 326 billion in 2007 and is slated to go upto USD 490 billion by 2016. Cost of rehabilitating aging network, need of better technology in water treatment along with operations and maintenance of these networks involves high expenditure. In many countries private players are playing an active role with increased adoption of innovative models of service delivery like DBO, BOT, TOT and BOOT. Industrial Water and Waste Water Treatment Market Industries use twice as much water as households, and this water usually requires a higher degree of treatment both before and after it is used. Water is an important production factor for industries like power, food and beverages, pulp and paper, pharmaceuticals, refineries etc. The spectrum of industrial water ranges from cooling and boiler feed water in power stations and process water for a wide range of industrial uses to ultra pure water for the electronics and Promoter s Profile Wabag promoters are Rajiv Mittal, Amit Sengupta, Shiv Narayan Saraf and S. Vardarajan. Promoters have an average of 20 years of work experience in the industry. In September 2005, Promoters, with the support of India Advantage Funds I and represented by the investment manager ICICI Venture Funds Management Company Limited, effected a management buy-out of company from Siemens. In November 2007, the company through its wholly owned subsidiary Wabag Singapore acquired the entire shareholding of Wabag Austria. Valuation At the upper band of ` 1310, the stock is available at a P/E of 29.2x FY10 on post issue EPS of ` 44.9. As compared to its peers, we believe Wabag is fairly valued. Although company has a strong presence in the fast growing water treatment industry, there are concerns regarding higher debtor days and lower margins. Hence, we rate this issue as Neutral and recommend a re-look in the future when company showcases better operational efficiency. 4 S P A S e c u r i t i e s L i m i t e d

Financials Balance Sheet ` Mn. Year ended 31st March FY08 FY09 FY10 Share Capital 41.5 41.5 46.8 Reserves & Surplus 3075.3 3673.9 3961.2 Minority interest 13.3 14.0 Net Worth 3103.5 3701.4 4008.0 Secured loans 447.2 459.2 391.2 Current Liabilities & Provisions 5771.2 7355.6 6547.5 Total Liabilities 9321.9 11516.2 10946.7 Gross Block 416.2 502.8 514.5 Less: Depreciation 131.8 153.7 195.2 Capital work-in-progress 4.8 1.2 58.4 Intangible Assets 104.1 108.4 80.0 Net Block 393.3 350.3 377.7 Investment 126.5 146.8 133.7 Deferred Tax Assets 67.1 126.4 181.00 Current Assets, Loans and Advances 8761.6 10812.3 10174.3 Total Assets 9321.9 11516.2 10946.7 Income Statement ` Mn. Year ended 31st March FY08 FY09 FY10 Income from Operations 6108.9 11332.8 12237.4 Operating Expenditure 5932.8 10718.4 11124.6 Other Income 123.1 216.7 100.2 EBIDTA 299.2 831.1 1213.0 Depreciation 52.8 84.4 138.9 Profit before Interest & Tax 246.4 746.7 1074.1 Financial Charges 144.0 353.7 299.0 Profit Before Tax 102.4 393.0 775.1 Tax Expenses 10.3 40.1 303.5 Profit after tax 92.1 352.9 471.6 Prior period adj. -14.1-31.1 Reported PAT 92.1 338.8 440.5 Cash Flow Statement ` Mn. Year ended 31st March FY08 FY09 FY10 Cash Flow from Operating Activities - A 836.0 (576.6) (558.1) Cash Flow from Investing Activities - B 376.5 98.2 349.9 Cash Flow from Financing Activities - C 639.9 (85.6) (53.5) Net Cash Flow (A+B+C) 1,852.4 (564.0) (261.7) Opening Cash 426.6 2,428.7 2,023.1 Forex translation effect 149.7 158.4 (144.4) Closing cash 2,428.7 2,023.1 1,617.0 Ratios (Year ended 31st March) FY08 FY09 FY10 Debt to Equity (x) 0.1 0.1 0.1 ROCE (%) 6.9 17.9 24.4 Cash EPS (`.) 15.2 45.8 64.0 BV/Share (`.) 325.3 388.0 420.1 P/BV at lower band (x) 3.8 3.2 2.9 P/BV at upper band (x) 4.0 3.4 3.1 RoNW (%) 3.0 9.5 11.8 EPS (`.) 9.7 37.0 49.4 P/E at lower band (x) 127.4 33.3 24.9 Peer Comparison Company CMP (`) M-Cap (` Mn.) P/E at upper band (x) 135.7 35.4 26.5 EBIDTA Margin (%) 4.9 7.3 9.9 PAT Margin (%) 1.5 3.1 3.9 *Pre Issue Figures M-Cap/Sales (x) Sales (` Mn) EPS (`) P/E (x) BVPS (`) VA Tech Wabag @ 1230 1230.0 12985.0 1.1 12237.4 44.7 27.5 807.2 1.5 VA Tech Wabag @ 1310 1310.0 13748.5 1.1 12237.4 44.9 29.2 832.2 1.6 Thermax Ltd 789.0 94008.4 2.7 34411.2 12.1 65.4 90.5 8.7 Engineers India Ltd 355.0 119629.3 6.7 17767.4 10.4 34.1 41.9 8.5 Nagarjuna Constructions 161.6 41463.9 0.7 59926.4 10.3 15.7 89.9 1.8 Hindustan Dorr Oliver 137.9 9929.6 1.1 8926.2 7.9 17.4 31.6 4.4 *EPS and BVPS are calculated using post issue shares P/BV (x) 5 S P A S e c u r i t i e s L i m i t e d

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