Infotech IPO: Value unlocking potential for L&T

Analysts, however, await clarity on the IPO's valuation

The Larsen and Toubro (L&T) scrip surged two per cent in Tuesday's trade on the reports that the company would list its IT services company L&T Infotech around November-December 2015. From 100 per cent currently, the company management intends to dilute its stake by 10-12 per cent. While reports indicate the firm will raise Rs 1,500-1,800 crore, plans to rope in private equity investors before the IPO are also in the works. A separate listing of L&T Infotech, which contributes 9-11 per cent of L&T's FY17 estimated sum-of-the-parts valuation, should help unlock the value for its parent.

On the business front, L&T Infotech has the expertise in engineering services, and posted revenues of $810 million, net profit of Rs 762 crore and Ebitda margin of 20 per cent in FY15. The last financial year was tad weak for the domestic IT players. Prior to that, L&T Infotech’s track record has been good with a compounded annual growth rate of 27 per cent in sales and 33 per cent in adjusted net profit (excluding one-offs) during FY2011-2014. While cash flow from operations have been rising in the past four years, the return ratios have also been on an uptrend and stood at 50 per cent each in 2013-14.

  For FY16, the management hopes to clock revenues of $950 million, net profit of Rs 900 crore and maintain Ebitda margin at 20 per cent levels.

At the reported offer size and FY16 profit guidance, the price-to-earnings valuations work out to about 20 times. At these valuations, analysts seem divided.

Sagar Rastogi, IT analyst at Ambit Capital, says, “As per the numbers reported in media, the L&T Infotech IPO is valued at 20 times FY16 estimated earnings which is similar to TCS' FY16 price/earnings multiple of 20 times.”

While TCS is much bigger in terms of revenues as well as scale of operations, the guidance implies 18 per cent earnings growth in FY16 which is decent, says Rastogi, adding that relatively lower Ebitda margin and size versus peers is a key negative. TCS posted revenues of $15.45 billion and Ebitda margin of 28.8 per cent in FY15.

The company’s financials, say analysts, should be compared to mid-tier peers such as Mindtree which posted revenues of $584 million in FY15 and Ebitda margin of 19.9 per cent. At Tuesday's closing price, Mindtree trades at 18 times FY16 estimated earnings.

Apurva Prasad, IT analyst at Reliance Securities, however, says, “We believe the IPO is reasonably valued when compared to other mid-tier peers. L&T Infotech will be sixth largest listed player in terms of revenues.”

For now, it is not clear at what valuations the offer will finally hit the market.

Notably, given that L&T Infotech derives about a large part of revenues from the US, analysts estimate the parent's (L&T) contribution to the company’s revenues will be smaller. This reduces client concentration risk for the IT company.

L&T Infotech derives about 65 per cent revenues from the US, another 20 per cent from Europe and the balance from rest of the world. The company has mainly pursued strategic acquisitions in its bid to boost growth. Among key verticals, the company expects banking and financial services and media and entertainment to drive growth. Two clients in the energy vertical, however, are witnessing a slowdown which could have a bearing on the company's financials in the near-term. Although the US and Europe will be key growth markets, L&T Infotech is also excited about Smart Cities coming up in India and will be partnering with its parent to work as an end-to-end ‘master system integrator’.

Going forward, the company plans to step up investments in the digital space which is the next growth driver for the IT sector. The firm has consolidated its smaller clients’ portfolio and focus on mining its existing 200 clients. New client acquisition is aimed at customers with revenues of $5-10 million.

L&T Infotech is also planning to strengthen the structure of its top management, besides hiring more personnel to drive growth across verticals as well as its digital businesses.