TechM bets big on $41 bn network services market with LCC acquisition

Even as margins might be hit in the first year, analysts remain bullish on the LLC acquisition deal

Mobile network is the future and Tech Mahindra is betting big on it. Over the past two years, Tech Mahindra has focused on service offerings around network management, which has an addressable market of $41 billion. The acquisition of LightBridge Communi-cation Corporation (LLC) fits with Tech M’s strategy, as the company’s expertise spans  network planning, network design, deployment and optimisation. So far, LCC has built 350 networks and designed 350,000 cell sites. The company works with some of the largest wireless service providers across the globe.

The deal has valued LCC at $240 million, implying a enterprise value (EV)/sales of 0.55 times and EV/Ebitda (earnings before interest, taxes, depreciation, and amortisation) of seven times. While the acquisition will further strengthen Tech M’s service offering in the segment, the acquisition will not be earnings-accretive for the company in the first year. Also, the network management services tend to have an unfavourable onsite mix, which possibly explains the shift seen in Tech M’s revenues in the past year.

HDFC Securities says Tech M’s revenue by delivery centre has been deteriorating over the past few quarters, with revenues from onsite at 55 per cent for the second quarter of FY15, compared to 51 per cent in the year-ago period. Network services tend to command lower margins in the initial phase of execution compared to traditional information technology  services deals. LightBridge’s operating margin in FY14 stood at eight per cent against Tech Mahindra’s 20 per cent in the second quarter of FY15. In its conference call on Thursday, after the deal announcement, the management guided the deal would lead to a dilution in earnings in the first year, but would be accretive in the second year.

However, this acquisition will improve Tech M’s estimated revenues by 11 per cent in FY16 to $4.66 billion from the $4.2 billion at present. Emkay Global says Tech M is moving closer to its ‘$5 billion in annualised revenues by the fourth quarter of FY15’ target with the LCC acquisition. With the consolidation, the brokerage expects 10 per cent incremental revenue in FY16. Its current FY16 revenue estimate for Tech M is $4.2 billion incremental earnings to be one per cent. Most brokerages are viewing this development positively, though it would weaken Tech M’s vertical footprint. After the acquisition, the telecom vertical will account for 56.5 per cent total revenues compared to the present 52, per cent. However, Nomura views the acquisition positively, although the synergy benefits, especially on the cost side, will be gradual.