Hexaware: Open offer a good opportunity to exit

While outlook for the company's future growth remains mixed, most analysts believe open offer price is attractive

Ending about one-and-half year of speculation, Hexaware Technologies on late Friday announced the sale of 41.8 per cent stake by its promoters and General Atlantic to Baring Private Equity Asia (Barings). Hexaware stock, which has outperformed the Sensex in this period, was up about six per cent on Monday as well and closed at Rs 128. While the speculation about stake sale is partly responsible for the outperformance in the past 18 months, improving financial performance has also contributed.

Hexaware has been able to bag more number of larger, long-term deals, thus, providing improved revenue visibility in the past two years. This deal flow is largely driven by higher mining of its existing customers. Hence, the sustainability of these clients post the ownership change will be key for growth. Analysts say, as the current management team will continue, the deal is unlikely to have an impact on Hexaware's operations, at least in the medium term. They also believe that even as near-to-medium term prospects of the company remain healthy, there is limited room for upside given the deal valuation.

The last big acquisition in this sector was the takeover of the Patni promoters’ stake of 83 per cent by iGate for $1.22 billion. This deal priced Patni at a price to earnings ratio of 10.8 times. the Hexaware deal, too, is valued at 11 times CY13 and nine times CY14 estimated earnings - in-line with the Patni deal. While Hexaware has traded at a one-year forward price/earnings (P/E) band of 5-13 times historically, the deal value is higher than its average P/E multiple of nine times. The open offer (to garner additional 26 per cent stake) price of Rs 135 a share implies a 12 per cent premium over Friday's closing price of Rs 120.

“Hexaware has seen mixed revenue performance in the past two-three quarters. While September quarter guidance is better, we would look for changes in growth trajectory with new ownership in place. We believe the stock is fully valued and advise investors to tender shares in the open offer,” says Rumit Dugar, IT analyst at Religare Capital Markets.

Of the 13 brokerages polled by Bloomberg since August 23, seven have a buy rating, while five have a neutral view on the Hexaware scrip. Their average target price of Rs 131 a share, which also implies limited upsides from current levels.  According to the announcement, Baring will purchase the promoter, Atul Nishar’s 27.7 per cent stake and General Atlantic's 14.1 per cent stake in Hexaware for Rs 126 a share, totaling Rs 1,570 crore. However, the acquisition price will stand increased to Rs 135 a share if Baring reaches a holding of 50 per cent or above (including open offer).

What does Hexaware offer?
Apart from a few blips on a quarterly basis, Hexaware has posted consistent improvement in its financial performance in the past two years. Further, analysts expects CY13 revenue and net profit growth to be about 14 per cent, which is in line with sector revenue growth expectations. The company has a healthy deal pipeline which is a result of strong mining of its existing clients (repeat business of 94 per cent). Its strong and long standing relationship with existing clients is among key factors that would have attracted the new buyer. Retaining this relationship post buyout will be the key for sustained growth.

Further, Hexaware’s growth is driven largely by its Enterprise Application Services (EAS forms close to 30 per cent of its revenue pie). Strong traction in PeopleSoft 9.1 upgradation (forming 66 per cent of EAS revenues) is fuelling this growth for the company. Hexaware derives about 70 per cent revenues from the annuity based maintenance services, thus making it less exposed to more volatile discretionary demand from clients. Also, the company’s employee base of 8,700 lends a decent scale.