L&T Infotech: Low valuations, but lower growth too

There is nothing exciting about the offer; those looking for an exposure to the Indian IT sector can look at other high-growth investment ideas

Lack of a differentiated business model, high dependence on top clients and relatively smaller presence in high-growth areas such as digital and infrastructure management services (IMS) are some reasons why investors could give a miss to L&T Infotech’s initial public offer (IPO) of equity.

While the Larsen & Toubro (L&T) parentage is a key positive, the subsidiary has been struggling with issues surrounding its senior management stability and has among the highest attrition rates in the sector.

These factors have restricted revenue growth over FY14-16. Although rupee-denominated revenue has grown at a compounded annual rate (CAGR) of 13.5 per cent, dollar revenues have seen a CAGR of only nine per cent. The latter is lower than that of comparable peers such as Mindtree (closest listed peer in terms of revenue), where revenue has grown 19.4 per cent in this period; Tech Mahindra’s (TechM's) was 14.2 per cent.

This trend for L&T Infotech is likely to continue, say analysts. Analysts at Antique Stock Broking peg its consolidated revenue growth (rupee terms) at 13.5 per cent in FY17, lower than the 19 per cent expected at Mindtree’s.

Notably, L&T Infotech’s FY16 Ebitda (earnings before interest, taxes, depreciation and amortisation) margin at 17.7 per cent is a shade better than TechM and at par with Mindtree but these have been falling for some years (see table), not a good sign. The fact that foreign currency gains (non-core, unsustainable in nature) forms 26 per cent of its profit before tax is another concern; this share is much lower for Mindtree.

While L&T Infotech derives a relatively lower share of its revenue(17 per cent) from Europe and, hence, is relatively least impacted by the Brexit development, there are other risks in the form of high revenue and client concentration. A little over half of its revenue comes from the top 10; the top five account for 38 per cent of revenue, higher compared to peers. Also, BFSI (banking, financial services and insurance) contributes about 47 per cent of revenue, which means any slowdown in this vertical could pull down performance.

In this backdrop, it is not surprising that the IPO is priced at about 13 times the FY16 earnings (after considering the retail discount). This is lower than Mindtree’s 18.7 times but not far from the 16 times of much larger peer TechM, which reported revenue of Rs 26,494 crore and net profit of Rs 3,118 crore in FY16.

All these factors will need to be addressed for growth to improve meaningfully, believe analysts. “To become a Tier-1 service provider, L&T Infotech needs to build intrinsic competitive advantages (e.g digital capabilities, strong execution) and stabilise the senior leadership team (effective absorption of new talent with older ones),” writes Sagar Rastogi, technology analyst at Ambit Capital, in a recent report.

Simply put, there is nothing exciting about the offer. Those looking for exposure to Indian sector can look at other high-growth investment ideas. Rising demand concerns after Brexit have pulled down stock prices of most information technology companies. This correction offers an attractive entry point in relatively stronger companies having lower impact from Brexit. The IPO is an offer for sale, wherein the parent is looking to sell 10.3 per cent stake in its wholly owned subsidiary. At the upper end of the IPO band of Rs 705-710, L&T Infotech is valued at about Rs 12,000 crore. While L&T is looking to list its other technology services subsidiary, L&T Technology Services, sometime in the future, there will not be any benefits from this for L&T Infotech. For, L&T Technology Services, which houses the engineering services business, was hived off from L&T Infotech in 2014.