Quess Corp: High growth, but low entry barriers

Thomas Cook-owned Quess Corp, a business services provider, plans to raise about Rs 400 crore from its forthcoming initial public offering (IPO). The company, which seeks to be a preferred partner of corporate firms for handling business functions, has used the acquisition route to expand its operations.

One of the reasons it has been able to grow annual revenues and operating profit by an average of 52 per cent and 55 per, respectively, over the past five years is because of successful purchase of companies (11 on last count) and scaling them up. As a result, revenues in this period have grown to Rs 3,400 crore.

However, margins have improved by only 40 basis points to five per cent. Low margins are because of its presence in the largest of the four segments it operates in, people and services management or general staffing segment. While this segment accounts for 57 per cent of revenues and around 39 per cent of operating profits, it has margins of 3.5 per cent.

The company, however, is looking to enhance margins by improving its business mix and cross-selling across segments, leading to operating efficiencies. Quess will also look at improving its leadership position in the Global Technology Solutions business, which is the largest information technology staff provider in India. This is the second largest of its segments and contributes 29 per cent of revenues with margins of around seven per cent. Some key acquisitions such as Magna Infotech, Brainhunter and MFX have been in this vertical.

While these two segments account for 86 per cent of revenues, the company also operates in facility (building maintenance) and industrial asset management (plant and machinery maintenance) segments that fetch margins in the range of 6-11 per cent, higher than the overall average. Its presence in these two businesses is part of the company's strategy to offer end-to-end services within a vertical.

Going ahead, Quess will continue to expand through the acquisition route to scale up its presence across segments by looking at under-served geographies to boost market share, improve client base and grow at a faster clip. The company is looking at a budget of Rs 80 crore from the IPO proceeds to fund inorganic and strategic initiatives. While the company has a good record in turning around acquisitions and growing them manifold, it suffers from poor cash-flows.

The company had negative cash flows from operating activities in FY16 at Rs 441 crore with working capital requirement funded through debt (debt to equity ratio at 2.2 times). It has indicated that higher growth and need for more working capital has reflected in the cash flow situation, which could stabilise once growth moderates.

Further, it is looking at improving its debtor days from the current 45 as well as improve margins to improve cash flows. Quess is also looking at reducing debt by Rs 50 crore from the proceeds. Around half of the IPO proceeds (about Rs 229 crore) will be used for funding capital expenditure and incremental working capital requirements.

However, the company has been able to maintain its return ratios (on equity and capital employed) around 22 per cent levels over the past five years. On the business front, the company is focusing on managed services (last-mile connectivity) in the fastest growing e-commerce segment with current clients such as Amazon and Urban Ladder.

At the IPO price band, the stock is priced about 45 times FY16 consolidated fully diluted earnings (post IPO capital) as compared to Teamlease (revenues Rs 2,500 crore, operating margin of one per cent), which is valued at 58 times its earnings. The difference, however, is that Teamlease hardly has any debt (0.1 times) while Quess is more leveraged at 2.2 times. On an enterprise to Ebitda (earnings before interest, taxes, depreciation and amortisation) basis, too, it is valued at 22 times against Teamlease's 32 times.

While the segments that it operates in should see growth of around 20 per cent over the next few years, weak cash flows, business challenges and volatility could impact earnings. Low entry barriers in the business and single-digit margins are other potential risks. Though valuations are lower than peers, they are not cheap. Investors with an appetite for risk may consider the IPO.