L&T Technology Services IPO: Should you subscribe?

Earlier in July, L&T Infotech had tapped the primary markets for funds. The stock listed 6% below the IPO price

Another Larsen & Toubro (L&T) subsidiary, L&T Technology Services Limited, is looking to raise up to Rs 890 crore via the primary market route. The initial public offer (IPO) opens on Monday, September 12. The entire issue is an offer for sale by promoter L&T, which is looking to offload its 10.2 per cent stake. 

The company provides engineering, research and development (ER&D) services to manufacturing, technology and process engineering companies. It operates in five industry segments – transportation, industrial products, telecom and hi-tech, process industry and medical devices, each of which represent a significant component of G500 ER&D spend, reports suggest. 

 

According to reports, L&T Technology Services has allotted 3.12 million shares at Rs 850 apiece to 13 anchor investors to raise Rs 268 crore.

Earlier in July 2016, another subsidiary of the engineering and construction giant, L&T Infotech had tapped the primary market for funds. The Rs 1,243 crore IPO was oversubscribed nearly 12 times with over a million applications – the highest in five years, but saw a tepid listing. The stock had debuted 6% below its issue price of Rs 710 per share.

So, should you subscribe to the latest offering? Here is what leading brokerages suggest:

ANTIQUE STOCK BROKING

L&T Technology Services with revenue of $468 million in FY16, operates in an underpenetrated engineering and R&D (ER&D) outsourcing market size of $67 billion (addressable outsourcing market of $365bn). Strong engineering parentage in the form of L&T, which provides them with the requisite domain expertise will be one of the key beneficiaries of ER&D spend as global ER&D spenders increasingly embrace outsourcing. 

Based on our estimates of USD revenue compounded annual growth rate (CAGR) of 11% over FY16-18e and EBITDA margin of 19.3% and the offered price at the upper end implies a P/E of 16x in FY18. This, we believe, factors in the premium owing to its L&T parentage in the engineering space.

MOTILAL OSWAL RESEARCH

The top line grew at 17% and PAT at 35% in FY16. The EBITDA margins have significantly improved in Q1FY17 at 19%, as against 15% in FY15 on account of better product mix and higher utilisation levels. At valuations of 21x FY16 EPS, there is some scope for re-rating when compared to its peers. The fact that customers may set-up captive R&D centres, which may result in loss in volume of work is one of the key risks. Also, the revenue depends to a large extent on limited number of clients and could decline if the company loses a major customer.

ANGEL BROKING

Considering strong growth potential of the company, which is ahead of some of the industry peers, coupled with 38%+ return on equity (RoE) levels in FY2016; FY2015-16 average cash flow from operations of Rs 446 crore; strong around 64% dividend payout (translating to around 4% dividend yield), we are of view that L&T Technology Services stock has the potential to trade at premium to the peers. However, if we consider the average of the peers, then LTTS stock has been priced at 19% discount. Given that the L&T Technology Services IPO has been priced at discount, we advise SUBSCRIBE.

PHILLIP CAPITAL

While the company operates in a segment with huge growth potential, we find the asking valuations highly expensive. Assuming 10%/12% USD revenue growth over FY17/18 and flat margins we expect the company to report an EPS of Rs 52 in FY18. That values the company at 16x FY18 P/E at the upper price band of Rs 860. We would have been more comfortable with a valuation in line with Cyient (13x FY18 P/E) leaving something on the table for the investors. We recommend Avoid.

IIFL

L&T Technology Services’ in-depth engineering capability and end-to-end service offerings are its key differentiators that are well appreciated by the ER&D spend decision makers. Its customer base includes 43 of the Top 100 global ER&D spenders thus offering significant growth opportunities from existing accounts.

In FY16, USD revenue growth stood at healthy 12% y-o-y in constant currency (CC) terms and the company was able to improve operating margin by 170 bps y-o-y to 17%. At the upper end of the price band, valuation stands at 21x P/E and 15x EV/EBITDA on FY16 financials. While the stock deserves better valuation than IT companies, the near-perfect IPO pricing leaves very limited room for listing gains. Long-term investors can hope for decent returns.

IDBI CAPITAL

While PER of 21x FY16 is at a premium to the large-caps and is expensive in the current IT services business environment, we believe that it provides good investment opportunity for long-term as it has the potential to deliver higher growth than the industry.