Should You Subscribe : L&T Technology Services Ltd IPO

L&T Technology Services LTD - A long term tech play

About the issue:

• L&T TS is coming up with an initial public offering (IPO) of around 10.4mn shares (fresh issue: nil; OFS shares: 10.4mn) in offering. Total IPO size is estimated at around Rs. 8,840 – 8,944mn.
• The issue will open on 12th Sept. 2016 and close on 15th Sept. 2016.
• Not more than 50% of the issue will be allocated to qualified institutional buyers. Further, at most 15% of the issue will be available for non-institutional bidders and the remaining 35% for retail investors.
• Net proceeds from the issue will go to selling shareholder. The company will not receive any money from the issue.
• Pre-issue promoter group stake in L&T TS stands at 100%. Post IPO, promoter group stake will decline to 89.8%. Source: Company RHP Pre and Post Issue Shareholding Pattern (%) Pre Issue Post Issue Promoter & Promoter Group (%) 100% 89.8% Public 0% 10.2%

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Salient features of the IPO

• L&T Technology Services Ltd. (L&T TS) a leading global pure-play Engineering and R&D services company
• The company globally serves over 200 customers, which includes more than 50 Fortune 500 companies. 
• The public issue is completely an offer for sale, thus it will not receive any IPO proceeds.

Key competitive strengths:

• Leading global pure-play ER&D services company
• Well-diversified player with multi-vertical industry expertise.
• Focus on innovation through in-house R&D, IP and strategic alliances

Risk and concerns:

• Inability to develop new services or enhance existing services
• Nearly balanced onsite and offshore revenue composition
• Employee cost
• Foreign currency fluctuations

Valuation & recommendation:

At the higher price band of Rs. 860, L&T TS’s share is valued at a P/E multiple of 20.1x (to its FY16 EPS), which is in line with the average P/E multiple of 21.4x of its domestic peers. Moreover, its global peers are trading at a P/E multiple of 23.2x.

Particulars (Rs Mn)	FY14	FY15	FY16	Q1 FY17
Revenue From Operations	1261.7	25605.9	28940.4	7653.9
EBITDA	195.7	4043	5324.1	1621.1
Reported PAT	62.1	3151.8	4342.4	1350.6
EBITDA (%)	15.50%	15.80%	18.40%	21.20%
Reported PAT (%)	4.90%	12.30%	15%	17.60%
RoE( %)	1.30%	29.80%	38.90%	11.60%
RoCE (%)	3.40%	28.40%	38.30%	11%

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Below are few key observations of the issue:

• L&T TS is one of the global leading ER&D players, with leadership position in eight industry verticals (Source: Company RHP).
• Its clientele includes 43 of the top 100 global ER&D spenders, which covers 66.3% of G500 ER&D spend in 2015. Additionally, it derives over 80% of revenue from North America and Europe, which cumulatively accounted for 73% of the ER&D service spending.
• The ER&D market is currently under served with a penetration level of around 6.7% in 2015. Thus there is a significant growth opportunities in the outsourcing of ER&D services. 
• As of 31st Aug. 2016, L&T TS has filed 35 proprietary patents and 134 co-patents with customers that can be monetized in future.
• Since the last quarter, the entire IT sector is under pressure, mainly due to the risk associated with the Brexit. Although the company’s exposure to UK market is around 2% of the total revenue, it will not be spared from the overall prevailing negative sentiment. Moreover, the recent lower growth guidance given by the domestic major IT companies, would support the near term negative sentiment.
• Recently the L&T group came up with an IPO for its group company L&T Infotech Ltd., which was not well received by the market, despite being a fundamentally strong company. This time I believe, the investors will be cautious before subscribing for the issue. 

Verdict 

Considering its market leadership and higher profitability and return ratios, I feel that the issue is fairly valued. Thus, I recommend a “SUBSCRIBE with Caution” rating for the public issue.

Do let me know your thoughts in comment section....

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