L&T Infotech Primary Offer: Cheap, but no key differentiator

L&T Infotech, a mid-sized Indian IT services company, is making an initial public offer. Larsen & Toubro (L&T), the promoter, is selling 10.3 per cent stake (of 94.9 per cent now) to raise about ₹1,240 crore through the issue. At the asking price of ₹705-710 per share, the stock is valued at 12.5-12.6 times the company’s per share earnings of 2015-16 (₹56.13).

Companies of similar size such as Hexaware, Mindtree, Persistent Systems and Mphasis trade at about 16-18 times the trailing earnings. Retail investors will be offered a discount of ₹10 per share on the offer price. So the asking price is cheap, leaving room for gains on listing. Those with a stomach for risk and eyeing quick gains can buy into this offer.

For long-term investors though, there does not seem to be much promise in the stock. Those looking for a bite of the IT sector can pick up growth stocks such as Mindtree or Persistent Systems in the mid/small-cap space. Of the big five IT stocks, HCL Technologies and Tech Mahindra also now trade at attractive valuations of 13-14 times.

L&T Infotech has grown revenue at a compounded annual rate of 13.5 per cent in the last two years, while peers of similar size have grown at 18-25 per cent.

The attraction with smaller IT services companies is their strength in niche businesses. Persistent Systems, for instance, has a promising IP business; NIIT Tech is strong in travel and logistics space and Mindtree has been driving innovations through its digital offerings. But L&T Infotech’s business lacks any such differentiator. The company competes with big IT service providers in BFSI and other verticals. Given that the global economic conditions are tough, if clients prune their discretionary spends, they will consolidate their vendors and smaller players such as L&T infotech, with no unique business offering, are most likely to lose out.

L&T Infotech’s revenue was $887 million in 2015-16. It will take one to two years to cross the $1-billion mark in revenue and lay hands on larger deals.

The company’s attrition rate is also among the highest in the industry — 18.4 per cent in 2015-16.

Concentration risks L&T Infotech’s portfolio is heavily concentrated on a few clients. The company’s top ten clients accounted for 52.7 per cent of revenue in 2015-16, higher from the previous year’s 49.5 per cent. Though most smaller IT companies have a focused portfolio, L&T Infotech’s revenue mix is overly skewed, thus posing a risk to revenues, even if one of them withdraws. For Mindtree and Persistent Systems, the business from top 10 clients accounts for about 45 per cent of revenue.

In terms of contribution from different verticals again, the company has a concentrated exposure. The banking and financial services vertical, along with the insurance business, account for about 47 per cent of revenue. L&T Infotech’s other key business — energy — which accounts for about 13 per cent of revenue now, is also under pressure due to crash in oil prices. Among the Indian IT services companies, L&T Infotech has the highest exposure to the oil space.

L&T Infotech’s differentiating capability is in the infrastructure and manufacturing space, thanks to the L&T parentage. But the industrials cluster — that accounts for about 46 per cent of revenue and comprises energy, automotive, aerospace, engineering and construction among others — has grown at a slower pace. The annualised growth in the industrials cluster in the last two years was 8 per cent, lower than the 18.5 per cent in the services cluster.

Though L&T Infotech has set foot in the next-gen digital business, it is yet to carve a niche for itself in the highly competitive global market. The company’s digital business now accounts for 11 per cent of revenue. Given the challenging global economic scenario, the next few years is going to be tough for Indian IT services players. Only those who differentiate may grow.

L&T Infotech’s management has indicated its intention to expand into new geographies, target high contract value orders and expand on IMS (infrastructure management services) offerings in the next few years. But how quickly it is able to do this will determine its prospects.

Positives L&T Infotech’s margins have been in line with peers. The operating profit margin in 2015-16 was 17.7 per cent, two percentage points lower than the previous year. All Indian IT services companies have been facing margin pressure due to rising competition. But the good thing about L&T Infotech is that its employee productivity is high. Its revenue per employee stands at $48,550, in line with big players.

Another positive is the company’s lower 17 per cent exposure to Europe. Risks from ‘Brexit’ may thus not hit it as much.

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