L&T Technology Services-IPO Analysis

About the Issue
L&T Technology Services Ltd., a subsidiary of L&T has opened its public offer from September 12, 2016 to September 15, 2016. Company is issuing 10,400,000 shares under offer for sale of face value Rs 2 in the price band of Rs 850- Rs 860 per share. Shareholders will raise upto Rs 894 crore from this offer for sale.

Purpose of the IPO
The company wants to gain benefits of listing the equity shares on the stock exchange by carrying out selling of shares by shareholders.

Industry Outlook
Engineering research and development (“ER&D”) services is defined as the set of services provided to product and process companies for helping them develop and deliver their own products and services for their end customers. The demand in this sector mainly comes from in-house teams and off-shore centres. Mostly companies prefer off-shore service centres from India and China owing to low cost of employees. 

According to Zinnov, global in-house R&D centres have grown by 7.6 per cent in FY2015 over FY2014 whereas global third-party ER&D service providers have grown by 8.7 per cent in FY2015 over FY2014. The growth of global in-house R&D centres also benefits third-party ER&D service provider growth, as in-house R&D centres tend to use a co-sourcing model, which uses talent and expertise from third-party ER&D service providers.

There is huge opportunity for Indian ER&D companies due to huge untapped market as India has only 22 per cent market share in ER&D segment and quality talent pool at low cost. We see growth at 13 per cent CAGR over FY15-20 in Indian ER&D market. In-house ER&D service providers exhibit growth at 12.5 per cent CAGR over FY15-20, which is slower than Indian offshore ER&D service centres.

Company Outlook
L&T Technology Services is incorporated in 2012, engaged in the business of third party engineering, and is a research and development service provider. According to Zinnove's report, LTTS has been recognised in the leadership zone among eight industry verticals. Being a pure play engineering and end-to-end service provider, it has advantage over other IT companies.  
 
LTTS enjoys strong parentage from L&T as this brand is associated with other global capabilities. Strong parentage benefits the company to cater to potential business opportunities and to grab quality talent. LTTS has lower attrition ratio of 13 per cent, which is considered healthy in the industry.  LTTS has reached utilisation rate of 76 per cent in Q1FY17 vs 70 per cent in FY15. 

Being an innovative and solution oriented service industry, it has been successful in retaining customers as it has 90+ per cent business as a repeat business. Top 20 customers of LTTS contributed 54 per cent in the revenue pie in FY16 vs 56 per cent in FY15. According to Zinnov, LTTS serves 43 per cent business out of top 100 global ER&D spenders, which embodies 66 per cent of G500 ER&D corporate spending. Growing top 100 ER&D spenders leaves huge opportunity for LTTS. The company has added 36 new clients in FY16 which caters to 5.4 per cent of business revenue, which in turn increases scope of client mining. The company focuses on developing relationship with clients in $ 5-10 mn revenue bracket under “T30:A30” model. 

LTTS is focusing on investing in innovative labs to cater to customer needs. Currently it has 31 labs in India that provide competitive advantage over peers. LTTS has done two selective acquisitions till date under inorganic growth strategy. LTTS intends to go in for acquisitions outside India to expand its overseas footprint. 

Financial Performance

Company’s topline has increased by 15 per cent to Rs 2969.4 crore in FY16 vs FY15 driven by repeat business. EBITDA margin of the company has expanded by 300 bps points to 20 per cent on a YoY basis in FY16 due to improved utilisation rates and better onshore-offshore mix. PAT of the company has increased by 38 per cent to Rs 434.2 in FY16 on a YoY basis.
 
Peer Comparison and Valuation

LTTS with EPS of 43.5 at upper price band P/E of 19.77x looks attractive as compared to its peer TATA Elxsi. Company also enjoys healthy leveraged position at D/E of 0.2x with higher RoNW of 38.85 per cent and average cash flow from operation of Rs 446 crore. Considering strong financials in line with peers, we suggest to go in for subscription with long term vision.