Investors better off buying L&T Tech on dips after listing

ET Intelligence Group: Investors may skip the initial public offering ( IPO) of L&T Technology Services. The offer price makes its valuation expensive when compared with peers.Investors may , however, consider buying the company's stock on dips after listing due to its niche focus on engineering design and research and strong parentage in the form of India's largest infrastructure company, Larsen & Toubro (L&T). The parent's stake will fall to 89.8% in L&T Technology from current 100% after the listing.

BUSINESS
With over 9,400 employees across 12 global delivery centres, the company provides engineering, re search and development services in the fields of manufacturing, technology, and process engineering. Some of its clients in clude BMW, Caterpillar, John Deere and Intel. It derives over half of the revenue from transportation and industrial segments. The US and the European Union form 60% and 20% of its total revenue, respectively.The company has significant presence in research and design services (ERD).It works with 43 of the top 100 global ERD spenders.

Globally , product engineering market is estimated to be close to $ 215 billion and India's share is just over $20 billion.Within this, the share of third-party vendors such as L&T Technologies is $7.8 billion. To take advantage of the opportunity , the company has a strategy of expanding the billing size of 30 existing customers to $ 50 million each from $10 million at present.

FINANCIALS
Revenue increased at a compounded annual growth rate (CAGR) of 23% over the last three years with stable margin at 17%. In the past two years, it paid 80% of its net profit as dividend.The return on equity ( RoE) is 38%, which is superior to mid-sized and large-sized IT Services companies.Revenue per employee of the company is $50,000, compared with that of peers at $45,000-46,000.

VALUATION
Considering 10% and 12% expected revenue growth in dollar terms with a flat margin for FY17 and FY18, the compa ny will be valued at 16 times the FY18 earnings.This is more than the valuation of some of the top and mid-sized IT services companies. In addition, the asking market capitalisation of L&T Technology services is 1.7 times that of Cyient despite having similar revenue base. Cyient earns nearly 68% of revenue from ERD with a margin of 13%. Its client base includes Boeing, Airbus and IBM among others. Based on the higher-end of the offer price, L&T Technology demands a premium of 60% to its peer Cyient on market cap.

Given such a high asking valuation and subdued market sentiment for technology stocks, long-term investors may wait for the secondary market buy instead of participating in the initial offer.