L&T Technology Services IPO: a pricey niche play

L&T Technology Services, a subsidiary of the engineering major L&T, operates in the engineering, research and development (ER&D) services market. A prominent player within the space, L&T Technology Services is well placed to ride the opportunities, thanks to its strong parentage. However, the asking price for the issue, which is on the higher side, is a dampener.

The parent L&T is selling 10.2 per cent of its stake in the company through the primary offer and raising about ₹894 crore. The higher end of the price band of ₹850-860 discounts the company’s 2015-16 earnings by 20.9 times, which is higher than the valuation its peer Cyient commands. A comparable peer in the domestic space, Cyient trades at about 18 times its trailing earnings (of 2015-16).

Moreover, technology stocks have been beaten down lately, owing to concerns emerging on the possible impact of Brexit on Indian service providers. Markets have been particularly unkind to mid-cap IT players that face additional challenges of expanding into new geographies and acquiring companies to sustain their growth momentum. Also, investors who want a slice of the action in the engineering services space have the option to buy stocks of bigger companies such as HCL Technologies or Tech Mahindra that have a large engineering services business. Hence, investors can avoid the issue and watch for consistency in earnings for a few quarters before investing in the stock.

ER&D service is likely to see a stronger growth than the plain vanilla IT services over the next few years, given the momentum seen in segments including automobile and aerospace, and the increased adoption of robotics and IoT technologies by users worldwide. In 2015, according to Nasscom, Indian engineering services exports grew 12.6 per cent. In comparison, IT Services exports grew by a lower 10.3 per cent.

The outsourced ER&D space is under-penetrated and has a large scope for growth. In the next few years as demand for smart products grows, there will be demand for ER&DS providers to develop and maintain products and platforms. And, since not all of it can be done in-house, third-party service providers with cross functional skills, will see opportunities.

L&T Technology provides services to manufacturing, technology and process engineering companies. The company derives about 80 per cent of its revenues from customers in North America and Europe which represent about three-fourth of the global ER&D services market. L&T Technology is a prominent player among pure play engineering service companies globally. Till 2014, the company was functioning as a division within L&T, but, it has since started functioning independently with the group’s Integrated Engineering Services (IES) and Product Engineering Services (PES) business having come under it.

The company serves five segments — transportation, industrial products, telecom and hi-tech, process industry and medical devices. It has seen rupee revenues grow at a compounded annual rate of 23 per cent in the last three years (including revenues of L&T’s IES and PES business for 2012-13 and 2013-14). In 2015-16, the total revenue was ₹3,066.5 crore (similar in size to Cyient). Operating margins stood at 17 per cent for 2015-16, up from 15.2 per cent in the previous year. Considering that peers in the pure play engineering services space operate at margins of around 14-20 per cent, L&T Tech’s margins are good.

While the ER&D space looks promising, L&T Technology being a mid-sized player, has several challenges to tackle. For one, the ever changing dynamics of the industry, require huge investments by players in research and building consulting capabilities. The bigwigs of the Indian IT industry are themselves finding it difficult to ramp up their capabilities.

Two, L&T Technology will have to actively look for opportunities to grow inorganically to scale up its business. Despite its strong foothold in the plant engineering and industrial equipments space, thanks to its L&T parentage, the company will have to expand into more geographies and add delivery centres in Europe and Asia.

Meanwhile, the public issue of L&T Technology Services was subscribed 18 per cent on the first day of the three-day bidding on Monday. The portion set aside for qualified institutional buyers was subscribed 28 per cent, while non institutional investors got 2 per cent subscription and retail investors category 19 per cent.