L&T-E2E deal throws up some questions

With a marketcap of ₹5 lakh crore or almost $60 billion, one can argue ₹1,400 crore is pocket change for the country’s infrastructure major Larsen and Toubro (L&T). So ideally the company making a ₹1,400 crore investment to acquire a 21 per cent stake in an emerging cloud services provider – E2E Networks (E2), while very significant for E2E, must not be much of a material event for L&T investors. But when one weighs the opportunity versus the price paid, there are few questions that L&T investors need to seek answers for, irrespective of the immateriality of the deal value.

Digital Hot bed

E2E business can be classified as under the IaaS or ‘Infrastructure as a Service segment’. This is a business model under which companies deliver IT infrastructure like computing and storage and network resources on a pay-as-you-go-basis over the internet. While this was already a fast growing business that accelerated during the Covid-19 driven digital transformation boom, it has garnered more importance under the AI theme. The largest players in this space are Amazon Web Services, Microsoft Azure and Google Cloud Platform.

Cutting edge IaaS companies want to provide computing services using Nvidia GPUs to customers to drive their AI journey. E2E is amongst the early companies in India to provide computing infrastructure powered by Nvidia GPUs. This has in recent times caused a frenzy in its stock which is up 900 per cent in the last one year.

In recent times, cloud service providers like E2E have had a booming business with 1H FY25 revenue growing by 115 per cent and EBITDA growing 169 per cent. But its worth noting the company has been in an aggressive investment phase over the last year and has leveraged this. Thus consistent high revenue growth will require consistent capex and need for cash. This is not a business like software where once you have developed a successful product, it generates cash for the long term with minimal investments. In fact E2E’s FY24 annual report notes that ‘the size of the market dictates that we aggressively rely on debt apart from internal cash generation to build out capacity based on the size of the opportunity.’

Valuation out of whack?

But when one looks at the valuation at which L&T is making this investment, the numbers get a bit head-scratching. The valuation at which L&T is buying the stake in E2E appears extreme. If you take March 2024 numbers, the deal valuation works out to an outlandish price by book (P/B) multiple of 94 times. One can argue that if we take the  unaudited Balance Sheet as of September 30, 2024, the P/B multiple is more a sober 13.7 times. But it is important to note here that this difference in P/B multiple between the two dates is mainly due to capital raise of ₹393 crore in 1H of FY25. Excluding this cash boost to net worth/book value, the P/B (considering net worth excluding cash) for the deal works out to 71 times.

When considering the trailing twelve months revenue ending September 30, 2024, the EV/Revenue valuation for the deal is a pricey 47 times while EV/EBITDA is  around 75 times!

And after paying such a high valuation L&T is only going to remain a minority shareholder with a 21 per cent stake and does not even get a chance to take control of the company. So the answers that L&T investors must seek is  what is the unique moat in E2E, that actually justifies a deal at such valuations? Is a stake buy from investing ₹1,400 crore at inflated valuations, a more profitable way to grow for L&T than building out the IaaS infrastructure  on its own?

For a perspective, while E2E may not be comparable with the mega cloud players like AWS, NYSE listed DigitalOcean holdings which is relatively smaller IaaS company trades at a EV/Revenue multiple of 6 times.   

The primary asset for cloud service providers is their net block (primarily investments in computers and equipment)  that are leveraged to provide services to customers. As of September 30, E2E had a net block of ₹212 crore. Business potential largely revolves around these operating assets and management/employees potential to optimize this. Company will continue to grow given the strong cash position built up from recent capital raise and the upcoming inflow of funds from L&T as well.

But for now the difference between its market cap (₹8,824 crore) and net block is quite stark.