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L&T Technology Services IPO - Should you buy?

If you believe in the brain-power of India's engineers, L&T Tech merits a long hard look. Go through our tests to find out if it also merits your money

L&T Technology Services IPO - Should you buy?

For a land of engineers, it is companies like L&T Technology Services that are its temples. 8000 of them (with an average age of 31) toil away in the company's facilities. It was established in 2014 from two former divisions of the famed Larsen & Toubro - Product Engineering Services and Integrated Engineering Services. The company essentially helps other companies design, develop, test and rollout their products and manufacturing processes. Which kind of companies, you ask? Telecom, Transport, Industrial Products, Processes and Medical Devices as the figure below shows. The company has 27 sales offices in India and 12 'Global Delivery Centres.' It also has 31 labs. Roughly 60% of its revenues come from the USA and about 20% from Europe with Fortune 500 names such as Caterpillar, John Deere, P&G and Shell featuring in the client list. As is common in small IT companies, a large proportion (about 54%) of revenues come from the top 20 customers. However 94.6% of them are repeat customers.

L&T Technology Services IPO - Should you buy?

The company displays a scorching ROCE of 48.76%, no debt (other than short term borrowings) and loyal customers. Its pedigree is also impeccable and it's generous with dividends, distributing about 80% of its profits as dividends. Weighing against this are its heavy client concentration, relative youth and expensive valuation (PE of about 21 and PB of about 8. Another way of looking at it is that at its current price band it will be valued at more than 1 crore per employee.

Before you make up your mind, read the answers to our tests.

Who's selling and how much? Larsen & Toubro is lowering its stake in the company from 100% to 90%.

Here's our risk score based on the tests we have set. A higher positive score denotes a stronger investment case and vice versa.

L&T Technology Services IPO - Should you buy?

  1. Is the company's earnings before tax more than Rs 50 cr in the last twelve months?
    Yes, it is 535cr.
  2. Will the company be able to scale up its business?
    Yes, the company provides design and development solutions in the areas of mechanical and manufacturing engineering, process engineering, software engineering and embedded systems. In short, it enables customers create new products and solutions, reduce costs of development and meet regulatory requirements. Companies around the world are increasingly focused on bringing more competitive products and solutions at lower costs creating plenty of opportunities for L&T Tech.
  3. Does the company have recognizable brand/s, truly valued by its customers?
    Yes, L&T Tech enjoys the brand and goodwill created by its parent L&T.
  4. Does the company have high repeat customer usage?
    94.6% of L&T Tech's customers are repeat customers.
  5. Does the company have a credible moat?
    No, L&T operates in an intensely competitive industry that experiences rapid technological changes
  6. Is the company sufficiently robust to major regulatory or geopolitical risks?
    No, the company has significant geographic customer concentration. If a major customer is negatively impacted by geopolitical event (eg Brexit), L&T Tech will also be impacted. Moreover, L&T Tech provides services to improve product quality and meeting regulatory requirements. If the product designed or developed by L&T for its customers does not meet regulatory requirements, L&T Tech could face legal issues and could also be liable to compensate its customers.
  7. Is the business of the company immune from easy replication by new players?
    Yes. The company's product and services are highly technologically complex and cannot be easily replicated.
  8. Is the company's product able to withstand being easily substituted or outdated?
    No. Rapid innovation in the industry can lead to the company's product being easily substituted or outdated.
  9. Are the customers of the company devoid of significant bargaining power?
    No. The top 10 customers contribute 36.2% to L&T Tech revenue giving them significant bargaining power.
  10. Are the suppliers of the company devoid of significant bargaining power?
    This question doesn't apply since the company has no major suppliers.
  11. Is the level of competition the company faces relatively low?
    No, competition in very high.
  1. Do any of the founders of the company still hold at least a 5 per cent stake in the company? Or do promoters totally hold more than 25 per cent stake in the company?
    Yes, L&T will continue to hold 90% stake after the IPO. However, it is required to bring its stake below 75% within 3 years of listing as per its listing agreement and SEBI Rules.
  2. Do the top three managers have more than 15 years of combined leadership at the company?
    Yes, L&T Tech like its parent boasts of highly talented and well experienced management.
  3. Is the management trustworthy? Is it transparent in its disclosures and are they consistent with Sebi guidelines?
    Yes, there is nothing in the prospectus or in public domain that makes us believe otherwise.
  4. Is the company free of litigation in court or with the regulator that casts doubts on the intention of the management?
    Yes, however company does faces certain litigation on taxation matters (amount involved is only 4.4 million rupees).
  5. Is the company's accounting policy stable?
    Yes, but company has a financial history of only 2 years.
  6. Is the company free of promoter pledging of its shares?
    Yes, there is no pledging.
  1. Did the company generate current and five-year average return on equity of more than 15 per cent and return on capital of more than 18 per cent?
    Yes, but with the caveat that it has been in existence for less than 5 years.
    Particulars (for FY 15-16) Current Return
    ROE 38.14%
    ROCE 48.76%
  2. Was the company's cash flow-positive during the previous year and at least four out of the last five years?
    Yes, it was positive in the 2 years of its existence.
  3. Did the company increase its revenue by 10 per cent CAGR in the last five years?
    Limited Data is available on this question. Revenue grew by 18.86% last year.
  4. Is the company's debt-to-equity ratio less than 1 or is its interest coverage ratio more than 2?
    Yes, company is debt free in terms of long term debt. Short Term borrowings are 20% of equity. Interest payments (or equivalent bank charges) are negligible.
  5. Is the company free from reliance on huge working capital for day to day affairs?
    Yes, net Working Capital as a percentage of total assets is at a reasonable level of 21.57%.
  6. Can the company run its business without relying on external funding in the next three years?
    Yes, company pays more than 80% of its net profit to equity shareholders as dividend.
  7. Have the company's short term borrowings remained stable or declined (not increased by greater than 15%)?
    Yes, short term borrowings have fallen by 10% in last 12 months.
  1. Does the stock offer operating earning yield of more than 8 per cent on its enterprise value?
    No, at a price band of 850-860, it would be 6.16%-6.09%.
  2. Is the stock's price to earnings less than its five or ten year median level?
    At price band of 850-860, the price to earnings would be about 21.
  3. Is the stock's price to book value less than its five or ten year average level?
    At price band of 850-860, the price to book would be approximately 8.

With inputs from Kashyap Sriram and Neil Borate.