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Note: This article has no recommendation to either buy or avoid this IPO. Instead, we have presented all the relevant information based on which you can make your own decision.
Dixon Technologies is a contract manufacturer. It makes consumer electronics (think TVs, home theatres), mobile phones, lighting products (LED bulbs, CFL lamps etc) and home applies for companies such as Panasonic and Phillips. This is an unglamorous business but has proved to be a steady one (the company's been at it since 1993).
Dixon started with colour televisions in the 1990s and gradually expanded its product suite to include lighting products, washing machines and mobile phones. It has long-standing relationships with some customers (going up to 8 years for Phillips) as well as promising new ones with others such as Gionee. Although Dixon operates on slim margins, it has an return on capital of a whopping 37% in FY17. This is mainly on account of its rapid working capital cycle - churning out products with tremendous speed. Dixon is pushing to improve its value add in the manufacturing process, by trying to improve revenue share from the higher margin ODM (Original Design Manufacturing) business currently about 22%. It is also integrating backwards, a move that should control both quality and cost.There have also been instances of contract manufacturers later successfully launching their own brands. The most famous example is that of Microsoft which commenced operations by supplying software to IBM. A move in this direction, albeit risky, could transform Dixon's fortunes.
As you would expect with a contract manufacturer, Dixon operates on wafer thin margins (a roughly 4% EBITDA margin and 2% PAT margin). Its top 5 customers account for 83% of its revenues, a key vulnerability. Indeed among these just Panasonic and Phillips together account for about 60%. Its contracts are primarily short term and customers can easily walk away (though key ones have not, so far). A lot of its suppliers (about 80%) are foreign and many of them have to be approved by its customers.
Where the money is going?
57% is going to private equity funds run by Motilal Oswal (incidentally one of the lead managers of the issue).
33% is going to the promoters. Within this segment, 19% is going to Mr Sunil Vachani (its largest individual shareholder)
10% is going to the company as a fresh issue primarily to repay its debt, improve its IT systems and set up a new manufacturing plant in Tirupati.
Company / Business
- Were the company's earnings before tax more than Rs 50 cr in the last twelve months?
Yes, Dixon`s earnings before tax in the last twelve months were Rs 69 crores. - Will the company be able to scale up its business?
Yes, the company is a play on the Indian growth story and has huge potential given the size of the Indian market. Product life cycles are getting shorter (think people replacing their mobile phones often) generating more demand for Dixon's products. Two technological waves sweeping through India - the migration from feature phones to smartphones and from CFL to LED bulbs and lamps are acting strongly in its favour. - Does the company have recognizable brand/s, truly valued by its customers?
Yes, Dixon has loyal reputed customers such as Philips and Panasonic. These companies have been Dixon's customers for more than 8 years and 4 years respectively. Within the market for contract manufacturing, Dixon commands market shares of 50%, 43% and 39% in FPD (fast panel display) TVs, washing machines and LED/CFL lights respectively. - Does the company have high repeat customer usage?
Yes, Dixon has substantial repeat business from it customers. It commenced operations by making colour televisions for Philips and then expanded to DVD players, home theatres and lighting products. It followed a similar path with Panasonic. - Does the company have a credible moat?
No, the company operates in a very competitive market which has little differentiation. New or larger players with significant cost advantage can take the business away from the company. - Is the company sufficiently robust to major regulatory or geopolitical risks?
No, changes in government regulations such as increases in mandatory wages in India or the withdrawal of specific advantages to the sector can affect its business significantly. - Is the business of the company immune from easy replication by new players?
No, it can be easily replicated by new entrants. It do not require complex regulatory approvals and large capital expenditure. - Is the company's product able to withstand being easily substituted or outdated?
Yes, outsourcing will always remain in demand. Companies are increasingly outsourcing their non-core activities and manufacturing processes to contract manufacturers for reasons of cost and specialization. - Are the customers of the company devoid of significant bargaining power?
No, Dixon has very large reputed clients who are not fully dependent on a single supplier. It also has short term contracts, allowing customers to leave at short notice if the company's pricing becomes uncompetitive. In 2017, its top five customers accounted for 83% of its revenues. - Are the suppliers of the company devoid of significant bargaining power?
Yes, there is no reason to believe that its suppliers have great bargaining power. In addition, Dixon's strategy is to have at least two suppliers for its requirements. - Is the level of competition the company faces relatively low?
No, the company operates in a very competitive environment where new entrants can easily enter the market.
Management
- 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, Sunil Vachani (Promoter and Executive Chairman) still holds 43.97% of the pre offer equity in Dixon. - Do the top three managers have more than 15 years of combined leadership at the company?
Yes, the top two executives of the company have been associated with the company since inception and its Chief Operating Officer has been associated with it since 2010. - Is the management trustworthy? Is it transparent in its disclosures, which are consistent with Sebi guidelines?
Yes, we have no significant reason to believe otherwise. However the promoter of the company is involved in litigation due to which he cannot travel abroad without court permission. The case relates to the promoter's father and is wholly unrelated to Dixon. The company is also unable to trace some of the documents related to educational qualifications and professional experience of its key managerial personnel. - Is the company free of litigation in court or with the regulator that casts doubts on the intention of the management?
Yes, there are no major cases against the company which cast doubt on the intention of the management. Some corporate filings for the period 2009-11 are not traceable. - Is the company's accounting policy stable?
Yes, we have no reason to believe otherwise. The company did change its inventory valuation method from weighted average to first in first out in FY 13-14 but this was a relatively straightforward change and did not distort the company's financials in any significant way. - Is the company free of promoter pledging of its shares?
Yes, no promoter holding is pledged.
Financial
- 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, the company`s average five year ROE and ROCE are 23% and 22% respectively. Current ROE and ROCE stand at 31% and 37% respectively. - Was the company's operating cash flow-positive during the previous year and at least four out of the last five years?
Yes, the company had positive operating cash flow in all five years. - Did the company increase its revenue by 10 per cent CAGR in the last four years?
Yes, the company has witnessed very healthy revenue growth at a rate of 34% in last four years. - Is the company's net debt-to-equity ratio less than 1 or is its interest coverage ratio more than 2?
No, as of July 31,2017 the company had a net debt to equity ratio of 1.02. Whilst we considered the latest debt figure, the equity figure we considered was that of 31st March 2017 due to lack of more recent data. However there is little reason to believe that its equity book value would have changed significantly in the intervening period. As of March 31, 2017 its interest coverage ratio stood at 6.4 times. - Is the company free from reliance on huge working capital for day to day affairs?
Yes, Dixon has low working capital requirements and its net working capital requirement stands at just 2.4% of its revenues. Its cash conversion cycle has also improved from from 9 days in 2013 to 5 days in 2017. - Can the company run its business without relying on external funding in the next three years?
No, Dixon procures working capital loans at regular intervals and it will continue to do so in future. - Have the company's short term borrowings remained stable or declined (not increased by greater than 15%)?
No, the company is increasingly procuring additional working capital loans. As of July 31,2017 Dixon had working capital loans of Rs 80.7 crores in comparison to Rs 33 crores on Mar 31,2017, an increase of 144% over a 3 month period.
The Stock/Valuation - Does the stock offer operating earnings yield of more than 8 per cent on its enterprise value?
No, the post IPO operating earnings yield of the company will range from 3.76%-3.77% based on the price band range. - Is the stock's price to earnings less than its peers' median level?
There are no suitable listed peers for Dixon. At a price band of Rs 1760-1766, its PE will range from 38.1-38.2. - Is the stock's price to book value less than its peers' average level?
There are no suitable listed peers for Dixon. At a price band of Rs 1760-1766, its PB will range from 9.78-9.81.
IPO Lead Managers - IDFC Bank, IIFL Holdings, Motilal Oswal Investment Advisors, Yes Securities
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