L&T Infotech’s valuation gets a reality check

In an unusual turn of events, L&T Infotech Ltd on Monday withdrew the draft red herring prospectus (DRHP) it filed with the Securities and Exchange Board of India, and filed it afresh on Tuesday. According to investment bankers, this was necessary because the estimated size of the issue has been cut by more than 10%. As it turns out, the estimated size of the issue has been cut by almost 30% to around $200 million, according to news reports.

The Nifty IT index has corrected by around 5% since the time L&T Infotech filed its DRHP the first time in end-September.

Clearly, its valuation estimates were far too high to begin with, necessitating the sharp cut in the issue size.

Parent Larsen and Toubro Ltd (L&T), which currently owns all of the company’s shares, is offering a part of its stake in the issue. The number of shares to be issued will remain the same at 17.5 million. Based on the earlier rumoured issue size of up to Rs.2,000 crore, L&T was expecting a valuation of around 24 times fiscal year 2015 earnings. This has been toned down to around 16-17 times.

Large-sized IT services companies such as Tata Consultancy Services Ltd and Infosys Ltd trade well above 20 times FY15 earnings, and so is the case with some smaller-sized firms such as Mindtree Ltd and Hexaware Technologies Ltd. But these firms have grown at faster rates.

Mindtree has grown revenues at an annual average growth rate of 23% in the three years till FY15, while growth at Hexaware has stood at 21.2%. L&T Infotech’s growth was lower at 16.1% during the same period.

Operating profit margins are comparable with Mindtree at around 20%, although they are ahead of Hexaware. However, free cash flow generation is lower at L&T Infotech at around 9% of revenue. For the other two firms, free cash flow generation as a proportion of revenue was in double-digits.

Besides, like most other mid-sized firms, L&T Infotech carries greater risks such as high client concentration. Its two largest customers, Citibank and Chevron, account for 21% of revenue.

Against this backdrop, L&T was clearly aiming too high by demanding valuations of around 24 times trailing earnings earlier. The fact that it has toned down expectations sharply should help the issue sail through.

Larsen & Toubro Limited