Tech Mahindra tests market with sizeable IPO

The telecom-focused IT services provider eyes up to $100 million as British Telecommuniations and Mahindra & Mahindra monetise part of original investment but retain control of the company.
Tech Mahindra has started to market an initial public offering of up to $100 million, which it hopes will draw investor interest both because of its position as one of IndiaÆs leading providers of IT services to the telecom industry and because of its high-profile controlling shareholders.

The latter may be needed as this will be the first sizeable IPO to hit the Indian market since the sharp correction in May and June saw the benchmark Bombay Sensex index lose a quarter of its value in little more than a month. The index has since risen 7% from those lows, but Tech Mahindra's IPO will provide a real test of whether the market is ready for new primary issues.

Founded as a joint venture between Indian tractor and utility vehicle manufacturer Mahindra & Mahindra and British Telecommunications in 1986, the company has branched out from its original focus of providing services to telecom operators. It now also count telecom equipment manufactures and independent software vendors as its clients, including Motorola and Oracle. However, itÆs key clients are BT, AT&T and Alcatel.

The company is offering 12.75 million shares, or 11% of its enlarged share capital, at a price between Rs315 and Rs365 per share for a total deal size of Rs4.01 billion to Rs4.65 billion ($86 million to $100 million).

ABN AMRO Rothschild and Kotak Mahindra are acting as joint bookrunners for the deal.

Of the total amount on offer, 9.6 million shares are to be sold by the controlling shareholders with BT providing 60% and M&M the other 40%. The remaining 3.8 million shares will be new shares issued by the company to raise fresh capital that will be used to improve its delivery infrastructure. According to a draft listing document, Tech Mahindra has already acquired 98,400 square metres of land at the Rajiv Gandhi Infotech Park in Pune to build a new facility for this purpose, adding to its nine existing development centres.

M&M will still hold 46.41% of the company after the IPO, while BT will hold 32.55%. A company named Mahindra-BT Investment Co, which is also part of the promoter group, will have 8.57% and employees of the company 1.47%

The indicated price range values the company at about 11 to 12.5 times its projected earnings for fiscal 2007, according to the consensus forecasts. However, according to one source, the companyÆs first quarter results were stronger than anticipated and if it keeps up that performance for the rest of the year, the current earnings forecasts are looking a bit on the conservative side.

The valuation looks quite generous compared with sector peers like Infosys Technologies, Tata Consultancy Services, Wipro Ltd, and HCL Technologies, which trade at fiscal 2007 earnings multiples ranging from 22 to 25 times. Patni Computer Systems stands out on the low side with a PE ratio of 12.3 times after underperforming the rest of the sector in recent months.

All of these players provide IT services to a wider range of industries, however, and one analyst noted that Tech MahindraÆs specialisation on the telecom industry, as well as its smaller size, should warrant a discount of some sort. New York-listed Amdocs, which also has a strong focus on the telecom industry, trades at about 20 times its forecast 2006 earnings.

However, the same analyst also noted that one could argue that a smaller, but fast-growing, company should trade at a narrower û if any - discount to it larger peers. Here, the Mahindra name should help as it provides a degree of comfort that the management will be able to deliver on its business plans and projections, given that Mahindra has a strong track record in that respect with other group companies.

In fiscal 2006, which ended on March 31, 2006, Tech Mahindra posted a 130% jump in net profit to Rs2.35 billion ($50 million), following a 61% net profit increase in the previous fiscal year. Based on the syndicate forecasts, the bottom line will grow by at least 40% in the current fiscal year.

Revenues improved by 31% to Rs12.4 billion ($266 million) in the most recent fiscal year.

ôWhile mid-cap companies arenÆt doing great right now, technology as a sector is looked upon as a defensive industry and it also has a low correlation with high oil prices. So, if the management has a clear and concise picture of next year to present to investors, I think it should do okay,ö says one market watcher, adding that the indicated valuations are by no means exorbitant.

The company, formerly known as Mahindra-British Telecom Ltd., seeks to cash in on expectations that global spending in the telecom industry will continue to grow at a steady pace, driven by the migration to next generation networks. The growing amount of offshore outsourcing û particularly to India û is also underpinning total industry investments, it said.

Ovum Research projects that spending on IT and software by telecom operators will increase at a compound annual growth rate of 5.8% from $30.6 billion in 2005 to $38.4 billion in 2009.

At the same time, telecom equipment manufacturers are expected to continue to spend to support a CAGR of 3% in revenue in that same period to $347 billion in 2009, given the technology intensive nature of the business and the amount of money historically spent on research and development by the leading players.

Given its ties to BT, the company still derives about three quarters of its revenues from Europe, with BT alone accounting for 69% in the last fiscal year û an obvious risk factor should BT for some reason decide to cut back on IT spending or shift to another provider. However, for the time being it also provides a certain stability to the earnings base.

However, the company is trying to offset its strong dependence on a limited number of clients û the five largest accounts generate 85% of revenues û and in recent years it has seen rapid growth in the US and in Asia Pacific. It now has clients in more than 40 countries, including Singapore, Australia, Taiwan, Indonesia and India. North America has seen its share of total revenues grow to 18% in fiscal 2006 from 10% two years earlier.

According to the National Association of Software and Service Companies, Tech Mahindra is IndiaÆs eighth largest provider of IT software and services in terms of export revenues, although the fact that it focuses solely on the telecom industry does make it quite unique among its peers.

According to the draft listing document, it also wants to expand the breadth of services on we offer and focus more on higher value added services such as managed platforms, managed services and consulting, which tend to be more long-term in nature. While the company has historically expanded only through organic growth, the acquisition of Axes in 2005 did mark a start of what is likely to be more acquisitions, joint ventures and strategic initiatives, the company says.

Axes offers various services to telecom equipment manufactures and significantly helped strengthen this part of the companyÆs business when it was bought last year.

About 27.3% of the total share issue has been set aside for retail investors, while 54.5% is expected to be sold to qualified institutional buyers. The rest will go to non-institutional investors and employees of the company.

The order books will stay open until August 4 and the shares are expected to start trading on August 23.
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