L&T Infotech IPO is going to open on 11 July and will close on 13 July 2016. The upcoming IPO has been priced in the range of INR705 – 710 per share, although retail investors will be offered a discount of INR10 per share, making it only the second public issue this year to offer a discount after Parag Milk Foods. The forthcoming IPO will involve the sale of 17.5 million shares by its promoter Larsen & Toubro (L&T) which owns 94.96% equity in the infotech subsidiary, the company said in its red herring prospectus (RHP).

At the upper end of the price band, L&T Infotech IPO will mobilize INR12.36 billion (INR1236.3 crore). Since all the shares will be sold through an offer for sale (OFS), L&T Infotech will not receive any proceeds from the IPO. On the basis of the upper end of the price band, the IPO puts a value of INR 120.5 billion on the operations of a Mumbai-based IT services and solutions company. L&T Infotech IPO will be closely watched as the IT pack has seen tremendous volatility in recent days on account of Brexit.

This IPO also comes after five consecutive listings which rewarded investors with at least double-digit percentage returns. Each of the previous five IPOs – Equitas Holdings, Thyrocare Technologies, Ujjivan Financial, Parag Milk Foods, and Mahanagar Gas attracted strong subscription levels which resulted in less allocation. Against this backdrop, L&T Infotech IPO has a difficult task to follow while investors may have high expectations from it.

Read more to find out in this IPO review if this public issue is worth investing into. Shares of L&T Infotech are proposed to be quoted on BSE and NSE and listing is expected on 21 July. Here is a quick snapshot of the L&T Infotech IPO before we delve deeper in the analysis.

L&T Infotech IPO details

L&T Infotech IPO Structure

L&T Infotech is a part of engineering conglomerate L&T which is also the biggest shareholder in it. L&T owns 94.96% of L&T Infotech while the remaining shares are held by long-term employees including AM Naik and YM Deosthalee.

L&T Infotech business background

Established in 1996, L&T Infotech offers an extensive range of IT services to its clients in diverse industries such as banking and financial services, insurance, energy and process, consumer packaged goods, retail and pharmaceuticals, media and entertainment, hitech and consumer electronics, and automotive and aerospace. In 2014, NASSCOM ranked it the sixth largest Indian IT services company in terms of export revenues. Its clients comprise some of the world’s largest and most well-known organizations, including 41 of the Fortune Global 500 companies. L&T Infotech was amongst the top 20 IT service providers globally in 2015 according to the Everest Group’s PEAK Matrix for IT service providers.

Headquartered in Mumbai, L&T Infotech has a track record of high client retention and this is highlighted by the fact that it generated 96.9% of its revenue from continuing operations from existing clients in FY2016. The company seeks to expand the scope of services offered to existing clients to achieve incremental revenue growth. Nevertheless, the company has been historically dependent on North America and Europe for most of its revenues. In FY2016, revenues originating from North America represented 69% of its revenue from continuing operations while Europe accounted for 17.4%. As of May 31, 2016, L&T Infotech had 22 delivery centers and 41 sales offices globally.

Fast and steady – that’s L&T Infotech

As mentioned above, L&T Infotech prioritizes focusing on its existing clients over acquiring new ones. This can give the impression that L&T Infotech is a slow mover but its financial performance is quite impressive. Between FY 2012 and FY 2016, the company has grown spectacularly, almost doubling its top line from INR31.9 billion to INR61.4 billion. This was accompanied by financial discipline and a strong balance sheet (total borrowings made only 0.03% of its total capital in FY2016). As a result, its profits from continuing operations more than doubled during this timeframe. In the financial year ended 31 March 2016, the company earned a profit from continuing operations after tax of INR 9.2 billion, marking a compounded growth rate of 21.8% in the four years. There is absolutely nothing to dislike here.

This is important to highlight that net profit after tax has largely mirrored this trend, except in FY2014 when its earnings got a massive boost as a result of selling PES telecom business to a group firm (which is also an IPO candidate, read more on this here). The transaction also caused its net profit margin to go as high as 19.2%. Margins in subsequent years have stabilized at 15%.

L&T Infotech IPO review: Is there money on the table?

L&T Infotech is not without its share of issues and concerns. While the strategy to focus on getting repeat business from existing clients is excellent, it places an unusually high dependence on a few clients. L&T Infotech suffers from this as its top 10 clients accounted for a whopping 52.7% of revenue from continuing operations in FY2016. In another sign of worry, this trend has been on the upside. Citibank, Chevron, Barclays, and Time Warner are among L&T Infotech’s largest clients. Citibank alone accounted for 14.9% of its annual revenues in FY2016.

The reason why L&T Infotech can get away with this client structure and still manage to grow at decent rates is large that its parent L&T has global business operations and helps its subsidiary tremendously in securing long-term business contracts. The fact that L&T Infotech has honed this craft gives us confidence that it can do so in the future as well.

All may be good with a company and investors may still lose money in its IPO if pricing is not right. That has happened in the past (more detailed accounts here and here) and may happen again. Not difficult to imagine promoters and bankers getting greedy, especially after the string of successful IPOs.

L&T Infotech was susceptible to this mispricing considering it made heavy changes in its offering and had to file the IPO paperwork again. Most important among the changes was the reduction in offer size at lower valuations as the number of shares to be sold remained the same in both instances. The company was reportedly looking to raise around INR20 billion originally by selling 17.5 million shares at a price-earnings (PE) ratio of nearly 24. However, the revised pricing means asking valuations are now more realistic.

Read Also: L&T plans USD1 billion acquisition spree before infotech arm’s IPO

This is indeed the case for L&T Infotech IPO as we learn the offer is at a discount to its listed peers. Remember this is purely an OFS so there is not going to be any dilution in future earnings. On a consolidated basis, the company’s earnings per share (EPS) stood at INR56.13 per share in FY 2016. This values the company’s business at 12.64 times the upper price band. After adjusting for the discount, the PE ratio for retail investors stands at 12.47.

This compares with PE ratio of more than 20 for industry leaders TCS and Infosys. Since L&T Infotech is much smaller than these bellwethers, there is no point comparing Akshay Kumar and Ritesh Deshmukh (Apples and oranges are so clichéd J). Among smaller players, Wipro, HCL Technologies, and Tech Mahindra trade at PE ratios of 15.6, 15.6, and 14.7 respectively. Thanks to its strong balance sheet and low gearing, the return on net worth (RONW) is much better at 45%. Infosys, Wipro, HCL Technologies, and Tech Mahindra have RONW values between 20% and 30%. In this one department, Ritesh Deshmukh manages to beat Akshay Kumar (TCS) which has an exceptionally high RONW of 41.9% for a large player.

This will be the second largest IPO this year after Mahanagar Gas IPO which raised INR21.76 billion and clearly, L&T Infotech IPO is leaving quite some money on the table.

We will round up broker recommendations in the coming days; meanwhile, check out this page to see grey market premium (GMP) and what our readers have got to say about L&T Infotech IPO.