Newgen Software IPO Review: Is it really peerless?

Newgen Software is coming up with its IPO on 16 January as the second mainboard public offer of this year. Priced in the range of INR240 – 245 per share, the IPO will remain open till 18 January.  The New-Delhi-based company plans to mobilize up to INR424.62 crore (INR4.24 billion) through a mix of fresh shares and sales by existing investors. Bids can be placed for at least 61 shares or in multiples thereafter. It was rewarding for investors to put money in IPOs last year, can it be the same this time? We try to find out through Newgen Software IPO review.

Newgen Software IPO Review: Private investors to exit

As mentioned above, the IPO will be a mix of fresh shares while some shares will also be sold by existing shareholders through Offer For Sale (OFS). By issuing new shares, the company plans to raise INR95 crore. These funds are proposed to be used towards:

• Purchase and furnishing of office premises near Noida-Greater Noida Expressway, Uttar Pradesh – 34 crore
• General Corporate purposes – remaining amount

In addition, 13,453,932 shares – amounting to INR424.62 crore – will be offered through the OFS route and thus, the company will not get these funds. Among the selling shareholders are Ascent Capital (7,464,510 shares), IDG Ventures India Fund II LLC (2,985,780 shares), SAP V (2,161,500 shares) and Pandara Trust (842,142 shares). Together these investors held a combined 20.6% equity stake in the company and all of them are making almost full exit. Post the IPO, Ascent Capital and IDGVI will be left with 60 shares each while Pandara Trust and SAP V will have no shares in the company.

Ascent Capital’s average cost of acquisition is INR91.62 per share while IDG Ventures’ is INR92.04 per share. The figure for SAP is even less at INR49.27 per share. As a result, all the firms will be scoring multibagger returns on their investments. SAP invested in September 2008 while Ascent Capital and IDG Ventures invested in December 2013.

Read Also: Planning to invest in SME IPOs? Know these facts first

It is normal for private equity investors to exit their portfolio companies and book profits but full exits show that investors don’t see further upside in the business.

Newgen Software IPO Review: Software services and support

As the name suggests, Newgen Software Technologies is into developing software products that effectively offer a platform to its clients for rapidly develop applications addressing their strategic business needs. Its solutions and products have been used by businesses in banking, government/PSUs, BPO/IT, insurance and healthcare sectors. As of 30 September 2017, it had over 450 active customers in over 60 countries. Newgen Software Technologies has more than 300 channel partners globally and also has 272 employees to drive sales through licenses and subscriptions.

For the six months ended 30 September, the company got nearly 24.2% of its revenues from sales of software while nearly 50% came from annuity based businesses such as support and AMC. Another 20% came from implementation of services. India is the biggest market for the company and contributed 35.48% of revenues followed by Europe, Middle East and Africa at 29.13%. Nearly a fourth of its revenues came from USA and APAC excluding India accounted for 10%.

Read Also: Upcoming IPOs in 2018: A quick look at India’s IPO pipeline

Newgen Software IPO Review: Margin headwinds

The company has done a commendable job of growing top line in each of the last four years. In the last five years, it has doubled revenues which is a terrific achievement. However, its costs have also increased with the expansion in operations. As a result, growth in profits has not been consistent, although earnings improved from INR37 crore in FY2013 to INR52.4 crore in FY2017. In fact, profits dipped in FY2016 as the company invested aggressively in research & development. Despite growing top line and bottom line, it is clear that growth in profits has not kept pace with revenue growth. This has caused a consistent erosion in profitability and margins have come down from 18% in FY2013 to just 12.1% in FY2017.

The performance in the latest six months is also underwhelming in terms of revenue and profit growth, as indicated in the table below.

Newgen Software IPO Review: Should you invest?

As seen so far, Newgen Software has an impressive story to tell. Promoters Diwakar Nigam and T.S. Varadarajan have extensive experience in the field of IT and software designing and development and have put together a competent team of experts. This is primarily the reason behind the company’s growth in the last couple of decades. We also like the fact that the company has negligible debt and it has tremendous confidence of its clients. Repeat customers accounted for 81.59% of Newgen Software’s revenues in the latest six months and we absolutely love it.

Despite these positives, there are some gaps and shortcomings which can’t be overlooked. The most obvious among these is declining profitability. Human resources are the key input in IT businesses and it is not different with Newgen Software which has seen a tremendous rise in salaries, wages and bonus from INR86.6 crore in FY2013 to INR194.2 crore in FY2017. This was primarily due to hiring of senior level professionals for sales and marketing in the US but has resulted in a high cost structure that is nearly permanent as these are full-time employees.

Another point worth highlighting is with valuations. The price band of INR240 – 245 per share and Earnings Per Share (EPS) of INR10.53 means the company is selling its software at the Price/Earnings (P/E) ratio range of 22.79 to 23.27. The company claims it has no listed peer and while that might be true, some benchmarking can be done with IT services players. It is not really a secret that valuations in the larger IT industry have faced pressures in recent years and several companies are available at better price points and lower valuations. Although not directly comparable due to their size, both Infosys and Wipro currently trade at P/E ratios of less than 20 despite earning better margins. Investors seem to have better options in the secondary market.

Overall, Newgen Software IPO review tells the development of a carefully crafted growth story that seems to have been derailed by high costs. The valuations demanded are not prohibitively high but are neither attractive and although the management can get a better grip at its cost structure and margins in the coming quarters, there is no harm in waiting in out. Meanwhile, head to the discussion page to see what the street thinks about the IPO.