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L&T Technology Services Ltd – Preferred Engineering Services Partner


Company Name – L&T Technology Services Limited (LTTS)


Current Share Price – INR 3,990 (December 19, 2022)


Market Cap – INR 42,133 cr


 

1. What is interesting about the stock?


No matter how much experience you have there is always something new you can learn and room for improvement.


I keep facing this in the stock market. Anytime I pick a stock to analyze in a new sector, I realize the limitations of my prior experience. Last, I had written on Laurus Labs which expanded my learnings in the pharma sector (though still at the Novice level). Now Engineering research & development (ER&D) outsourcing sector.


I keep getting amazed by the entrepreneurship level in India – I had known that we are strong in the IT (Y2K!) and Pharma (Generics) sectors but now we are moving into new spaces like Data Analytics (MuSigma, Latent View Analytics), ER&D sector. Wow!


Recently, we had another breakthrough when an Indian start-up, Polygon Technology, raised USD 450 million for a cutting-edge Web 3.0 start-up that is of a global scale (built on Ethereum to increase transactions per second)!


Coming back to the matter at hand.


LTTS is an ER&D services and digitalization solutions providing company, incorporated in 2012. It focuses its business on five areas which are Transportation, Telecom & Hi-tech, Industrial products, Plant Engineering, and Medical Devices. It offers consultancy, design, development, and testing services across the product and process development life cycle.


Its customer base consists of 343 global clients and 57 of the world’s top 100 R&D spending companies across those five areas. It’s 90% of customers are repeat customers. The major strength of the LTTS business model is customer-centric industry innovations, domain expertise, and multi-vertical presence spanning major industry segments.


Sector Outlook


Global ER&D spending stood at USD 1.5 trillion in 2020 which is expected to increase to USD 2.6 trillion in 2026 with the addressable market increasing from USD 86 billion to USD 128 billion. Indian ER&D market is expected to double in this period from USD 35 billion to USD 71 billion. This is due to an increase in digital engineering spending which is expected to increase at a CAGR of 19%.


ER&D sector has faced a dent in their business in the 2020-2021 financial year because of the pandemic. The manufacturing sector was highly impacted. But high-tech and services-led verticals have stayed resilient and increased their spending in R&D to drive digitalization to their end consumers. To build new-age digital products and services, enterprises across verticals will spend on digital engineering which will boost R&D spending. 5G, Digital threads, and sustainable engineering will be the key catalysts supporting higher digital engineering space.


Company Strengths

  • Offering multi-vertical services across the ER&D sector

  • Leveraging the cross-industry experiences and establishing itself as an innovative provider the company is poised to provide a unique proposition to clients across industries.

  • Recognized by industry experts such as Zinnov who have rated LTTS as one of the industry leaders across various categories.

  • LTTS derives 56% of revenue, in FY22, from digital engineering which is expected to grow fast

  • Strong partnerships

    • Amazon selected LTTS as consulting and professional service partner to support Alexa integration in various connected devices spanning multiple domains and industries

    • Airbus selected LTTS to provide technology and digital engineering solutions for its Skywise platform and the company has set up a dedicated engineering hub for Airbus

  • Experienced management team – Current CEO joined in 2009 and has grown through the ranks over the last 13 years

Company focuses on M&A to add capabilities and sector expertise. Company has done three acquisitions in the last 5 years:

  • In May 2017, the company acquired US-based design services provider Esencia Technologies Inc for USD 27 million

  • In September 2018, it acquired Bengaluru-based Graphene Semiconductor Services for USD 13 million

  • In July 2020, LTTS acquired Texas-based Orchestra Technology, a company providing engineering services and solutions for telecom network management, for USD 25 million

2. Key Historical Financials

  • Company’s revenue growth (CAGR) for the last 5 years is 15% and PAT (CAGR) is 18%

    • Growth of 24% in Q2FY23 on a YoY basis - 14% in constant currency

  • Business was impacted in 2021 – due to COVID 19; recovered in FY22 - revenue growth of ~16% in FY22 over FY20

  • EBITDA margins improved to 22% in FY22 vs 20% in FY19 and 18% in FY21

  • WC days worsened: 126 days in FY22 vs 45-70 during FY19-21 leading to poor cash flow convertibility (CFO/EBITDA)

  • ROE at 25%

  • Revenue growth guidance of 13.5-15.5% (constant currency) in FY23

3. What is my view on company valuation?


The stock has moved up 3x since March 2020 but is lower compared to other players like Tata Elxsi (~6x) and Persistent Systems (~8x). The company trades at a P/E (TTM) multiple of 40x with a 5-year average P/E multiple of 21x.


I expect the company to have USD growth (long term) of ~7% and USD-INR depreciation of ~3% leading to revenue growth of ~10% with stable margins. The company has guided ~15% growth for FY23. So, the company valuation of P/E 47x is quite expensive and should revert to the long-term mean (20-25x).


Capgemini acquired Altran Technologies, a major ER&D player, in April 2021 at an implied P/E multiple of ~15x.


LTTS could be an interesting target for an IT player looking to expand in the ER&D space. There remains the possibility of a player like Tata Elxsi getting merged into TCS as part of the restructuring, which could trigger more such deals in this space.


4. What are the risks to the investment analysis?


Risks to the analysis are:

  • Any acquisition interest can keep the price high for the short/medium term

  • ER&D space is getting increasingly competitive which can lead to high attrition levels

  • Backlash in the developed markets can lead to higher onshoring which impacts the cost arbitrage

 

About the Author


I have over 17 years of experience in venture capital, private equity, and investment banking in India and the Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in the Middle East, to look after investments, M&A, and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB), and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.


I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).


I am an Insignificant Investor in the public market and co-founder of SocInvest.


Disclosure


I have had no stock, option, or similar derivative position in any of the companies mentioned in the last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.


I am not a SEBI registered advisor. This article is purely for educational purposes and is not to be construed as investment advice. Please consult your financial advisor before acting on it.


I have used publicly available information while writing this article.


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