Infotech Enterprises banks on acquisitions and offset clause opportunities for the next leg of growth in the engineering design space.
Due to the subprime crisis in the US, the banking and financial services segment has turned into a bane from a boon for most Indian IT companies.
While the conditions in the West do not seem like they will improve in a hurry, there are some good investment opportunities in the domestic IT space, investors can consider. Once such company is Hyderabad-based Infotech Enterprises, which provides engineering design (ED) and geospatial information system (GIS) services, besides regular IT services.
The ED segment, which accounts for 63 per cent of the company’s total revenue, services clients in the engineering, manufacturing and industrial products fields. GIS on the other hand caters to clients in the utilities, telecom and government space.
The company has organically grown its revenues and net profits at a CAGR of 38 per cent and 47 per cent, respectively over the last three years and is now looking for strategic acquisitions to fuel its future growth.
Infotech’s foray in new verticals in the ED segment is a positive as it will derisk its revenue model over a period of time. Product development programmes have become increasingly important for manufacturing companies and they cannot afford to classify them as discretionary, making Infotech’s business sticky in nature and relatively insulated from the current global slowdown.
Traction in engineering design
Indian IT services firms have done reasonably well, when it comes to tapping the $1 trillion IT services and BPO market; but penetration into the $783 billion market for engineering and R&D services remains modest.
The good news is that design testing, prototyping, stress-testing and documentation services are increasingly outsourceable. The market for outsourced engineering services is expected to reach $38-50 billion by FY20E, compared with $2 billion now, as per a Nasscom-Booz Allen Hamilton study.
As for Infotech, its ED segment is set for a strong growth on the back of a secular demand upswing in aircraft-related engineering services.
Despite the fact that the global aviation industry has been facing tough times primarily on account of high oil prices, significant thrust is being put towards more efficient aircrafts, which is providing a fillip for extensive R&D.
Infotech is well-positioned to tap this opportunity, by virtue of its growing relationships with Boeing, Airbus and long-standing association with Pratt & Whitney.
Going steady on GIS
GIS primarily involves surveying and digitisation of spatial maps and associated features. Digital map leader, TeleAtlas, is Infotech’s largest client in the GIS segment. Infotech recently signed a new multi-year contract (of about $50 million) with TeleAtlas to provide extensive map database and software development services.
Opportunities in the GIS space in India are largely coming from the state governments, which want their land parcels to be digitised. For instance, in Andhra Pradesh, five districts are being digitised for a cumulative sum of $50 million. The state itself has 21 districts, which gives a sense of the potential in this space for companies like Infotech.
Eyeing the offset opportunity
India’s offset policy stipulates that 30 per cent worth of its civil and defence aircraft purchases should be sourced domestically.
The potential is huge, given that already-inked deals alone put the offset opportunity at around $40 billion. While most of the offset contracts by value are likely to go to component manufacturers, IT firms expect to get business worth 20 per cent of the offset value.
Infotech’s expertise in services related to aircraft component design positions it favourably to win these offset contracts. Infotech has already formed a 50:50 joint venture (JV) with Hindustan Aeronautics (HAL) to offer engineering services to the aerospace sector. The JV would provide growth visibility to Infotech and help it deepen offerings within the aerospace segment, through HAL’s strong domain expertise.
Strategic moves
Recently, the company acquired California-based design service provider Time To Market (TMM), an embedded software services company, through its wholly-owned unit Infotech Enterprises America Inc.
TTM is focused on the niche area of backend physical design within ASIC design (integrated circuits for specific use) for several semi conductor manufacturers. TTM’s revenues stand at $7.5 million and the company has 130 employees (based in US and India).
Infotech refused to divulge the value of the acquisition, but it is estimated close to $8 million. The combined entity would possess the capability to provide end-to-end design services to Hi-tech markets comprising of semiconductor, medical, industrial automation, telecom, and computing industries.
Although the acquisition is not going to make any meaningful change to Infotech’s financials in the near future, the acquisition exhibits the company’s intentions to focus on the lucrative Hi-tech markets. According to the NASSCOM BAH report on Design Engineering Services, global engineering spend on Hi-tech design services stood at $170 billion in 2004 and is estimated to reach $300 billion by 2020. The potential in Hi-tech industry for offshoring is estimated in excess of $15 billion by 2020. The company is looking at more acquisitions, especially in the automobile space.
Last month, Infotech signed a contract with US based information service provider IHS Inc., marking its entry into the oil and gas industry. Such initiatives will not only provide new growth levers to the company but also improve its revenue mix in the engineering design segment, which is currently tilted towards aerospace industry.
Investment Rationale
Infotech is an end-to-end service provider in the ED and GIS domains, which are expected to grow at 35 per cent and 25-30 per cent, respectively in FY09 for the company.
Infotech has created a niche for itself over the last two decades by building long-term relationship with marquee clients like Pratt & Whitney (P&W), Bombardier, Boeing, Alstom Transport and Hamilton Sundstrand. While this creates an entry barrier for new players, a significant portion of its revenue is annuity-based, which results in a sustainable revenue model.
The management is confident of a 30-35 per cent revenue growth in US dollar terms on the back of 80 per cent revenue visibility so far.
The company also hopes to achieve a billing increase of 3-4 per cent across clientele in FY09, which could help expansion in margins. If the dollar stays above Rs 45 level, the company’s operating margins could get a boost of 4-5 per cent.
| STEADY GROWTH | |||
| Rs in crore | FY08 | FY09E | FY10E |
| Net sales | 674.10 | 880.30 | 1083.10 |
| Net profit | 85.40 | 112.70 | 140.00 |
| OPM (%) | 18.10 | 18.50 | 18.90 |
| NPM (%) | 12.70 | 12.80 | 12.90 |
| P/E (x) | 14.20 | 10.80 | 8.70 |
| E: Analysts estimates | |||
The tax incidence for the company at 23-24 per cent is high compared to its peers. But, the company is in the process of establishing workstations at three SEZs in India and hopes to reap the benefits by the end of 2009.
At Rs 225, the stock trades under 11 times and 9 times its estimated FY09 and FY10 earnings, respectively. These valuations turn further attractive considering the cash on the company’s books, which is about Rs 50 per share.
Its peer, Rolta India, trades at 14 times and 12 times its estimated FY09 and FY10 earnings, respectively on account of its dominant position in the domestic markets, higher margins and capabilities in the nuclear power field.
Nevertheless, continued revenue visibility, stable margin outlook and upsides from acquisitions as well as a huge offset opportunity make Infotech a worthwhile investment proposition. Expect the stock to deliver 20-25 per cent in a year’s time.
