Another attractive play in Auto ER&D Services: IIFL Capital Services

21 Nov 2023 , 11:50 AM

Tata Technologies Ltd. (TTECH), the first Tata Group company to go public in nearly two decades, is set to launch its IPO for 15% of the company, at a valuation of up to Rs203bn (US$2.44bn). TTECH is a leading ER&D Services company, offering product development and digital solutions including turnkey solutions, to global original equipment manufacturers (OEMs) and their tier 1 suppliers. TTECH has the second largest Auto industry practice among pure play Indian ER&D Services players after KPIT, and works with 7 of the top 10 Automotive ER&D spenders. With revenues of USD550mn in FY23, TTECH’s revenues have grown at 11% Cagr over FY20-23, with Ebit margins of 16.5% in FY23. However, client concentration is higher vs peers (top 5 clients contribute >70% of its FY23 Services revenues). At an IPO valuation of 28x trailing P/E (at the higher end of the IPO) that is a discount to peers trading at 30-90x, analysts of IIFL Capital Services recommend subscribing to the IPO. 

End-to-end portfolio of services in Automotive vertical: 

Given TTECH’s parentage and long-standing client relationships with Auto OEMs, it offers a comprehensive portfolio of services for the automotive industry. TTECH addresses the product development and enterprise optimisation needs of traditional OEM’s and new energy vehicle companies, together with their associated supply chains. TTECH also offers turnkey full vehicle development solutions from concept, detailed design and development, test and validation to the production launch of the vehicle. TTECH is rated as a leader by Zinnov in Automotive ER&D services provider. TTECH generated ~89% of its FY23 Services revenues from the Auto vertical and Tata Motors and JLR are the anchor clients. This contributed ~40% of its FY23 Services revenues. Among the new energy vehicle companies, VinFast (Vietman-based EV Company) is its largest client. Given its deep domain expertise in the Automotive vertical, TTECH has expanded into adjacent verticals like Aerospace and Transportation and Construction Heavy Machinery, where they are looking to further build capabilities. 

Client concentration significantly higher than peers: 

TTECH generated 73% of its FY23 Services revenues from the top 5 customers — significantly higher than similar-sized India-based peer ER&D Services providers at 16%-40%. While TTECH enjoys long standing relationships with these customers, as it scales, the client concentration needs to reduce significantly to enable sustainable growth. Within the Automotive vertical, TTECH works with 35 traditional OEMs and tier 1 suppliers and 12 new energy vehicle companies. 

Profitability comparable to peers: 

TTECH reported Ebit margins of 16.5% in FY23, broadly in line with the similar-sized India-based ER&D companies (excluding Tata Elxsi, reported Ebit margin of 28% in FY23). TTECH has one of the highest revenue per employee at ~USD52k in FY23 — partly driven by the lower offshore revenue mix of ~50%. How TTECH is different from Tata Elxsi: Tata Elxsi — another Tata group ER&D Services Company, is a design specialist focused on software and digital engineering services. TTECH provides services across mechanical engineering, digital engineering, embedded solutions and software for the product development of Auto companies. TTECH and Tata Elxsi have collaborated with each other in certain projects as well as competed on certain projects in the past. 

IPO valuation at a discount to peers: 

Total issue size is of Rs30.4bn (upper end of price band) — an OFS of 60.85mn (15%) shares. Selling shareholders are Tata Motors (46.3mn shares), Alpha TC Holdings (9.7mn shares) and Tata Capital Growth Fund (4.9mn shares). The IPO valuation of Rs203bn implies trailing PE of 28x vs 30-90x for the pure play India-based peer ER&D service providers. Analysts of IIFL Capital Services believe that industry tailwinds for the automotive industry are likely to continue to drive growth for the company in the medium term, while expansion into adjacencies provides upside risks. Analysts of IIFL Capital Services recommend subscribing to the IPO, given the valuation discount to peers.