Reblog: Newgen Software IPO review
Newgen Software Technologies is entering the primary market on Tuesday 16th Jan 2018, via a fresh issue-cum-offer for sale of equity shares of Rs. 10 each, in the price band of Rs.240 to Rs. 245 per share. The issue comprises a fresh issue of up to Rs. 95 crore and an offer for sale (OFS) of 1.35 crore equity shares by 4 PE investors. Representing 25.01% of the post issue paid-up share capital at the upper end, total issue size is Rs. 485 crore at the upper end, of which, 80% or Rs. 390 crore is the OFS portion. The issue will close on Thursday 18th Jan while the listing is expected on 29th Jan.
Newgen Software Technologies is a software product company serving banking, Govt agencies, BPO / IT, insurance, healthcare verticals, through its basket of 3 product platforms – enterprise content management, business process management, customer communication management. While 40% revenue comes from India, approximately 27% comes from the US and Middle East each, and balance from Asia Pacific. Broadly, 27% of revenue is generated through sale of software product, 28% from implementation service, 22% from annuity based support service and 17% from AMC.
While the topline has grown at 20% between FY14-17, margins have been on a decline, with EBITDA CAGR at 11% and PAT CAGR at 8% only. Operating margins have contracted from 25% in FY13 to 12% in FY16 and 6% in H1FY18.
|EBITDA (Rs. cr.)||12||77||42||66||55||50|
|EBITDA Margin (%)||6%||18%||12%||21%||22%||25%|
|PAT Margin (%)||3%||12%||8%||15%||17%||18%|
Operating margins have been on a decline despite rise in revenues – from peak of 24% operating margin in FY13 to 18% in FY17. Net margins are impacted even more sharply, falling from 18% in FY13 to 12% in FY17. Due to high operating leverage, Middle East crisis in FY16 shrunk net margin 8% that year, indicating high earnings sensitivity to macro events. While EPS for FY17 stood at Rs. 10.53, H1FY18 EPS of 96 paise is very daunting.
Company states that H1 comprises of ~40% of revenue while H2 accounts for ~60% of revenues as clients make IT purchase based on year-end budgets (December for international customers, March for domestic clients). According to the company, costs being linear, margins are stronger in H2. Since H1FY17 financials are not reported in the prospectus, it is difficult to gauge whether H1FY18 EBITDA may improve to 12% or 18% or higher for full year FY18. While H2 margins are likely to be better, how much better is vital. Estimating them accurately is crystal ball at this point in time, as EPS of less than a rupee in H1FY18, versus Rs. 10.53 in FY17 is quite an outlier.
Hence, as a prudent investors, all one can do is wait for results post listing to understand the financial trajectory. In such cases, one understands why disclosure premium is justified/ deserved for already listed companies, having quarterly track record of reported financials and other material information regularly.
As of 30th September 2017, company’s net worth stood at Rs. 271 crore, leading to a BVPS of Rs. 43. Total debt stood at Rs. 66 crore, while cash and equivalents were at Rs. 93 crore, translating into surplus cash per share of Rs. 4. Company’s return on equity (RoE) has also fallen from 22% in FY15 to 19% in FY17. Besides, business is extremely working capital intensive, quite unusual for a software company, with debtor days over 6 months. Such high debtor days are seen when sole customer is the Government. For Newgen, barely 10-12% of revenues come from Govt, while its key clients are banks, insurance and healthcare firms. Such lenient receivables policy is not resounding. Also, if it has a lot of repeat business (over 70%) with sticky customers, why are provisions for doubtful debts rising at a rapid pace – from Rs. 0.9 crore in FY13, to Rs. 7 crore in FY15 to Rs. 15 crore in FY17. The figures don’t add up!
Shareholding and Objects of Issue:
The issue is being undertaken essentially to provide an exit to the 4 PE investors (Ascent Capital, IDGVI, Pandara Trust and SAP V) collectively holding 20.59% and are invested in the company for over 4 years now. While Pandara and SAP are making a complete exit, Ascent and IDGVI will be holding a token 60 shares each, post issue, which in spirit, is a complete exit, offloading 75 lakh and 30 lakh shares respectively.
Fresh issue proceeds of Rs. 95 crore will be mainly used to buy 1.2 lakh sq. ft. office space in Noida. This can be easily funded via internal accruals (cash of Rs. 85 crore as of 30-9-17 and annual cash profit of nearly Rs.60 crore) versus adoption of an expensive route of ~5% equity dilution. Thus, IPO is structured to merely provide a complete exit to PE investors.
Current promoter holding of 70.27% will shrink to 68.00% post IPO, while employee trust, owning 2.36% stake, will reduce to 2.29% post IPO.
At Rs. 245 per share, company’s market cap will be Rs. 1,654 crore while its enterprise value will be Rs. 1,627 crore. Since FY18 financials are difficult to estimate (as explained above), based on FY17 earnings, PE multiple (net of cash) is 23x and EV/EBITDA multiple is 21x, which is on the higher side. While company likes to state no direct peer, Noida head quartered Nucleus Software, offering software products in the BFSI vertical in India, South East Asia, Far East and Europe, clocked topline similar topline as Newgen, of Rs.372 crore for FY17, with much stronger and consistent EBITDA margin of 23% and net margin of 18%, making it a good comparison, or rather a better comparison. Nucleus’ receivables are outstanding for less than 2 months, and have been so throughout the years, besides balance sheet with surplus cash of Rs. 390 per share. Nucleus is ruling at FY17 PE multiple of 19x, net of cash, and EV/EBITDA multiple of 13x, which is lower vis-a-vis Newgen. Moreover, even if one were to factor in superlative financial performance for Newgen in H2FY18 and FY19, its valuation does not seem to be leaving enough money on the table for prospective investors, based on unwritten rule of the primary market of 10-15% discount to fair value for incoming shareholders. Lastly, IT sector is not ‘in flavor’ currently, which is again not helping the IPO much.
Based on historical financial performance and lack of clarity on future earnings, the valuation is expensive. Better to gauge the performance over the next few quarters before evaluating Newgan as a candidate for investment. For now, it makes sense to skip the IPO.
The original review is written by Geetanjali Kedia of sptulsian.com and is available here.