Public party

Riding the novelty train has fetched newly-listed companies a massive valuation. But can they sustain their gains?

A flurry of IPOs, from still-nascent and emerging sectors, have hit the capital markets recently, with most drawing positive response. Seven of the 10 public offers in 2016 have been oversubscribed — the highest being Teamlease at 65x. Is this simply bull market exuberance or are these sectors really worth the valuation?

Considering that they offer high growth opportunities, hopes sure are high. But what about the risks? Are the valuations factoring them in? Prithvi Haldea, chairman and managing director, Prime Database says, “Just because these IPOs are from new sectors, they are not necessarily good long-term stories that will just keep growing. Investors would do well to continuously monitor their investments as valuations of these stocks would be sensitive to any mid-term disturbance.”

For now though, Haldea’s warning may seem unwarranted given the kind of returns these companies have clocked post-listing. Except for three companies — Coffee Day Enterprises, Quick Heal Technologies and Healthcare Global Enterprises — that are trading 18-23% below their issue price, rest of the pack has amassed varying gains (See: Healthy overdose).

Microcredit Brigade

Take the case of small finance bank (SFB) licence holders Equitas Holdings and Ujjivan Financial Services. The MFI duo launched their IPOs to bring down the ownership of FIIs below 49% as mandated by the Reserve Bank of India (RBI).

In September 2015, the RBI had issued in-principle licences to 10 entities including Equitas and Ujjivan to set up SFBs, with the objective of furthering financial inclusion. However, analysts believe the transition from MFIs to SFBs may not be that straightforward. “Some of the known challenges are regulatory cost in the form of CRR and SLR, building liability franchisee, and more importantly changing the DNA of the organisation from a mono line to a multi-specialty financial service company,” say analysts at PhillipCapital.

This is partly taken care of at Equitas. While it started off as a micro-finance player in 2007, it has since diversified. In 2010, it set up Equitas Housing Finance (EHL) to provide micro-housing and affordable housing loans. Next year, Equitas Finance came into being, dealing with used transport and commercial vehicle finance besides micro and small enterprise financing. All these entities will now be consolidated under the banking entity.

But Pritesh Bumb, banking analyst at Prabhudas Lilladher points out another issue. “While moving from bank funds to building one’s own deposit base would help in bringing down the cost of funds, building a strong CASA base or attracting bulk deposits from corporates will not be an easy task. Investments will be upfront and the benefits of having a CASA base will come in years later.”

At the consolidated level, Equitas’ AUM has compounded at 50% between FY11-15, net earnings at 39% and net interest income at 28% respectively. When it comes to valuation, at the upper price band of Rs 110, the issue was valued at 1.9x its December 2015 book value on a post-dilution basis. In comparison to Ujjivan (1.8x price to book), Equitas’ valuation seems fair.

But Ujjivan scores when it comes to geographical presence. A regional break up shows 27% presence in the South, 22% in the East and just under 20% presence in the West and the North. Even in terms of AUM, Ujjivan boasts a diversified mix, with no state contributing more than 15%, something that would make it easier for it to transform into an SFB.

Additionally, its profit and net interest income have grown at a faster clip — 60% and 35% CAGR between FY11 and FY15, respectively. While its business is primarily based on the joint liability group-lending model for economically active women, it is now looking at disbursing more individual loans.

At the current market price, Equitas is trading at 2.9x its FY16 book value, and Ujjivan at 2.4x. With the RBI saying SFB licences would be given “on tap”, there could be more IPOs from this sector in the coming days.

Health Check

It’s not just the financial sector, a clutch of companies from the healthcare industry have also floated IPOs. Narayana Hrudayalaya, Thyrocare Technologies, Dr Lal PathLabs and HealthCare Global Enterprises (HCG) together have raised around Rs 2,400 crore.

Bangalore-based HCG though, has found the going tough because of its debt burden. For 4QFY16, the company reported sales of Rs 153 crore, posting a growth of over 16% YoY. However, its net margin was a measly 2.4% at Rs 3.6 crore. While it is better than the loss of Rs 25 lakh reported last fiscal, the debt of Rs 370 crore is an overhang.

Moreover, aggressive expansion is taking a toll. Despite a capacity utilisation of 50%, the company is looking to add 12 new cancer centres. So, while HCG is looking to repay Rs 147 crore of its existing debt, the overall burden may remain the same.

The company is also facing delays in executing projects due to government approvals, construction, technical and regulatory concerns. This has led to significant cost overruns. Between FY11-15, EBITDA margin has contracted 290 basis points to 14.7%.

The valuation, thus, has come down, with the stock currently trading at 20.7x FY16 EBITDA. When the issue was launched on March 16, it was 24x (at the upper price band of Rs 218) FY15 EBITDA of Rs 76 crore.

While the debt is hurting, it has the largest number of cancer treatment centres in India where the demand-supply gap is huge. A report by ICICI Direct claims that India has only 200-250 comprehensive cancer care centres — that’s just one per six million people. Moreover, about 40% of these centres are located in metros; there is a shortage of oncologists (one oncologist per 1,600 patients); and limited access, with only around 15-20% of cancer patients currently able to undergo radiation treatment. This augurs well for the company.

Narayana Hrudayalaya is in the same boat when it comes to demand and profitability. On a consolidated basis, the hospital chain reported a net profit of Rs 30 crore in FY16, a margin of 1.8%. With debt coming down to Rs 200 crore in September 2015 (Rs 305 crore in March 2015), and most of the capex behind it, profitability is expected to improve. “We expect 20% revenue CAGR coupled with 450 basis points improvement in EBITDA margin to 16% (as utilisation improves) over FY16-20,” say analysts at Axis Capital.

EBITDA, too, is expected to improve as more hospitals climb the maturity curve. As of now, hospitals over five years are yielding an EBITDA margin of 24% while those in the 3-5 year range are operating at a margin of 4%. Taking the current revenue of five hospitals in the 3-5 year range (Rs 209 crore), at 24%, additional EBITDA of about Rs 42 crore could be added. This could ramp up consolidated EBITDA margin from 11% to 13%.

Moreover, the chain is run on an asset-light model, with investments in land and building coming in from the partners. During its IPO, at the upper price band of Rs 250, Narayana was valued at 42x EV/EBITDA (trailing FY15 earnings). While the correction in valuation to 35x EV/EBITDA on trailing FY16 earnings may reflect concerns over profitability, on a one-year forward basis the stock is trading at 20x EV/EBITDA (closer to Apollo Hospitals’ 19.6x).

However, unlike Narayana Hrudayalaya, Apollo remains in expansion mode as it plans to add close to 1,000 beds to its existing network of 40 hospitals and over 7,000 beds (own hospitals) by FY19, with an additional capex of over Rs 1,000 crore. While Apollo’s EBITDA margin stands at 15.8% currently, analysts expect the margin to be hit due to its capex plans.

Diagnosing the Margin

The question, when it comes to diagnostic providers such as Dr Lal PathLabs and Thyrocare Technologies, is if they can sustain their margins going forward.

Thyrocare’s stock is currently trading at 54x (trailing FY16 earnings), with EBITDA margin of close to 41%. While analysts expect revenues to grow at 25% and profit to ramp up to 30% over FY15-18, the possibility of margin deterioration cannot be ruled out due to its strategy of using disruptive pricing to drive volume. Also, significant portion of Thyrocare’s revenue come from the low-value thyroid testing business. In FY15, thyroid tests accounted for 29% of total volume and contributed 17% of revenue.

“Within the pathological space, we need to assess undercutting is driving volume, as there are strong incumbents in this space,” says Sadanand Shetty, vice-president and senior fund manager at Taurus AMC.

As for Gurgaon-based Dr Lal PathLabs, it is trading at 61x its trailing 12-month earnings. Over FY11-15, the company’s topline has grown at 29% and profit at 34%. Analysts at Citi Research expect this to temper down to 20% and 27% over FY15-18, respectively.

Deven Choksey, managing director, KR Choksey Shares and Securities, adds that while margin deterioration is a concern, these firms could protect their margins by bringing in segmentation and increasing footfalls. The issue with the segment though, is that low capital requirement can attract more players, increasing competition. Dr Lal PathLabs also faces a concentration risk as 70% of its revenues come from North India, largely Delhi and NCR. While the company plans to open reference labs in the East and Central India, it remains to be seen if it can scale up business in those regions.

Pause Or Play

In the fast-growing e-commerce segment, Infibeam has been the first to launch an IPO worth Rs 450 crore. Besides its namesake retail site, the company also has a BuildaBazaar (BaB) market place that provides customisable online storefront solutions. It, however, has a long track record of operating at a loss. According to the draft red herring prospectus, Infibeam made losses from FY12-FY15. In FY16 though, the company reported profit of Rs 8.7 crore. Is this a turnaround or just a pause?

Having an e-tail site and a market place under one umbrella can provide synergies when it comes to merchant and customer acquisition. Infibeam has already grown its merchant network close to 50,000 at a CAGR of 273% since 2012. The user base too, has increased at 30% to more than 7.8 million as of March 31, 2015.

But analysts reckon the valuation (7.9x FY15 sales) is “rich” even if the stickiness and higher growth potential of the BaB marketplace is factored in. Analysts at PhilipCapital value the consolidated business at Rs 1,500 crore, which is 5.2x the company’s FY15 sales. Compared to Infibeam, Flipkart, the market leader, is valued at 3.34x its FY15 gross merchandise value (GMV), while Snapdeal is valued at 1.4x GMV.

Currently, the stock is trading at 12.4x its FY15 sales and 10.6x FY16 sales. “The problem with technology-based companies is that they are valued on the basis of traffic or sales happening on their platform. But these valuations are not sustainable as they are not reporting any profit. That is the reason we are seeing e-commerce players like Flipkart losing their valuation,” says forensic accounting expert Abhishek Asthana.

Moreover, the e-commerce industry is highly competitive, with companies starting price wars to gain market share. “Companies operating in the sectors are burning cash in acquisitions and heavy discounts. Any future inability of the company to raise fresh funds may put the company at risk of losing market share,” analysts at IIFL say in a note.

Under The Scanner

In the case of Pune-based IT security solutions provider Quick Heal Technologies, corporate governance-related matters have put the stock under the scanner. A day ahead of listing, Manohar Malani, managing director at Kolkata-based firm NCS Computech, wrote to Securities and Exchange Board of India (Sebi), complaining about the transfer of 20,000 shares of Quick Heal Technologies, which he claimed belonged to him and his family. The red herring prospectus filed by Quick Heal did not feature either Malani or any of his family members. While Quick Heal has issued clarification to the exchanges and Malani has been arrested following an FIR filed by the company accusing him of forgery, cheating and criminal intimidation, the matter remains sub judice.

The company has a market share of over 30% in the retail segment. The company provides security solutions under ‘Quick Heal’ and ‘Seqrite’ for desktops, laptops, mobiles, cloud, network, gateways etc. But running a technology business comes with its own risks. Failure to anticipate disruptive technology or low-priced strategy of a competitor can have a negative impact. Already, a worry point is the decline in the size of the laptop/desktop market (Quick Heal’s mainstay) due to higher adoption of tablets and smartphones.

“Quick Heal has invested substantially in new businesses in the last three to four years. This is visible in higher R&D expenses and a decline in EBITDA margins. The company’s future performance is predicated on the success of new businesses — enterprise, government and mobile,” says Govind Agarwal, analyst at Prabhudas Lilladher.

If it can’t scale up in these segments, it could further erode operating margins. From 53.5% in FY12, the EBITDA margin has already dropped to 32% in FY15. The topline though, has grown at 17% CAGR during the same period.

At the upper price band of Rs 321, the stock got a valuation of 36.4x P/E based on FY15 earnings, which is expensive compared to global peers such as Symantec (17x) and SAP SE (27x). This has now come down to 32x FY15 earnings and 30x trailing FY16 earnings.

To Hire Or Not

Then there is Teamlease, the Bangalore-based recruitment consultant, who is the leader (5% market share by employees) in the formal flexi-staffing industry.

Its revenue has grown at 31% CAGR over FY11-15. The bottomline, too, turned the corner during this period. But the EBITDA margin stood at a poor 1.2% in FY15, with employee expenses eating into 97% of the revenue. Analysts though, estimate revenue growth of 26% CAGR over FY15-18.

Margins, however, are unlikely to rise given the competitive, fragmented and low-entry-barrier nature of the sector. The seasonal nature of the segment is an added pain point as demand fluctuates with commercial activity and economic conditions.

The stock at the issue price of Rs 850 got a valuation of 44x its FY15 earnings. On one-year forward basis (FY17 earnings), it is valued at 31x. Global peers like Adecco SA-REG and Randstad Holding NV, however, trade at 10x their estimated FY17 earnings.


And while in some cases investors are yet to wake up and smell the coffee, in some cases too many beans might have turned the cup bitter. Take Coffee Day Enterprises (CDEL), the holding company, with stakes in coffee and non-coffee businesses such as logistics, financial services, information technology and hospitality. It has sub-divisions in the coffee business, too, with cafés falling under Coffee Day Global (CDGL) and the trading business under CDEL and Coffee Day Trading.

It is this complicated holding structure that is impacting the stock. While the company’s consolidated topline grew at a healthy 25% CAGR in FY11-15, it has been incurring losses for the past three years. In FY16, though, it flipped over, reporting a profit of Rs 18 crore, thanks to a number of initiatives.

Coffee Day Global shut down unprofitable, small and poorly located stores in FY15. When it comes to cafés, the company has the largest footprint (over 1,600 stores in FY16) spread over 219 cities under the Café Coffee Day (CCD) brand and a market share of approximately 46%.

While coffee and allied businesses (52% of sales in FY15) have been growing at a steady pace of 7.6%, the company is working on increasing its sales further. For FY16, CCD’s average sales per day per café was around Rs 13,000. It is looking to take this to Rs 20,000 over the next three years. With regards to vending machines, the management says they already control over 90% of the market.

Cafés and vending sub-segments are both accretive for CDGL’s overall margins. Analysts estimate café segment’s gross margin in the high-60s and EBITDA margin in the 20s. For the vending segment, it is in the early-50s and mid-30s, respectively.

Meanwhile, in Q4FY16, CDEL’s net revenues grew 21% YoY to Rs 870 crore, driven mainly by strong growth in the financial services and logistics segments, which rose 71% and 23% YoY. The company’s net sales are expected to grow at 12.5% CAGR over FY15-18, while operating margins are expected to improve 330 basis points to 18.4% during the same period.

At the upper price band of Rs 328, the company was valued at of 23.6x EV/EBITDA during its IPO. The enterprise value comprised of assumed market cap of Rs 6,756 crore and debt of Rs 4,496 crore. As per the EV on August 1, the stock is valued at 14.3x FY16 EV/EBITDA.

For Coffee Day, capital misallocation, management focus and operational issues including inter-company/segment transactions are some of risks posed by the conglomerate structure. But to his credit, the promoter did not sell a single share in the IPO, unlike most others (see: Cashing out).