You wouldn’t think there’s much in common between a 1960s’ American baseball player and the leadership at Tata Elxsi. But read their statements over the past year on a few, critical issues and you won’t be surprised if Yogi Berra’s classic one-liner springs to mind: “It’s like déjà vu all over again.” Whether it is the impact of the ramp-down in orders from Tata Elxsi’s No.1 client, Jaguar Land Rover (JLR), or the possibility of using some of its enormous pile of cash on acquisitions, the management at the Rs.16 billion, Bengaluru-based engineering tech and design company has stuck to a prepared speech, with unfaltering sameness, quarter after quarter. The been-there-done-that feeling continues when you look at the broader picture as well. In fact, the first half of CY2019 — Q4FY19 and Q1FY20 — was especially grim for Elxsi, thanks to the auto industry slowdown as well as JLR cutting volumes drastically. Jump ahead to 2020 and the past six months have been no walk in the park, either. This time, thanks to the double whammy of a prevailing economic slump and the COVID-19 pandemic. But as it happened, Elxsi recovered from last year’s stress faster and better than most expected. Could it be déjà vu once more?
Driving with the brakes on
It could not have been easy for Tata Elxsi to carve out a separate identity for itself, with two tech majors already in the group (Tata Consultancy Services and Tata Technologies). Add to that a constant battle against rumours of being merged into TCS. Yet, over the past few decades, the company has steadily created a niche for itself in the engineering research and development space, with global clients in automotive, broadcast and communication and healthcare sectors. It has even developed several proprietary products such as Autonomai (software that provides a modular solution to build and test self-driven cars), FalconEye (an AI-driven test automation suite to help operators roll out services across multiple screens, including set-top boxes, mobiles, laptops and IPTVs) and, most recently, a new platform for remote operation and monitoring of assets in the telecom space. “Its parentage is a big advantage for Tata Elxsi because it has opportunities to test upcoming new technologies within the group itself,” says Parvati Rai, head of research at KRChoksey Group.
Its business is spread across three segments — embedded product design (EPD), industrial design and visualisation (IDV) and system integration and support. But about 10 years ago, Elxsi restructured to focus on industry verticals and now divides its attention between transportation, broadcast and communication, and the relatively new healthcare and medical devices verticals; although, until very recently, the company earned the bulk of its revenue — over 53% — from the transportation business. And group company JLR was its biggest client in this sector, accounting for about 25.7% of sales in Q1FY19. That changed in just a few months, as JLR’s troubles spilled over into Elxsi’s books (See: Shifting gears). Between Q4FY19 and Q1FY20, revenue dropped 10.7% (5.3% on YoY basis), while net profit plunged 31.6% (30.8% YoY).
At the earnings call after the Q4FY19 results, then-MD and CEO Madhukar Dev pointed out, “We had an excellent JLR order book in the middle of the year, and we saw a slight change in Q3. During Q4, existing orders were put on hold and they were ramped down without much notice.” By Q1FY20, JLR’s contribution to Elxsi’s sales had plummeted to 16.7% and, in this last earnings call before retiring from Tata Elxsi, Dev admitted, “Though we did know there would be ramp-downs, the extent was a bit surprising.” But that justification did not go well with some analysts. Mayank Babla, senior research analyst, Dalal and Broacha, says Elxsi should have pre-empted the situation since JLR is a group company.
In the quarters that followed, the new MD and CEO, Elxsi veteran Manoj Raghavan, who took over in October 2019, would ever-hopefully declare that the JLR account had bottomed out, only to be confronted by a new set of lower numbers three months later. But this time, Elxsi was smart — while it remained optimistic about JLR’s turnaround, the company quickly swung into action to limit its dependence on the luxury carmaker’s business.
A new pivot
De-risking was a two-pronged strategy. Within the transportation sector, the company began exploring areas outside its main passenger vehicle markets — and discovered adjacencies in areas such as rail (long-distance and metro), off-road vehicles and commercial vehicles. It quickly won a couple of deals in this space, working on electronics related to passenger comfort and entertainment, as well as vehicle propulsion, safety and connectivity — all familiar territory for Elxsi. According to a media report, the company also put together a focus team of close to 100 engineers to “reduce its concentration risk in automotive.” When contacted, the company declined to participate in this story.
The larger part of the new approach was to increase focus on other verticals. After all, the dwindling JLR revenue was a microcosm of a bigger problem — a continuing slump in the automotive business across the world. IMF’s World Economic Outlook of October 2019 also pointed out that global car sales fell by 3% in 2018 and production fell by 1.7% (2.4% when adjusted for unit value differences), reflecting “both supply disruptions and demand influences”. The report added, “Consistent with performance, stock prices of the largest 14 car manufacturers have declined by 28%, on average, since March 2018.”
It made eminent business sense then, for Elxsi to hedge its transportation bets by strengthening its other verticals (See: In with the new, out with the old). The broadcast and communication businesses had been merged a few quarters earlier, and around the same time the medical devices and healthcare vertical was incubated. Elxsi now began ramping up its brand and market presence in the broadcast and communication universe by participating in key international conferences and trade shows, such as the International Broadcasting Conference in Amsterdam and the RDK (Reference Design Kit) Euro conference, ensuring it had large stalls and speaker slots at these events. It also invested in expanding its sales bandwidth across geographies and actively chased new deals outside the EPD segment (which accounts for nearly 90% of revenue), winning long-term corporate content development deals in the IDV division. “That brings in both… steadiness and predictability to revenue and also some amount of margin improvement,” pointed out Nitin Pai, Tata Elxsi’s chief marketing officer and chief strategy officer, in the Q2FY20 earnings call.
Green shoots were clearly visible by then, as was Elxsi’s optimism. Raghavan pointed out in the same call that the top three media operators in the world, the top two in India and the top OTT operator in India were all Elxsi customers. “We have really morphed this business and all these customers are undergoing significant digital transformation. That provides a good opportunity for a company like us, because we bring in both the engineering capabilities and the impact of digital domains such as cloud, IoT (Internet of Things) and OTT,” he stated.
The much-smaller healthcare and medical devices, too, has received its share of attention, both in terms of scaling existing customers and adding new ones, and in terms of the services provided. Elxsi’s core competency in this vertical relates to medical devices — the design capability and workings of electronics. Last year, the company decided to expand its offerings by entering the home care segment with IoT-enabled devices and sensors. It also moved in a much smaller way into healthcare applications related to telemedicine, telecare, hospital management and more. The company worked downstream with clients by helping them meet regulatory guidelines for selling medical devices in Europe; the region is especially strict when it comes to standards on everything from product design to packaging and time-bound certifications.
The pivot from transportation began paying off almost instantly, even though the general economic climate meant some contracts were being pushed into subsequent quarters, some were held up by paperwork delays and some were just hanging fire. While rail and off-road vehicles began making a space for themselves within the transportation segment (4-5% of segment revenue by Q3FY20, with ambitions of growing it to 15-20% of the segment in three years), the segment’s share in overall sales began to drop. “The idea is that [this business] accelerates a little faster than the rest of the automotive business. And that not only makes up for some of the gaps, but also builds the platform for the future, because the skills are adjacent,” said Pai in the Q4FY20 call.
Thus, the company’s revenue mix started looking a bit different. From a mix of 53%-36%-5% for auto, broadcast and communication and medical devices, respectively, in Q4FY19, it moved to 47%-40.9%-7.7% a year later. The latest numbers, for Q1FY21, show a 42% share for transportation, 45% for broadcast and communication and 8.6% for healthcare and medical devices. JLR remains the top client, but its share of revenue is down to just 12.1% now.
“We have well and truly recovered,” exulted Raghavan in the January 2020 earnings call. The numbers certainly seemed promising — revenue was up 9.7% QoQ, PAT increased 51.4%, the two biggest divisions (EPD and IDV) grew about 10% each and within EPD, transportation grew at the same rate over the previous quarter. Healthcare and medical devices remained the fastest growing vertical (albeit on a much smaller base), clocking a 40% hike in business over Q2FY20.
Elxsi ended FY20 in good shape, much better than what most anticipated. Total income was almost flat compared with the previous year, having grown just 1.7%, and profit before tax had declined 18.7%, but given the headwinds in the auto sector and the dramatic reduction in JLR business, it could have been far worse, say analysts. “My personal expectation was de-growth, but Elxsi ended the year flat. So, the management has done a decent job,” says Sarath Jutur, research analyst at Karvy Stock Broking. The brokerage had a ‘sell’ recommendation on the Elxsi stock in its Q2FY20 results update, down from ‘hold’ the previous quarter.
Just when the going was great, everything had changed, for everybody. Before the financial year could close, all bets were off.
The more things change…
The COVID-19 pandemic, the extended lockdown and the shutting down of international travel took a toll on the entire world economy and all businesses. Elxsi was not spared, either. In a matter of weeks, it had to move 98% of its workforce to work from home, which meant additional investment in security and laptops for employees. The Systems Integration division caught the full brunt of the lockdown, since neither hardware could be shipped nor software could be installed, which meant revenue would take a beating. The slowdown in the auto sector was exacerbated by the pandemic, leading to muted sales forecasts from car manufacturers and changes in budget allocations and programme fundings. All of this led to a cascading effect on suppliers and R&D companies such as Elxsi. The medical business was affected as well, since medical equipment manufacturers re-prioritised their R&D spends into COVID-19 related expenditure, which resulted in less business for Elxsi in terms of medical devices and regulatory work. Raghavan stayed optimistic, though. “The market remains uncertain and the full impact of COVID-19 on the industry, markets and business for us in the first quarter and beyond is still not entirely clear. But, having been through this over the last year and having recovered well, I have the confidence in our capabilities and our people to meet this challenge, too,” he declared during the Q4FY20 concall in April.
Under the circumstances, the latest quarter results can be termed encouraging — they aren’t as bad as they could have been. Sure, revenue and net profit have fallen sequentially, but the company closed a couple of new deals in Q1FY21, with the numbers still showing an improvement when compared with Q1FY20. While operating costs are on a tight leash right now, mainly due to the travel ban, Elxsi has also held back big-ticket items such as bonuses and hikes and new office space. Instead, it will relook at its existing lease agreements, since WFH may mean less demand for office space going forward. “The de-risking strategy has been effective. Also, the negligible-to-zero exposure to aerospace has been a blessing in disguise for the company since there is severe stress in that sector currently,” says Babla.
Importantly, the broadcast business has been doing quite well, overtaking transportation to become the biggest vertical this quarter. Compared with the same quarter last year, the sector has grown 20.6%, and Elxsi is pursuing opportunities in the space across the world — from the US, Europe, India and South Africa, where it is already active, to seeking deals in West Asia. “In general, any pressure on companies typically reduces their discretionary spend on R&D... but there has been an upsurge of consumer demand, whether it is voice, data or OTT. The other tailwind includes new demand from companies for anything that can digitise and enable automation, and facilitate remote access,” Pai said in the latest earnings call.
Not surprisingly then, there is a stated objective for rejigging the revenue mix in the coming few years. As auto’s share falls, broadcast and healthcare are expected to pick up the slack, and in three years or so, Elxsi expects to get over 40% from the broadcast and communications vertical, and 20% from healthcare and medical devices, with transportation at a new low of 40%.
That may be a big ask, say analysts. Karvy’s Jutur says that expecting 20% revenue share from healthcare is a daunting task. He adds, “COVID-19 has come at a bad time; the company was already in de-risking mode and will now face additional challenges.” KRChoksey’s Rai agrees and says, “Healthcare at 20% seems a bit far-fetched but 12-15% in five-years’ time could well be achieved, given the current rate of growth.”
Die another day
For now, Tata Elxsi is holding out (See: In top form). The company has a strong balance sheet, zero debt and a good dividend payout record (why not, when it has Rs.6.6 billion in reserves?). Management execution appears sound and current utilisation rate of 70% leaves headroom for future growth. The increased focus on broadcast and healthcare will be margin-accretive and even the auto segment may recover in a post-Covid world if demand for private vehicles picks up as an alternative to public transport. Dalal and Broacha’s Babla would prefer a more aggressive stance on acquisitions and more teasers on what’s in the pipeline in terms of new platforms, but points out that the management’s successful de-risking strategy of last year is reassuring. At least, there will be “no knee-jerk reaction to future problems, if any”. On the other hand, Jutur is a tad more circumspect. “Profitability may be hit in FY21, and there may be temporary blips on the working capital front because of the pandemic,” he believes.
The most optimistic is KRChoksey’s Rai. “A low single-digit growth (5-8%) this year is achievable and the second half of the year could see closure of some deferred deals,” she says, while adding that a changed business mix can bring margin improvements, especially if the economy improves. So, looks like a little sound management execution may be all it takes to bring back the sense of déjà vu.
