Sell L&T Technology Services (Stock recommended by Saurabh Mukherjea & Hiren Ved) for target price of Rs 3250 (11% downside): DART

In-House Acquisition in Unproven Landscape & low margins

 LTTS announced acquisition of Smart World & Communication (SWC) unit from Parent L&T for a total consideration of Rs8Bn (0.73x on Sales).

 Acquisition is aimed to complement LTTS in: a) Next-Gen Communications (around 5G networks), b) Sustainable Spaces, and c) Offer full stack of Cybersecurity Solutions to global clientele.

 Transaction is valued at 0.73x of FY22 sales of Rs10.9Bn, which is attractive but lacks immediate synergy benefits, and with EBITDA Margin profile of 8-10%, would be EPS Neutral in near term.

 Acquisition can help LTTS achieve its guided $1.5Bn run-rate by FY25E, but path to achieving LTTS’ profitability is likely to be an elongated one. Maintain Sell rating on the stock with TP of Rs.3,250, valued at 24x of FY25E EPS of Rs135.2.

Products and Platform Business of Parent’s Construction Segment

Founded in 2016, SWC is a Connected Intelligence Solution provider operating in 3 segments: Communications (74%), Safe & Smart Solutions (25%), Cybersecurity (1%) with 700 employees, with India as key market.

Merging Additional Capabilities and Extending Scope of Offerings

Acquisition aims to align 3 of 6 Big Bets of LTTS viz. 5G, Sustainability & Digital Products & AI, and enhance LTTS’ playbook to its Fortune clients across the markets. In 5G, LTTS aim to provide full stack offerings for Operators, OEMs & Enterprises. For Sustainable Spaces, SWC has solutions for Smart cities, utilities, Public safety, etc. In Cybersecurity, LTTS aims to provide security lifecycle management.

Uneasy Shift; Growth & Margin Trajectory Remain a Concern

Currently the biz. comprise of Govt projects, thus bulk of revenues will continue to see these projects over next 18 months until new Global deals are announced. It is yet to be proven what kind of GTM strategy will be formed. Existing EBITDA margin of 8-10% is quite low and would impact blended margins by over 150bps in FY24E. While management has expressed that profile of this business, will see a shift towards Managed Services model, but until a precise customer set, actual serviceable market is identified; acquisition rationale will remain susceptible.