Acropetal Technologies: Avoid

The macro trends in the IT sector are such that the top tier and relatively larger players have seen a considerable revival in fortunes after the financial crisis.

Mid-tier, and more so the smaller software companies, are yet to see significant revival in volumes or pricing, especially after the debt crisis in Europe. In this light, investors can give the IPO of Acropetal Technologies, a provider of engineering design and IT services, a miss, given the challenges in scalability of its business and relatively higher valuation that the offer demands.

At Rs 90 (upper end of the price band), the offeror asks for around 10 times its annualised (9MFY11) earnings on a fully diluted basis. This valuation is about the same or marginally higher than what companies such as Geometric, KPIT Cummins and Infotech Enterprises (that are 3-10 times larger) trade at.

Acropetal, which commenced operations about a decade ago, has revenues of Rs 153.5 crore as of FY10, with net profits of about Rs 35.7 crore. This has been helped by the acquisition of Vision Info in the UAE, which was completed in the later part of FY09. Vision Info recorded revenues of Rs 45.4 crore in 2009-10. Organically, Acropetal has grown its revenues at a compounded annual rate of 27.5 per cent over FY07-10, while net profits expanded only at the rate of 11.4 per cent over this period.

The company works predominantly in three verticals/services ? engineering design services (almost 38 per cent of revenues), IT services (29 per cent) and healthcare (33 per cent). The US accounts for more than 55 per cent of its revenues, while West Asia's contribution is around 35 per cent, thanks to the acquisition it made. There is a fair bit of revenue fluctuation among geographies. Europe and Asia, which collectively used to account for over a fourth of revenues, have seen reduction in absolute revenues to less than half this fiscal compared with what they were in FY10. The company also has to contend with rising interest costs, heavy client concentration, higher days sales outstanding, and possibly increased tax-incidence.

Macro challenges

After the initial run-up from the lows of 2009, mid-tier IT companies have not been marked up as their earnings either continue to languish or grow at a tepid pace. The re-rating has largely been restricted to bigger IT companies . With clients across the world undertaking a consolidation of vendors, mid-tier players have hardly made any dent. The flow of large deals too, has only been to the top-tier companies. Investors may be well advised to stick to the top-tier companies while cherry picking a couple of stocks from the mid-tier pack.

Acropetal has only about 10 clients accounting for almost all of its revenues, posing serious concentration risks. The company had a debtor collection period of 109 days in FY10, which it estimates to go up to 121 days this fiscal. This is substantially higher than the 60-80 days timeframe that most Indian IT vendors work with. Acropetal has over Rs 130 crore in debt with a debt-equity ratio of 1:1. Interest costs too are rising steadily. Both of these are at variance to the relatively tight balance sheets of most software players.

Finally, with the tax exemption on STPIs set to expire this fiscal, tax incidence, insignificant currently, may go up manifold. These apart heavy competition and the resultant pricing pressure may not allow easy scalability.

The issue is open from February 21 to 24.