Hexaware Technologies’ return to the bourses is built entirely on an offer for sale of ₹8,750 crore, by the promoter CA Magnum Holdings (affiliate of Carlyle private equity). Post issue, promoter stake will reduce to around 75 per cent vs current 95 per cent. CA Magnum Holdings had acquired majority stake from the Barings PE in 2021 (Barings PE had taken Hexaware Private in 2020), wherein the company was valued at close to $3 billion or ₹23,000 crore at the then USDINR exchange rate. At the upper end of the IPO price-band of ₹674-708, Hexaware is now valued at ₹43,000 crore. Should investors go for it? Here are a few things to consider before making the call.

One, since the time CA Magnum acquired Hexaware, its revenue has grown around 60 per cent on absolute basis, EBITDA 44 per cent and net profits around 40 per cent. As compared to this, the asking rate in the IPO reflects a near doubling in market cap. This IPO comes amid a slowdown the industry is facing following the Covid/lockdowns-driven digitisation boom in CY20, 21 and 22. For example, Hexaware revenue after growing 28 per cent in CY22, has slowed down to 12-13 per cent now.

Two, while this revenue growth of Hexaware is better than that of larger IT services companies like TCS and Infosys (5.5 per cent and 4.5 per cent respectively), its margins as in the case of all mid-tier IT services companies is much lower. For example, as compared to TCS’ net profit margin of 19-20 per cent, Hexaware margins are much lower at between 9.5 per cent and 10.5 per cent. Important to note, in a highly competitive industry like IT services, those with higher margins are better placed to push for aggressive growth if they want to (although so far top-tier companies have shown relentless focus on maintaining margins).

Three, the industry will go through huge disruption in the coming years as Artificial Intelligence (AI) gains significant traction. The AI theme is both an opportunity and threat. For example, while it can reap huge productivity gains for IT services companies as AI can be effectively used in coding, it also comes with the threat of clients insourcing IT-related work using AI, or pushing for lower prices with IT services vendors negating the productivity gains. Hence it is important to note that the disruption can go either ways. Nevertheless, the successful track record of IT services companies including Hexaware in more than two decades tilts the scale in favour of AI being an opportunity, but the journey could be a bit rocky for a few years.

Four, while the US economy has been incredibly resilient over the last two years, risks of slowdown remain with interest rates remaining high and inflation persistent. With Hexaware deriving 73 per cent of revenue from North America, this is another potential near-term headwind that investors need to factor for.

At a valuation of trailing PE of 41 times, the IPO is priced expensively and does not offer any margin of safety for new investors when the above four factors are considered.  Even when making adjustments for a few one-off items as mentioned in the RHP (although some of the costs are recurring every year), the valuation comes to trailing PE of around 35 times. Still expensive, given the risks. Listed peers are priced similar or even higher, but expensive peer valuation cannot be a benchmark for IPO investors here. Hexaware will be a good stock to own, but only at a lower valuation. Hence investors can wait and watch for now.      

Business

When relisted, Hexaware will be the eighth largest listed IT services company in India by revenue. The industry can be largely classified into large providers, mid-sized providers and niche or boutique players. Most IT services companies listed in India will come under the first two categories. The categorisation is based on scale, capabilities and strategic focus.

Hexaware fits in the category of mid-sized providers. The scale of mid-sized providers is much smaller than the large players. For example, Hexaware’s trailing 12 month revenue at around ₹11,436 crore and total employee count at 32,536 is just around 4.5 per cent and 5.25 per cent of TCS respectively. While larger players bring to clients the value proposition of end-to-end spectrum of IT services and are suited for large corporations, mid-sized players offer specialised industry-specific expertise and compete with large players on pricing their offerings competitively. There will also be a few segments not focused on by large players, as the opportunity may be below the scale they are looking for, and mid-sized players seize opportunities in those segments as well. Thus they have their entrenched space in the industry and have grown well over the last two decades. Besides, they have also been building their capabilities and give good competition to large players in some large deals (contract value above $100 million) as well.

In terms of business segments, major verticals for Hexaware are Financial Services (28 per cent of revenue), Healthcare and Insurance (21 per cent), Manufacturing and Consumer (17 per cent), and Hi-Tech and Professional Services (16.9 per cent). While its revenue from Financial Services companies at 28 per cent is similar to that of most peers, if the separate ‘Banking’ vertical is clubbed with this, the exposure at 36 per cent would be at the higher end. In terms of geographic revenue segments, 73 per cent of revenue comes from North America, 21 per cent from Europe and rest from Asia Pacific.

Company outlook

The global industry size for IT services is currently at around $1.4 trillion and is estimated  to grow at a CAGR of 7.2 per cent to $1.98 trillion by 2029. In the four-year period from CY20 to CY24, the industry grew at a CAGR of 6.46 per cent in dollar terms. In the same period, Hexaware revenue in dollar terms too grew much stronger at around 11.5 per cent. If the company continues to execute well as in the past, investors can expect Hexaware to continue to better the industry growth rate.

However, it is important to note here that the growth of 7.2 per cent estimated in a third-party report forming part of Hexaware’s RHP must be taken with some caution – this is given the AI disruption and also possible slowdown in the US economy. Such factors make forecasting more challenging and less reliable.  Further, the above growth rate estimated is for both inhouse and outsourced IT services spending combined. If clients use AI to inhouse more, this too can impact growth for Indian IT services players. While none of this is a given, it is important to factor for varying outcomes.  In that context, the valuation of Hexaware is expensive.

Published on February 8, 2025