Should you subscribe to Data Patterns IPO?

Data Patterns (India), a vertically integrated defence and aerospace electronics solutions provider, is raising ₹588 crore through an IPO . The offer will be open from December 14 to 16.

It comprises a fresh issue of ₹240 crore, and an offer for sale of ₹348 crore at the higher end of the price band (₹555- ₹585 per share). The proceeds from the fresh issue will be used for funding working capital needs, repayment / prepayment of borrowings and capacity expansion. Post the IPO, the promoter stake will go down from the current 57 per cent to 45 per cent.

Company snapshot

Data Patterns, which has been around for over three decades, is a vertically integrated electronics company with end-to-end capability ranging from in-house designing to manufacturing complete systems and sub-systems across the entire range of defence and aerospace electronics products. It reported revenue of ₹224 crore, EBITDA of ₹92 crore and net profit of ₹56 crore in FY21.

There are many positives on the business front – vertically integrated business operations, high-margin specialized products, healthy order book and a strong balance sheet. The big focus on indigenization in Indian defence procurement too is expected to open up significant opportunities for private sector defence companies such as Data Patterns which is also undergoing capacity expansion.

At ₹555-585 per share, Data Patterns discounts its trailing twelve-month (TTM) earnings by around 31-32 times. While the stock valuation is not cheap, those interested in a fast-growing company in a high-growth potential sector, can consider investing in the IPO. But, investors need to watch if the company continues to bag more production orders.

The Data Patterns IPO stock valuation is cheaper than the 44 times TTM P/E that the ₹2,265 crore market cap Astra Microwave Products stock is trading at. Unlike Data Patterns, Astra Microwave is focused on radio frequency and microwave systems (not the entire spectrum of electronics), and operates at much lower margins. On the other hand, the behemoth in this segment, Bharat Electronics (BEL) trades at a relatively lower TTM P/E of 22 times. While like Data Patterns, BEL too is backed by a strong order book and is well placed to benefit from the focus on indigenization, the former has seen a sharper revenue and profit growth and rise in profit margins over the last two and a half years.

About business

Data Patterns derives 85 per cent of its revenues from defence and the rest from aerospace applications. Its portfolio comprises products and sub-systems in domains such as radars, avionics, communication, automated test equipment and satellites, electronic warfare, and the BrahMos missile programme. Domestic sales account for 90 per cent of its revenue.

Its customers include government organisations such as the DRDO and ISRO and defence PSUs. While most of Data Patterns’ contracts are fixed price, its existing margins provide scope for cost absorption, if needed.

Starting out with supplying to DRDO at the product development stage, Data Patterns has gone on to also winning production contracts (or repeat orders) in the Ministry of Defence tenders over the years. Here, it competes with defence PSUs such as Bharat Electronics, which is also one of its key customers.

Profitable model

Data Patterns’ approach of building complete systems using its own designed and developed components and sub-systems helps it provide higher value addition. Substantial development costs incurred in the initial years to develop sub-systems and products for use in large scale production (repeat orders) in later years, get written off as revenue expenditure the same year. When the company secures production orders in future years, a large part of the resultant revenue flows directly to operating and net profit thereby bumping up margins. Data Patterns reported EBITDA and net profit margins of 39 per cent and 24 per cent for the first half of FY22.

As of July 2021, Data Patterns had an order book of ₹582 crore (book-to-bill ratio of 2.6 times) comprising development (21 per cent), production (67 per cent) and service contracts (12 per cent). In FY17, the high cost lower-margin development contracts accounted for 74 per cent of the order book.

According to the company, it will be focusing on orders where the initial development stage is over and there are opportunities for getting high volume or high value repeat production orders. Unlike in case of development contracts (new products) which entail higher working capital requirements and revenues that may be lumpy, production contracts have a staggered delivery that provide revenue visibility and stable cash flows.

Growing fast

For the six months ended September 2021, Data Patterns reported revenue of ₹96 crore (up y-o-y 117 per cent), EBITDA of ₹38 crore (20 times of that a year ago) and net profit of ₹23 crore (loss of ₹6 crore a year ago).

A higher quantum of repeat production contracts - which are more margin-accretive and have a more regular quarterly flow - in H1 FY21 as opposed to development contracts, the revenues from which flow in typically in the last quarter (as happened in FY20) explains the sharp rise in revenue and profit.

Between FY19 and FY21, Data Patterns grew its revenue 31 per cent (CAGR) to ₹224 crore. During this period, the company’s EBITDA rose 90 per cent (CAGR) to ₹92 crore and net profit rose 169 per cent (CAGR) to ₹56 crore. Driven by a rise in the quantum of production contracts along with a slower rise in operating costs, profitability improved. The EBITDA margin jumped from 19.5 per cent to 41 per cent during FY19 to FY21. As of September-end 2021, Data Patterns had a debt-to-equity ratio of only 0.24 times.

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