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Mindtree IPO Analysis

Mindtree Consulting is offering shares in an IPO between 9th and 14th Feb 2007. The offer is for around 56 lakh shares, of which about 6.6 lakh shares are reserved for employees and customers.

Price : Rs. 365 to Rs. 425 per share
Issue size: 204 cr. to 238 cr.
Pre Issue Shares: 3.17 cr. shares
Post issue public equity: 15% (total: 3.73 cr. shares)
FY 07 EPS : (Pre issue) Rs. 27.55 annualised.
P/E: 13.25 (lower band) and 15.43 (upper band)

The company
Mindtree provides software services – R&D and IT services. While the company provides standard IT services such as software development, consulting, data warehousing etc. it also has a research arm that produces proprietary technology in the wireless space.

The company was started in 1999 by Ashok Soota, previously CEO of Wipro Technologies. Another famous MindTree “mind” is Subroto Bagchi, their COO. Capital was initally provided by Walden Investments and by Amalgamated Investments, a V.G.Siddhartha company. (Siddhartha owns Coffee Day, and has seed funded a large number of tech ventures like Kshema Technologies)

Further funding has been obtained from Global Technology Ventures (another Siddhartha company), Capital International and Franklin investments, and a customer, AIG, has also chipped in. In the last two years, the company acquired three different companies for a total of 33 cr.

What are the funds for?
Mindtree intends to build a big development center in Chennai, for which they’ll spend about 12 cr. This will be in an SEZ, which ensures that they don’t pay income tax for the near future.

18.7 crores will be used to immediately pre-pay a loan from HSBC.

That adds up to about 30 crores. The rest of the issue is for “general corporate purposes” and issue related expenses. Let’s say the issue expenses are about 12cr (6%) – so nearly 188 cr. at the higher band is now unallocated!

Mindtree has acquired an IC design company for cash on Jan 10, 2007. No further details are available, but I assume that IPO proceeds will be used for the acquisition and perhaps for further expansion.

I am happy that this company has provided financial data upto December 31, 2006. Mindtree grew at about 46% annually over the last four years (revenue wise) and profit has grown from from 17 cr. in FY05 to a forward looking 87 cr in FY07. (annualised growth of 121% ).

Revenue and Profits for 9M FY07 are 407 cr and 65 cr respectively, which is a pre-issue EPS of Rs. 20.66.

Annualised EPS for FYO7 is Rs. 27.55. The corresponding upper band P/E ratio is 15.43.

(Note: this does not account for about 24 lakh shares as outstanding ESOPs, but they won’t affect the valuation by much – about 8%)

Most competing companies have a much higher P/E – most of the top companies like Infosys, Wipro and TCS command over 30 P/E and most second rung companies (like Tech mahindra, Visualsoft, Patni) get 25+. The only comparable company is NIIT Technologies which gets a P/E of 16, still higher.

I feel the company is extremely cheap at this IPO price.

Other interesting points
Mindtree has always wanted to contribute to society and has provided 6500 shares to the Spastics society, so that they will reap benefits as the company grows. This, and their other social responsibility initiatives are highlighted on the company web page and shows their commitment to social growth.

Low top management compensation: Ashok Soota has a CTC of only 60 lakhs, and Subroto Bagchi of Rs. 30 lakhs. This is much lower than what other companies pay their middle management! This is good for shareholders of course, but I wouldn’t mind a 300% increase in top management compensation, based on performance.

The company has about 40 cr. in cash investments which is about Rs. 10 per share (post issue).

In general, I feel that there are some issues with the tech story going forward. The dollar looks to be under some pressure with India’s market rating improving, and if more dollars come in (as investment) the rupee will gain and the dollar will lose. A slide in the dollar will affect exporters – and therefore the margins of most tech companies.

Compensation overheating: With salaries growing at over 20% in real terms, there is immense pressure on margins. Additionally, there is high attrition – nearly 20% – which affects profitability in terms of hiring and retraining costs. The market itself is overheated, and there is a severe lack of high quality middle management. Mindtree, though, has been rated among the best companies to work with (in India), and that cultural advantage will benefit it very much in these mercenary times.

Lack of H1-B visas: With so many tech companies in the fray, the limited number of H1-B visas to the U.S. (which are work permits) is slated to be used up in a very short period, some say by April 15. Lack of work permits means lower onsite presence, which reduces the growth potential by a little bit – onsite presence is required even for projects which are mostly done in India, because contracts are usually fashioned with a mix of onsite and offsite personnel.

Debt: Even though some debt will be retired through the issue, there is still some debt left over from HSBC and OBC. This is all less than 10%, but excess cash from the IPO should have been used to remove such debt – to leave the door open for further leveraged acquisitions later.

Overall recommendation
At the valuation given, this is a blind buy. “Aankh band kar ke le lo” types.

But I think this IPO will be severely oversubscribed so there is simply be no point in holding up your money in it – I would recommend buying after it lists (around March 9 or so). Yes, you will end up paying substantially more than the IPO price. But the Firstsource IPO was oversubscribed 50 times, and I expect as much for this IPO. Frankly, I don’t think you will get many shares for your money. So why lock the money?

Buy at any price upto Rs. 800. Remember that they have announced an acquisition but more details are forthcoming – and that acquisition in a new space (IC Design) will surely prop up the share price later, when they provide the details.

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