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Cyient Ltd: REL to help move up the value chain? - Views on News from Equitymaster
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Cyient Ltd: REL to help move up the value chain?
Jan 7, 2015

The India Letter recommendation for the month of November 2014 was Cyient Ltd. The most important growth driver for this Hyderabad based IT firm is its ability to move up the value chain by offering differentiated services. While the company has good in-house domain expertise, it will need to make strategic acquisitions to bridge gaps in its high value services. To this end, the management has a sound acquisition strategy in place. This strategy was one of the reasons for our high conviction in the company's prospects. On the path to deepen its domain knowledge, Cyient has acquired Mysore based Rangsons Electronics Limited (REL).

About Rangsons Electronics Limited (REL): REL is an electronics system design and manufacturing firm with about 1,000 employees. It caters to Fortune 500 clients in verticals like aerospace & defense (69% of sales), industrials (18% of sales) and medical (11% of sales). Incorporated in 1993, this privately held firm (Ranga Group) has over the years, developed deep domain expertise in high end integrated manufacturing capabilities. These include system integration (79% of sales) and contract manufacturing (21% of sales).

The synergies: Cyient's revenue profile (as on FY14) comprised of about 80% of IT services (which may or may not command high pricing power) and 20% systems (high end manufacturing) and solutions (end-to-end manufacturing + IT services). By 2020 the company wants the revenue profile to be 30% services, 50% systems and 20% solutions. The REL acquisition will certainly help the company in this endeavor. The synergies are quite obvious in this case. Currently, Cyient's clients get the design work done by the company and after adding their own value proposition to the design, they hand it over to a firm like Rangsons to manufacture. With this acquisition, Cyient will be in a position to provide end-to-end solutions.

The deal: The financial details of the deal have not been disclosed. However, the managements of both Cyient and Rangsons were quite forthcoming on the conference call about many aspects of the transaction. Cyient will acquire 74% stake in REL in an all cash transaction. This is expected to be completed in a 4-6 weeks. The full integration of REL with Cyient will take 4-6 quarters. One REL promoter will find a place on Cyient's board. The remaining 26% stake will be acquired by Cyient over a 4 year period based of certain financial performance parameters. As of FY14, REL revenues were approximately US$ 66 m. The EBITDA margin was in the range of 10-12%. The deal will be EPS accretive for Cyient from day 1. REL's US dollar sales have grown at about 30-35% CAGR over the last 3-5 years. However, it is expected to be 15-20% CAGR going forward.

Our view

The acquisition is certainly a positive for Cyient from a long term perspective. However, in the short term, this deal does not warrant significant changes to our estimates. On a consolidated basis for FY15, Cyient's reported revenues would rise by 15-17%. However, the EBITDA would rise by about 5% due to the fact that REL's EBITDA margin (at 10-12%) is far lower than the same for Cyient (18%). The EPS too will be boosted marginally by about 5% for FY15. We would wait for more financial details from the management before changing our forward estimates. Our view on the stock remains unchanged. We recommend investors to invest around 50% of the sum that they were intending to put into this stock at current levels and invest the remaining once the stock corrects by around 20% from current levels. However, for all the investors who have brought the stock already, we recommend that they do not buy any more at these levels. They may invest upon a 20% price correction.

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