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Does ICICI's stake sale impact 3i Infotech? - Views on News from Equitymaster

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Does ICICI's stake sale impact 3i Infotech?

Dec 10, 2009

Investors in 3i Infotech (3i) must be curiously watching the recent activity happening in the companyís stock lately. Talks are going around that ICICI Group which holds around 27% stake in 3i is eyeing an exit. Investors may be worried if this is to do with ICICIís confidence in the future of 3i. Letís throw some more light onto this. Whatís the ICICI -3i link?

Investors will be well-aware that ICICI Group established 3i-infotech in 1993 as its back office IT products and services provider. However, ICICI group has been slowly pulling out of the Infotech investment by selling shares in the open market. By the end of October 2009, its stake in 3i remained at 26%. Now it seems to be planning to sell the rest as well.

Whereís 3i now?

3i is now a mid-sized IT company focusing mainly on the banking, financial services and insurance (BFSI) vertical. It no-longer remains only an IT back-office for the ICICI group. Rather it has become a leading technology company providing IT services and solutions to over 1,500 clients in over 50 countries. It is one of the rare Indian IT vendors that earn revenues from products as well as IT services. During the 5-year period of FY04 to FY09, 3i grew its sales and operating profits at average annual rates of 68% and 73% respectively, though duly helped by several acquisitions.

Reasons for the stake sale

3iís financial performance over the year has been pretty decent. Amidst economic slowdown which plagued the global financial markets, it grew its topline by 90% YoY in FY09. Its net-profits jumped by a commendable 60% YoY for the same fiscal. Even for FY10, itís half-yearly report-card boasts of a 14% increase in sales and 10% increase in net profits. At current market price of Rs 89, it has a total market cap of Rs 15 bn.

One worrying factor about the company has been its very high leverage ratio. At the end of FY09, the company a large debt of around Rs 22 bn on its books, with a debt to equity ratio of 2:1. It used a large part of this debt in order to fund as many as 30 acquisitions over the years. Nevertheless, the company has currently stopped its inorganic foray and is now focusing on bringing its debt levels down. The recent QIP issue of Rs 3.2 bn is expected to reduce the debt levels of the company to around 1.3:1 as the debt repayment will occur in a phased manner over the next 3 months. It aims to achieve a 1:1 debt to equity ratio by the end of this fiscal. Moreover, only 25% of its debt is repayable in the next 3 years. So it appears to be comfortable on the debt repayment front.

Given all the track record, one might question the prospects of ICICIís stake sale. We believe that this stake sell has nothing to do with ICICIís confidence in the company. It is a strategic move for ICICI to disinvest from the non-core infotech business. This business has become peripheral to its operations. So it is simply attempting to unlock its investment in the same. Moreover, 3i has achieved a size, scale and brand that it can very well sustain on its own.

Implications on 3i Infotechís future

At the current price of Rs 89, the stock is trading at a multiple of 4.2 times our estimated FY12 earnings. This makes it an attractive ĎBuyí. No doubt that global private equity firms like Apax Partners, Carlyle and KKR are scouting for ICICIís stake in 3i. It is being said that the potential acquisition might mandate a launch of 20% open offer i.e. a total investment of Rs 8 bn to Rs 9 bn.

The proposed stake sell will be similar to what happened at Mahindra British Telecom (MBT). It is well known that it was incorporated in 1986 as a JV between Mahindra & Mahindra (M&M) and British Telecom (BT). The company leveraged the expertise and brand name of the global telecom player BT in gaining a strong foothold in the telecom segment. When it matured to become a leading IT player in its vertical, BT hived off its stake and this gave birth to the present Tech Mahindra (TM). Tech Mahindra now has BT as its largest client contributing about 50% of its topline. 3i can replicate TMís success story as after leveraging its association with the ICICI group it has become a leading player in the BFSI segment. Moreover, unlike TM it is no longer over-dependent on its largest client, ICICI Group. ICICI contributes only around 8% of 3iís revenues. The top 5 and top 10 clients (excluding ICICI) contribute around 16% and 22% respectively to the companyís topline. So it has a pretty diversified client base which cushions it against any drop in revenue from its top client ICICI Group. More than 56% of the revenue comes from the US and Asia contributes around 30% to its topline.

To conclude, we believe that 3i is still an attractive investment opportunity for long-term investors. And the proposed stake sell will not have much of an impact on companyís future prospects.

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