KPIT announced a merger with Birlasoft and a subsequent demerger of its Engineering business, effectively implying creation of two separate businesses – the combined KPIT-Birlasoft entity and the Engineering entity. As part of the deal, shareholders of Birlasoft will receive 22 equity shares of the combined KPIT-Birlasoft entity for every nine shares of Birlasoft. Post this, the Engineering business will be listed and shareholders of KPIT Birlasoft will receive one share in the Engineering entity for every one share held in the combined entity. While the company has detailed swap ratios in the transaction, it is difficult to derive the valuation ascribed to Birlasoft or the combined entity because the financials and number of outstanding shares in Birlasoft are unknown and undisclosed. We will have to wait for more details on the conference call to make more sense of it. Since the acquisition of the IT business by KPIT (Sparta and Systime), overall financials (both revenue and EBITDA margin) have been subdued, and the company has failed to derive any material synergy benefits from cross-selling.
The Engineering business (currently 42% of revenue) has been growing in double-digits and has a superior margin profile (mid-teens v/s 10% on the overall company). On $290 million of revenue in Engineering by FY20E, 15% EBITDA margin and 10% net profit margin, the entity can command a higher multiple than the current 15.8/12.2x FY19/20E, given its better financial profile, superior service offerings, improved competitive positioning and sharper go-to-market.
Comparable pure-play engineering peers like L&T Technology Services, Tata Elxsi and Cyient have been trading at significantly higher valuations and the Engineering business of KPIT will have the potential to mirror that. We, thus, see potential for value unlocking in the deal announced, independent of the valuation ascribed to KPIT-Birlasoft.
