KPIT to merge with Birlasoft, demerge Engineering
Merger with Birlasoft; Demerger of Engineering: 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.
Implied EV of ~USD200m for Birlasoft: Share count at Birlasoft was 31.4m, implying that the swap ratio would lead to creation of ~77m shares, 39% of current equity base. At CMP of INR208 as on 29th January 2018, this implies EV of INR13b (USD200m) for Birlasoft, after adjusting for net cash of INR3b (USD47m) on the company’s balance sheet.
Engineering business to demerge, process to take more than a year: Post the merger with Birlasoft, 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. The entire process is likely to take more than a year, with the merger likely completing by end-FY19 and the demerger of Engineering Services taking place in early FY20.
Combined entity to be ~USD500m IT Services business: Revenues at Birlasoft are USD140m, with an EBITDA margin of ~14%. This implies USD700m revenues for the merged entity with a 10.9% EBITDA margin (80bp higher than KPIT). IT Services will be ~USD500m business and Engineering Services run-rate will be USD200m+.
A positive development with potential to unlock value
* Since the SaaS-ification of application offerings hurt the ERP segment, it weighed heavily on KPIT’s Sparta and Systime acquisitions, and overall financials have been subdued ever since. Additionally, the company has failed to derive any material synergy benefits from cross-selling – with hardly any IT services clients in the automotive segment and hardly any engineering clients in other industries. The core engineering business (currently 39% of revenue) has been growing in double-digits and has a superior margin profile (mid-teens v/s 10% for the overall company).
* Against this backdrop, we see the demerger as a positive development not only from the point of view of unlocking the value of the attractive engineering business, but also channelizing the bandwidths of different businesses under separate companies and leadership.
* Zinnov placed KPIT in the leadership zone for automotive engineering ratings in 2017 on its capability/scalability matrix. The demerger brings these capabilities in limelight, and thus, harbors potential to unlock value.
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