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M3bi acquisition to help add scale to ZENT’s BFSI practice

ZENT’s announced the acquisition of M3bi, a US and India-based Data Engineering, Big Data and Advanced Analytics, and Digital Engineering firm, for USD33m on 15th May’21.

M3bi to add to ZENT’s capabilities

* M3bi (founded in CY10) provides Data Engineering, Big Data, and Advanced Analytics and Digital Engineering Services. It works with some of the leading global brands targeting CIOs, CMOs, and CDOs.

* The company works with marquee clients, including Fortune 500 Banks, and should help scale ZENT’s BFSI capabilities and client portfolio. With ZENT’s increased focus on the Banking vertical (currently sub-scale with only 10% of 4QFY21 revenue), we see the acquisition as a good fit.

* M3bi also works with clients in other verticals like Industrial, Healthcare, and Education, allowing ZENT to drive a wider set of offerings to global firms.

* This acquisition is expected to augment ZENT’s Digital Engineering and Data Analytics capabilities, both of which are key focus areas in its new strategy.

* M3bi has 445 employees across the US and India, which ZENT will onboard.

ZENT to pay 1.2x revenue for the acquisition

* ZENT would acquire 100% of M3bi for USD33m. Of this, USD24m would be upfront payment and the balance would be performance-based deferred payment over 36 months.

* This implies a trailing 1.2x EV/Sales valuation, which we view as reasonable. Given the higher share of on-site revenue (85%), M3bi has room for margin improvement from greater synergies with ZENT.

* We expect the acquisition to be EPS Neutral in FY22E. The acquisition would be funded through internal accruals (ZENT has USD166m in net cash).

* The acquisition is expected to be completed on or before 31st Aug’21. We have not factored in the acquisition in our current estimates.

Valuation and view

* ZENT’s current valuation at 14x FY23E EPS is the lowest in our midcap coverage and is at a 43% discount to the median valuations of peers.

* We expect revenue growth to rebound from 2HFY22E as the new leadership (Mr. Ajay Bhutoria took over in Jan’21), refreshed strategy, and reinvestment of margin gains in sales start paying off. With a likely return to double-digit growth in FY23E (we estimate 15% YoY) on a good FY22E exit and recovery in key accounts, we see potential for a significant stock re-rating as valuations catch up with its peer group.

* We see higher downside protection in the share price at current levels as 21% of ZENT’s m-cap is in cash v/s only 8% for its midcap IT Services peers.

* We maintain our Buy on the stock in the likelihood of a recovery in growth and attractive valuation. Our TP implies 16x FY23E EPS.

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