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CTC acquisition to bolster TECHM’s Insurance capability

Deal valuation inexpensive on account of higher client concentration

* TECHM has announced the acquisition of Com Tec Co IT (CTC), an East European IT Services company with a presence in the Digital engineering and outsourced product development space, for EUR310m.

* CTC services clients in the Insurance vertical, which should strengthen TECHM’s capabilities in that space. It has development centers in Eastern Europe (Latvia and Belarus) and has a workforce of 720. TECHM has also acquired a minority stake (25%) in two group SaaS companies (SWFT and Surance) for EUR20m, along with an option to acquire an additional 20% at current levels.

* CTC had a revenue of EUR36.6/EUR57.6/EUR71.3 in CY18/CY19/CY20, implying ~40% CAGR, although the growth has progressively moderated. It posted a revenue of EUR58.8m for the nine months ended Sep’21, implying a run-rate of ~EUR80m in CY21 (1.5% of TECHM’s FY22 revenue). As per the management, CTC has industry-leading EBIT margin and will be accretive on an EPS, RoE, and FCF basis. While TECHM has not shared additional details, our rough estimates suggest a PAT accretion of less than 1% to our FY23 estimate.

* Given its presence in the high growth Digital and product development work, along with high operating margin, the CTC acquisition is attractive for TECHM at the trailing EV/sales of 3.8x and mid-teen EV/EBITDA multiple (our estimate). Moreover, CTC is operating at high single-digit attrition rate in today’s environment, which is also a positive.

* The key strategy for this acquisition is to scale and cross-sell. TECHM will invest in expanding CTC’s marketing capabilities and integrate capabilities, which will unlock scale for the latter.

* This is a good move by the company and will further add to the Digital and ER&D capabilities of TECHM in the Financial Services space.

* We maintain our Neutral rating with a TP of INR1,910/share, implying 22x FY24E EPS. We have not incorporated the numbers in our estimates yet.

Valuation and view

* TECHM’s higher exposure to the Communications vertical remains a potential opportunity as a broader 5G rollout can lead to a new spending cycle in this space. The company is seeing traction in 5G investments.

* We expect a gradual improvement in EBIT margin, given the levers around productivity and cost optimization. Elevated operating metrics and supply side pressure remains a risk to our margin estimates

* We expect TECHM to deliver mid-teens growth in FY22. We value the stock at 22x FY23E EPS. We remain Neutral on the stock.

Highlights from the management interaction

* TECHM will completely acquire CTC for EUR310m, of which EUR210m will be paid upfront and the balance will be paid in the form of earnouts and synergy payouts over the next four years.

* TECHM also acquired a minority stake (25%) in two Insurance technology platforms (SWFT and Surance), which share common ownership with CTC. It has the option to increase its stake by another 20% at its discretion. Both of these are relatively new businesses (1.5-3 years old).

* The deal will be financed by cash and there are no plans to raise debt.

* The management iterated that the business has deep digital skill sets and capabilities, marquee projects, and delivery centers in Latvia and Belarus. The management intends to take leverage of these disruptive business models to double down on scaling the Insurance business.

* The business has industry-leading EBIT margin and the deal are EBIT, EPS, RoE and cash flow accretive. There is no seasonality in the business and the attrition rate is in single-digits.

* Synergies include opportunities to scale and cross-sell. There may be some investments in sales and talent in the near term as the business had many constraints on marketing spends (it is in a private ownership structure) and therefore the company left some money on the table. With the acquisition and TECHM’s sales and marketing capabilities, it expects to scale and cross-sell not only CTC’s products, but also its own products to new clients so that they leave no money on the table.

* The Insurance market is very attractive as the technology spends here are generally 2-3% higher than the industry.

* SWFT is B2B SaaS platform focused on sales and distribution, digital broking, and helps Insurance companies to launch new products. It has clients based out of Europe. Revenue is based on a percentage of brokerage.

* Surance is a B2B SaaS platform developed in Israel and is focused on personal cyber Insurance. It helps Insurance companies with the collection of relevant data and managing underwriting associated risk based on that data. The management believes there is a huge market for data driven Insurance underwriting.

* The amortization will be one-third of cost over an eight-year period.

* The company has a good set of digital capabilities and 30-40% of the employees are tenured employees with deep knowledge expertise.

* The company earns ~60% of its revenue from its anchor client.

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