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TESTing new waters

We present a high-conviction investment idea on Expleo Solutions, an under-researched premier quality assurance company, with a fair value of Rs1,420. The company is likely to be a ‘One Stop Solution’ provider with the merger of engineering, design and testing capabilities. Its investment in the high-growth next-gen testing segment, where it has a leadership position, has started to reap benefits.

We believe, a niche company like Expleo Solutions is attractively placed considering its specialized offerings, growth visibility, MNC parentage, superior financials, increased outsourcing trend, traction in smaller deals (predominantly on the digital transformation front), and upcycle in the technology sector.

* Foray into high growth engineering business: The company added engineering and development capabilities to its already established quality assurance and consultancy services with the recently announced merger with its Indian sister concerns. This merger expands expertise to the automotive and aerospace segment in the ER&D space along with in-roads in the non-BFSI testing space. The company could bundle its engineering, quality assurance & consultancy services, leverage scale to win larger deals and pose as a ‘One Stop Solution’ provider. At 13x PE multiple, we believe potential synergies from the merger are far greater in times to come.

* Superior positioning in legacy quality assurance segment: Expleo Solutions’ (erstwhile SQS India BFSI) multi-decadal experience in testing, targeted BFSI services, newly added non-BFSI testing services, reputable clientele and investment in advanced technologies should lead to revenue growth of 15.7% CAGR during FY21-24E. The company is recognised in line with top global peers in the quality assurance service segment and is a leader in next-gen testing services owing to its proprietary tools and advanced analytical skills resulting in reduced costs and shorter timelines. Its digital transformation services are gaining traction and it plans to further boost its digital offerings by continued investments in technology, expanding sales presence and re-skilling employees. All these initiatives are leading to increased quality and quantity of deal wins

* Strong parentage + IT industry tailwinds = Sweet spot for Expleo Solutions: The parent’s heritage in engineering (among top 10 global players) and focussed approach to increase outsourcing from current single-digit to ~25-30%, improves growth visibility for the Indian merged entity. With the new-gen market estimated to grow at 13% CAGR during 2019-23E (as per Nasscom), we believe Expleo Solutions is in an advantageous position being a market leader in next-gen testing. Industry trends such as (i) increased outsourcing fuelled by the pandemic, (ii) digital transformation deals and, (iii) enhanced IT spends by banks, especially in cyber security further open up opportunities for the company.

* Outlook: We assign 18x P/E multiple on Sept’ 23 EPS, thus arriving at a fair value of Rs1,420 given its superior testing ability, acquisition of capabilities in the high-growth ER&D space, MNC parentage, and sound financials. We believe the company is well placed to capture the buoyancy in the quality assurance space led by shorter deliveries, faster time to market, and a growing outsourcing trend. Expleo Solutions’ capabilities to handhold clients through their digital transformation journey in a cost-effective manner further builds our conviction and the merger of high-traction engineering division provides further upside. Risks to the thesis: muted European demand, change in management, and hiccups in the merger.

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