Dixon Technologies is entering the primary market on Wednesday 6th September 2017 to raise Rs. 60 crore, via fresh issue of equity shares of Rs. 10 each and an offer for sale (OFS) of up to 31 lakh equity shares by Motilal Oswal PE fund (64% of OFS), promoter and other shareholders, both in the price band of Rs. 1,760 to Rs. 1,766 per share. Representing 30% of the post issue paid-up share capital, at the upper end, total issue size is Rs. 599 crore, most of which is the OFS portion at Rs. 539 crore. Issue will close on Friday 8th September and listing is expected on 18th September.

Dixon Technologies is a third-party manufacturer of consumer durables (LED TVs, washing machines), lighting products (LED bulbs, LED drivers, tubelights, CFL bulbs) and mobile phones, as also, reverse logistics solutions provider, undertaking repair and refurbishment of set top boxes, mobile phones and LED TV panels, with a 9.3% market share in India’s Rs. 15,000 crore electronic manufacturing services industry. Having 6 manufacturing facilities – 3 each in Noida (Uttar Pradesh) and Dehradun (Uttarakhand), two Dehradun units have income tax break at 30% profit for FY18 and FY19 (although subject to MAT), company is establishing a greenfield unit at Tirupati to cater to South and export markets.

Company makes products for a number of clients such as Panasonic, Philips, Haier, Gionee, Surya Roshni, Reliance Retail, Intex Technologies, Mitashi Edutainment among others. However, client concentration is very high as top 3 customers (Panasonic, Philips and Gionee) accounted for 75% of FY17 revenue, while top 5, made up of 83% of revenue. Original design manufacture (ODM) services earn high margin vis-à-vis OEM (original equipment manufacture) services, as it is completely end-to-end, staring with R&D, raw material sourcing, working capital management, delivery of product in client’s brand name to reverse logistics. ODM accounted for 21% of FY17 topline of Rs. 2,457 crore. 

During the past 4 years, company’s financials have grown from strength-to-strength, with FY13-17 revenue CAGR of 34% and net profit CAGR of 78%. FY17 topline growth was particularly very strong, at 77% YoY, to Rs. 2,457 crore, on account of diversification into LED lighting and mobile phones manufacturing. 34% of FY17 revenue came from LED TVs, 33% from mobile phones and 22% from lighting products. Net profit growth in FY17 however was quite muted at 18% YoY, to Rs. 50 crore, leading to net margin of 2.1%, down from FY16’s net margin of 3.1%. Thus, despite healthy topline growth, company was unable to capture all those benefits into its bottomline.

Since it is essentially a contract manufacturer, without owning the brand, it operates on very slim margin – company’s 5-year average EBITDA margin stood at just 3.5%! Scope for margin expansion and sustainability is both challenging and limited, given the rapid technological changes in the electronics industry, high risk of obsolescence (with respect to investment in R&D) and competitive cost pressures. Thus, it is mostly the topline which can drive company’s future growth. Moreover, business has low entry barriers, as capital requirement is not high. A greenfield plant is being set up with a capex of just Rs. 8 crore. On existing fixed assets of Rs. 140 crore, as of 31-3-17, company is able to garner topline of Rs. 2,500 crore and bottomline of Rs.50 crore, where utilization levels are between 35-70% for different product streams. High RoCE of 35% (for FY17) may attract other players, indicating another threat to margin expansion.

Consolidated EPS for FY17 stood at Rs. 48.85, on low equity of Rs. 10.99 crore (post 4:3 bonus issue in September 2016) and net worth of Rs. 198 crore. Currently, promoters hold 46.20% stake, which will shrink to 38.93% post IPO. Motial Oswal PE owns 23.68%, which will reduce to 5.8% post OFS. Other institutional investors in the company include GMO Emerging Domestic Opportunities Equity Fund (3.09% pre IPO holding) and Steadview Capital Mauritius Limited (1.75% pre IPO holding), who are not participating in the OFS. Fresh issue portion is very small at Rs. 60 crore, which will be used for (i) debt repayment of Rs 22 crore, (ii) new manufacturing unit for LED TVs at Tirupati worth Rs. 7.5 crore, with incentive for land rentals, GST, water and power, (iii) enhancement of backward integration for lighting products at Dehradun for Rs. 8.9 crore and (iv) IT infra upgrade worth Rs. 5.3 crore.

Total consolidated debt, as of 31-3-17, stood at Rs. 47 crore, while cash and equivalents was at Rs. 15 crore. Despite rapid growth and high manufacturing activity, company’s working capital has been very strong, with current ratio at 1.1:1 being maintained over the past few years. 

At Rs. 1,776, company will have market cap of Rs. 2,000 crore and similar EV of Rs. 2,009 crore, which discounts FY17 earnings by a PE multiple of 36x and EV/EBITDA multiple of 22x. It plans to foray into manufacture of CCTVs and digital video recorders, street lighting (accounting for 1/3 of domestic lighting market, with impetus from Govt’s Smart City Project), exports and greater reach in South India, through the Tirupati unit. Thus, 25% growth in FY18 performance looks quite practical. Based on these FY18 expected earnings, PE and EV/EBITDA multiples are 30x and 17x respectively, which is making the share appear fully priced.

In the absence of any direct listed peers, broad comparison can be made with auto component makers who engage in hard core manufacturing activities with some degree of research, although some own very strong brands. Most auto component makers of similar turnover as Dixon are currently ruling at PE multiples of 15-20x of FY18E earnings, most with higher net margins in mid-single digits. Rough comparison of the IPO can also be drawn with AC manufacturer Leel Electricals (formerly Lloyd Electric) whose 1/3^rd of Rs. 3,000 crore FY17 topline came from manufacture of OEM and packaged AC (other than own brand Lloyd), reported net margin of 2.8% at the company level in FY17 and is currently trading at a PE of just 7x, based on FY18E. Moreover, on 3rd May 2017, promoter of Dixon had purchased 233 shares from Times Group at Rs. 1,350 per share, which is 24% lower than the current IPO price, with just 4 months having passed. An unwritten rule of IPO market states that 15-20% must be left on the table for prospective investors, which is missing in this issue. Also, a four digit share price may act as a psychological dampener for retail participation. Thus, all the above factors conclude pricing to be on the higher side.  

To summarise, while topline growth looks promising, coupled with sound balance sheet position, wafer-thin margins, high client concentration, intense competitive nature of business and fully priced issue make the IPO less appealing. Based on fundamentals, better to skip the issue for now and keep it on radar post-listing. 

Disclosure: No Interest.