Security and Intelligence Services (SIS) is entering the primary market on Monday 31^st July 2017, to raise Rs. 362 crore via fresh issue of equity shares of Rs. 10 each and an offer for sale (OFS) of upto 51.2 lakh equity shares by PE investor CX Partners (68% of OFS), promoters (26% of OFS) and other shareholders, both in the price band of Rs. 805 to Rs. 815 per share, aggregating Rs. 780 crore, at the upper end. Representing 13.08% of the post issue paid-up share capital, issue will close on Wednesday, 2^nd August and listing is expected on 10^th August.

SIS, with strength of 1.5 lakh billing employees, provides security services through 94,281 security guards in India and 5,587 in Australia (as of 31-3-17), accounting for 35% and 52% of the company’s consolidated revenue, respectively. Balance revenue comes from manned services in India, such as facilities management (8% of revenue), cash logistics (4% of revenue), pest and termite control, electronic security and home alarms.

Australia, with man-power of just 3.7% of total billing strength of 1.5 lakh employees, accounts for over 50% of revenue, as realisation per guard per month in Australia, at Rs.3,57,200, is 25 times that of India’s Rs. 14,000, which drives margins for the company. Company’s standalone PBT margin stood at just 1.48% in FY17 as against 2.47% PBT margin on a consolidated basis, since Australia security business, housed under a wholly owned subsidiary, earns much higher margin both in percentage terms (of over 3%) as well as in absolute terms (due to higher ticket size). Thus, Australia business is the cash cow which has been milking the India business. However, as growth rates are lower in Australia (at 9%) versus 32% (on overall basis) in India, this profit arbitrage will dry down at some point in time, besides exerting downward pressure on margins, as share of India business expands in the total revenue pie. For now, Australia security service is the company’s key differentiator cum revenue driver.

Domestic facilities management business, which remains the company’s focus segment to drive future growth (acquired 79% in India’s 4^th largest facilities manager, Dusters Total Solutions in Aug 2016) has the lowest realization per employee (i.e. ticket size), at less than Rs. 9,000 per month (refer above table). Hence even if the sector is poised for healthy growth, profit per employee will be low, in relative terms.  

In relation to listed peers, Quess Corp and Teamlease both have average realisation per billing employee of Rs. 20,000-22,000 per month, which is higher than SIS’ domestic realisation of Rs. 12,500 per months (refer table above). Hence, SIS seems to be present in the lowest end of the manpower hiring pyramid, which will always restrict margins.

For FY17, consolidated revenue of SIS grew 19% YoY to Rs. 4,567 crore, while EBITDA of Rs. 223 crore resulted in margin of 4.9%. At 83% of revenue, employee cost accounts for a significant chunk of expenses, which is highly susceptible to minimum wages and other labour regulations, both in India and Australia. Retrospective changes in bonus payment affected financial performance for FY15, such that on 15% revenue growth, EBITDA rose by only 8% YoY. Also, due to higher ESOPs charge in FY17, employee cost swelled to 83% of revenue, which has always been sub-82% since FY13-16. Given the gigantic sum, even few basis point changes in employee cost affects earnings significantly. Corollary to this, scope for margin expansion is very limited, as constrained by the business model.

Another threat is low entry barrier and hence large and fragmented presence of unorganized sector, which leads to cut-throat pressure on pricing. Security guards and facilities management space has become a commoditized business, which is affirmed by the sky-rocketing attrition rates. For FY17, company’s India operations reported 56% attrition, while that in Australia was no less at 21%. IT sector which is also very manpower heavy (despite high technology dependence) is challenged by attrition levels looming in mid-teens too. While this business, with limited scope for technological intervention, will always have to cope with this mammoth task of managing high employee attrition, which affects performance in the form of high recruitment and training costs.

All this has dented company’s PBT margins, which have contracted from 3.31% in FY14 to 2.47% in FY17. It reported PBT of Rs. 113 crore for FY17, while PAT after minority interest stood at Rs. 91 crore, leading to an EPS of Rs. 13, on equity of Rs. 68.7 crore, having expanded post 10:1 bonus in Sep 2016.

As of 31-3-17, company’s net worth stood at Rs. 543 crore, leading to BVPS of Rs. 79. Currently, promoters hold 76.90% stake, which will shrink to 70.45% post IPO. PE investor CX Partners, having invested in the company since 2013, is looking to part-exit its 15.50% stake in the OFS. Its holding post IPO should contract to ~9.82%. Company had consolidated total debt of Rs. 762 crore (31-3-17), while cash and equivalents stood at Rs. 451 crore, with cash mostly lying in the books of subsidiaries. Of the fresh issue proceeds of Rs. 362 crore, Rs. 200 crore will be used for debt repayment (availed to fund acquisition of Dusters last year) while Rs 60 crore will fund working capital.  

At Rs. 815, company’s market cap and EV will be Rs. 5,962 crore and Rs.6,073 crore, which leads to FY17 EV/EBITDA and PE multiples of 27x and 63x respectively. After accounting for 2 acquisitions (Dusters in facilities management space in India and SXP in mobile patrol in Australia) and lower interest cost, based on FY18E earnings, EV/EBITDA and PE multiples are 22x and 50x respectively, which are very aggressive, given wafer-thin net margins of the business.

While the company likes to compare itself only to Quess Corp, which has clocked historical revenue CAGR of 46% since FY14, thanks to its highly successful inorganic approach, vis-à-vis only 14% for SIS, it is leaving aside peer Teamlease which has reported higher revenue CAGR of 26% since FY14. Only common piece between Quess and SIS is the facilities management business, which accounts for a small revenue pie for both. Hence, it is either futile to compare just with Quess or makes sense to do a broader comparison with all listed peers in the sector, as shown below:

From the above comparison, one can infer that SIS has the highest revenue as well as highest realization per employee, thanks to its Australia business. However, despite high EBITDA margin at 4.9%, its PAT margin is the lowest in the peer set at 2% (versus 2.2% and 2.7%). In contrast, debt free Teamlease scores over SIS, besides former having the highest return on capital employed (RoCE) of 30% and much lower valuation multiples. Quess Corp’s higher multiples are justified by its stunning historic growth rates (thanks to successful acquisitions), healthy margins and high profitability. SIS issue fades in comparison without leaving much on the table, in terms of valuation.   

While the business is scalable, wafer-thin margins, cut throat competition and unattractive pricing make this issue an avoid, based on fundamentals.   

Disclosure: No Interest.