Tejas Networks is entering the primary market on Wednesday 14^th June 2017 to raise Rs. 450 crore, via fresh issue of equity shares of Rs. 10 each and an offer for sale (OFS) of upto 1.27 crore equity shares by PE investors and senior management, both in the price band of Rs. 250 to Rs. 257 per share. Representing 33% of the post issue paid-up share capital, issue will raise Rs. 776 crore at the upper end, of which, OFS portion is worth Rs. 326 crore. Issue, closing on Friday, 16^th June, has a low retail portion of 10%, against the regular 35% portion size, substituted by higher QIB share of 75%. Listing on the bourses is expected on 27^th June.

Bengaluru based Tejas Networks supplies optical and data networking products to telcos, internet service providers, utility and defence companies in over 60 countries, with exports accounting for a third of its Rs. 880 crore topline. Since company has outsourced major manufacturing functions, it follows an asset light model. However, of the funds deployed worth Rs 940 crore (networth Rs. 500 crore and total liabilities Rs. 400 crore), majority is towards working capital (Rs. 650 crore total current assets), which is not a very healthy trait for any business. A look at the financials throws up humongous outstanding debtors at nearly 5 months of sales, whereas inventory is also high at close to 3 months outstanding, despite enjoying flexibility of outsourced manufacturing.

While it positions itself as an R&D (51% staff strength) and technology company (to have premium multiples of a product company, anyway!), it has written-off significant chunk of intangibles in the past - Rs. 30 crore in FY17 and Rs. 39 crore in FY13. This is quite meaningful, given the low base – total intangibles of Rs. 83 crore (31-3-17), de-grown from Rs.134 crore (31-3-13), over 3 years.

Company’s business model is not comforting enough - 

• High client concentration risks, as 60% business generated from top 5 customers like BSNL, Bharat Broadband (GoI), Bharti Airtel, Aircel, Tata Comm.
• 45% of FY17 sales were to PSUs. Hence strain on working capital is likely to continue.
• Return ratios – both RoCE and RoNW – are in low-teens – 12.6% for FY17.

Neither are the objects of the issue too convincing. Of the Rs. 450 crore fresh issue size, Rs. 303 crore will be allocated towards working capital (yes further!), Rs. 45 crore will be used as R&D staff salary (despite 31-3-17 balance showing cash and equivalents of Rs. 71 crore), while balance Rs. 102 crore (representing 23% of gross inflow) will go towards issue expenses and general corporate purposes, which are not productive means to utilize funds. Anecdotally, it is an R&D company, without having money to pay its R&D staff!

Coming onto the financials, FY17 consolidated revenue stood at Rs. 878 crore, with EBITDA of Rs. 174 crore, translating into EBITDA margin of 19.8%. While topline has grown at 24% CAGR since FY13, growth was not linear, with FY15 topline contracting 9% YoY, with similar fate of bottomline. FY13 PBT of negative Rs. 79 crore rose to Rs. 3 crore profit in FY14, dropping to Rs. 18 crore loss in FY15, which rose to Rs.29 crore in FY16 and finally to Rs. 64 crore in FY17. Such fluctuations in financial performance does not post a sound picture of company's fundamentals. EPS for FY17 came in at Rs. 9.40, vis-à-vis Rs. 4.36 for FY16. As of 31-3-17, networth stood at Rs. 501 crore, while total debt was at Rs. 255 crore, besides cash balance of Rs. 71 crore.

Interestingly, there is no identifiable promoter in the company and 100% is held by ‘public’ category shareholders. Those participating in the OFS include Cascade Capital Management (Narayan Muthy’s brother-in-law Gururaj Deshpande), Intel Capital, PE firm Frontline (India Industrial Growth Fund), besides few of the senior management. While Frontline is fully exiting via the OFS, others are making a part exit.

At Rs 257 per share, company’s market cap will be Rs. 2,350 crore while EV will be Rs. 2,536 crore, which discounts historic FY17 performance by a PE multiple of 27x and EV/EBITDA multiple of 14.6x. Estimating 20% growth in FY18, PE and EV/EBITDA mutiples are 19x and 12x respectively, which is quite stretched. On Rs.1,000 crore topline, sales multiple of 2.5x for actually a software cum hardware company is quite steep! While the company does not have strict listed comparable, smaller peer D-Link, being an MNC enjoying debt free status, is ruling at FY17 sales multiple of 0.45x, EV/EBITDA multiple of 11x, and PE of 18x. Tata Group’s smaller IT networking company Nelco is also ruling at FY17 EV/EBITDA multiple of 10x and sales multiple of 1.3x. Thus, Tejas Networks IPO is steeply priced, in addition to a weak balance sheet.

Citing poor fundamentals and expensive valuations, avoid this IPO.  

Disclosure: No Interest.