Action Construction Equipment: Invest

Investment in the initial public offer of Action Construction Equipment (Ace) can be considered at the cut-off price. In the price band of Rs 110-130, the offer is priced at 12-14 times its expected March 2007 per share earnings on post-offer equity. The offer is attractively priced compared to its peers such as TIL and BEML. Expanding product portfolio, marketing alliances with international players and solid fundamentals lend support to our recommendation.

Ace is one of the prominent players in the construction equipment space and a leading player in the hydraulic tower and mobile cranes segment. Much of the proceeds will be used to expand manufacturing facilities and set up units for new products.

Expanding product portfolio

Ace holds 50 per cent market share of the mobile and tower cranes segment. Escorts Construction is the primary competitor in this segment. Ace's broader product offering in terms of capacity and better margins give it an edge over its competitors.

The company plans to launch higher capacity tower cranes that could give it a better share in the construction equipment market.

The company also plans to foray into forklift trucks where Godrej and Boyce is the leader. It has already entered the Backhoe loader segment, where several players such as BEML, L&T and JCB operate. Ace's product offering in this segment is now restricted to lower end capacities.

Ace has forged marketing alliances with international companies such as Maber, Tigieffe and Autoguru of Italy for products such as aerial access platform and mast climbing platforms, which are used extensively in the construction of high-rise buildings.

These products are not manufactured in the country and, hence, imported. As clients prefer a one-stop shop, a broad product offering enhances the chances of cross-selling different products to the same client.

Immense opportunity

Given the scale of infrastructure investments planned in the country, there is immense scope for growth of the construction machinery sector.

Construction machinery accounts for 20-24 per cent of the total construction costs in high growth areas such as power, roads and bridges.

Availability of easy finance too has encouraged construction companies to own equipment. Ace's tie-up with financiers such as Citicorp and Srei Finance for infrastructure finance could help it improve volumes.

Financials

Ace is one of the fastest growing companies in the construction segment with a compounded annual sales growth of 96 per cent over the last five years. Even in 2005, when most equipment manufacturers suffered a slow down in sales due to delay in awarding road contracts, Ace managed decent growth.

Strong fundamentals indicated by the low debt-to-equity, high interest coverage and return on net worth in excess of 30 per cent lend support to our view.

We feel the offer is attractively priced, considering the immense growth opportunities in the sector, Ace's positioning in the construction machinery space and its strong fundamentals.

The offer that closes on September 7 is lead-managed by Karvy Investor Services.

Businessline - HOV Services: Invest at cut-off

Investors with a penchant for high risk and seeking to diversify their IT services portfolio can consider participating in the book-built offer by HOV Services. This business process outsourcing (BPO) company is making the offer in the price band of Rs 200-240 per share.

At the lower and upper end of the price band, the price-earnings multiple works out to 15-18 times the consolidated per share earnings for 2005-06 on the existing equity base. Bidding at the cut-off price will be appropriate in this offer, as investors will remain eligible to participate, even if the final offer price is fixed at a lower level.

Considering the risks and the overall financials, the pricing is quite stiff at the upper-end of the price band. We would be more comfortable if the final price is fixed at the lower end of the price band, which may leave adequate room for capital appreciation. HOV Services is a focussed player in the F&A (Finance and Accounting) BPO market, with good client relationships and domain focus created through a string of acquisitions.

On the flip side, however, it remains exposed to the risks of high client concentration, intense competition and pricing pressures in the voice-related lower end of the BPO value chain. Of the nearly Rs 90 crore to be raised through this offer, as much as Rs 65.5 crore is to be infused as capital into HOV's subsidiary, HOV Services LLC, for redemption of non-interest-bearing Class B units issued. Only the balance is to be used towards capital expenditure.

The positive signals

As part of the F&A market, HOV Services and its six subsidiaries operate across three business lines: Accounts Receivable Management (ARM), Enterprise Management Tools and Services (EMTS), and Insurance and Tax Services (ITS). Of the total revenues of Rs 163.8 crore for 2005-06, ARM accounted for 45.2 per cent, with ITS and EMTS contributing 42.3 per cent and 12.5 per cent respectively. In ARM, the company caters to a part of the low-end voice services.

However, since it also handles the entire gamut of third-party debt collection, the stickiness of its clients is likely to be fairly high. The other key segment — ITS — provides services to the surety insurance industry. HOV Services has clients that span the Fortune 1000 category across the four key verticals — telecom, insurance, healthcare and financial services.

According to the offer document, most of its clients have been with it for over five years. For the year-ended March 31, 2006, customers from the telecom, insurance and healthcare verticals contributed about 25 per cent each of the revenues, which opens up cross-selling opportunities from its clients across its three business lines.

Risks and challenges

The client concentration levels have been relatively high. For the year-ended March 31, 2006, HOV Services' top ten clients accounted for 70 per cent of its revenues, with the top five clients from the ARM segment contributing about 43 per cent. While the client concentration level may be similar across companies of HOV Services' size, this aspect exposes the company to growth risks arising from any loss or reduction of business from these top clients.

As a BPO outfit, HOV Services faces the challenge of managing high attrition. The offer document states that the attrition rate in the ARM business (including voice calls) has averaged 45 per cent. This along with rising salaries and relatively low operating margins, in the 12-13 per cent band, vis-à-vis its established peers can pose a major challenge.

The competition in the IT-enabled services business has also escalated sharply in the past couple of years. Multinationals such as Accenture or IBM are scaling-up their operations in India. Domestic software service companies such as Wipro, HCL Technologies, Infosys, MphasiS BFL (under the EDS umbrella), and NIIT Technologies are also positioning themselves in the voice-cum-transaction processing BPO business. Finally, pure-play BPO companies such as Genpact, WNS or ICICI OneSource with established operations have also enhanced the competition levels within the industry. If consolidation also takes off in some form, it has the potential to exert influence on the pricing front at the lower end of the BPO value chain.

The offer opens on September 4 and closes on 7.

Atlanta: Invest at cut-off

Source: Businessline

Investors can consider taking exposure in the initial public offering of Atlanta at the cut-off price. At the price band of Rs 130-150, the offer is priced at 13-15 times its per share earnings for March 2006 on a diluted post-issue equity. Valuations are comparable to players such as Valecha Engineering and Era Constructions. Reasonable valuations, good operating margins and a good order-book lend optimism to our view from a near-term perspective.

Business

Atlanta is primarily an EPC (Engineering Procurement and Construction) contractor in the road segment with a presence in the mining and realty space too. Much of the IPO proceeds will be invested in a special purpose vehicle to execute the Nagpur-Kondhali section of the highway on a BOT (Build-Operate-Transfer) basis. The rest will be used for initial investment in a housing project in Mumbai, to repay debt and buy machinery.

Atlanta is one of the smaller players in the construction business trying to transform itself from a pure EPC contractor to an operator of BOT projects. The company has gained experience by executing its first BOT project ahead of time. This could help the company qualify for more such projects in future. Currently, Atlanta has one BOT project under execution and has bagged another for which it is raising funds.

The revenues from both will start accruing in the next two years. BOT projects are lucrative and offer good opportunities for growth as the government encourages more public-private partnerships. The equity expansion will also enable the company bid for large projects. The ability to forge project-specific partnerships with bigger players such as Gammon India could also improve its chances of qualifying for bigger orders.

Near-term visibility

The company has an order book of over Rs 600 crore, of which the unexecuted portion, as of June 2006, is close to Rs 300 crore, approximately three times its 2006 revenues. These orders are only for the EPC contracts on hand and not for the BOT projects. Though the order book-to-sales ratio is lower than most other players in the construction sector (four-five times FY-06 revenues), the execution timeframe, at about a year, gives it near-term earnings visibility.

Financial performance

Over the last five years, the company's sales have grown at a compounded annual rate of 24 per cent and earnings at 47 per cent. Operating profit margins at over 30 per cent is high compared to its peers. Over the last two years, income from the high-margin mining segment has risen substantially to contribute 11 per cent of revenues from 2 per cent in 2004. The company also owns its own range of equipment, which gives it better margins as volumes increase.

The offer opened on September 1 and closes on 7. The lead manager is Karvy Investor Services.

IPO - Atlanta

Promoted by Rajhoo and Rikiin Bharot, Atlanta (formerly Atlanta Infrastructure) is engaged in the construction of road projects. The company also has presence in mining and real estate development.

The civil engineering works executed by Atlanta include road construction, airfield pavements, reclamation, reinforced concrete tracks, building sheds and other civil works. Road construction works on engineering, procurement and construction (EPC) basis as well as built-operate-transfer (BOT) basis are executed for the National Highway Authority of India (NHAI), urban bodies and the state public work departments (PWD).

Atlanta has executed the Udaipur Bypass Road Project II successfully and toll collection commenced in 1998-99 by the special purpose vehicle (SPV), i.e., Ideal Toll Roads Investment & Operations. It is currently working on two projects on BOT basis: the Mumbra Bypass Project and the Nagpur-Kondhali section. The former is in advanced stage of completion. Further, the company is currently executing road construction and development projects in Orissa (NHAI), Lucknow (NHAI & PWD), Mumbai (MMRDA), and Udaipur (PWD).

Majority of the revenue (about 89% in FY 2006) comes from road projects, which empirically offer thin margin. However, Atlanta maximised the margin by bidding for risky projects from urban local bodies and state PWDs and by not confining to high quality ????(NHDP) projects where competition is higher but margin thin.

The mining business of Atlanta involves excavation of coal / coal measure strata on job work basis for subsidiaries of Coal India. The company is currently extracting approximately 12.79 million cubic meters of coal from Mahanadi Coalfields at Bharatpur and Kalinga, Orissa. The contract value of the project is Rs 40.22 crore, with Rs 17.99 crore worth of project pending completion. The Bharapur Open Cast project contract will last up to October 2007 and the Kalinga open cast contract up to July 2008.

The real estate business of Atlanta consists of developing both residential and commercial complexes. The company has developed properties in Mumbai such as Amba Shanti Chambers, Atlanta Arcade and Atlanta Towers. The company proposes to construct a residential apartment complex with all amenities on its own land at Shil Phata in Thane district on National Highway (NH)-4 at a cost of Rs 50 crore. Total buildup area will be about 0.66 million sq. ft and the project is to be executed in five phases over five years. Rs 5 crore will be invested from the current issue proceeds to finance the first phase of the project.

The proceeds from the current issue are to be used to fund investment requirement in Balaji Toll Ways, a SPV incorporated for the execution of the Nagpur-Kondhali four-lane BOT project, for purchase of plant and machinery for mining and construction, investment in real estate projects, repayment of high cost debt and incremental working capital requirement.

Strengths

• Unexecuted order/work on hand amounted to Rs 293 crore end June 2006 in the road sector with six projects amounting Rs 118 crore scheduled to be completed by end March 2007.
• The high margin nature of the mining business lifts the overall margin. The mining business contributed about 11% of the revenue in FY 2006.
• Investment splurge in infrastructure projects, specially roads, and policy change in the mining sector approving captive mining blocks provide good growth opportunities.

Weaknesses

• Negative cash flow from operating activities in FY 2006 and FY 2005 with a strong rise in unbilled expenditure as well as delay in recovery. This affected the working capital recycling, leading to higher interest cost.
• Over-dependent on road projects and on a single client, Mahanadi Coalfields, in the mining business.
• Sundry debtors outstanding for the past couple of years amount to Rs 21.68 crore due to disputed claims.
• There are six group firms/companies engaged in similar business.
• Atlanta will be investing around Rs 42.9 crore (65% of IPO proceeds) in an SPV for executing the Nagpur-Kondhali four-lane BOT project, which is not appraised and which will not yield any return for the next few years.

Valuation

At the offer price band of Rs 130-150, the PE range works out to between 13.5-15.6, respectively, on FY 2006 EPS of Rs 9.6 on post-IPO equity. The TTM PE for Construction – Civil Medium/ Small is 20.4.

IPO - Action Construction Equipment

Promoted by Vijay Agarwal and his wife and son, Action Construction Equipment (ACE) manufactures mobile tower cranes, tower cranes and material handling equipment. The company has sold its equipment to most leading private and government sector companies in India such as Reliance Industries, Punj Lloyd, Gammon India, Nagarjuna Construction, Simplex Concrete, NTPC and Bhel.

ACE is setting up an assembly unit in Uttaranchal, which is funded by internal accruals. This assembly unit will be eligible for various tax incentives. The company is planning to set up a new plant (through the IPO proceeds) to manufacture loaders, higher capacity tower cranes and other material handling equipment at Faridabad.

Strength

• Infrastructure and construction industries are witnessing substantial investments. On an average, construction equipment forms 12-15% of the project cost. Thus, significant fresh demand is likely to arise in future. The useful life of construction equipment varies from 7-15 years. At present, replacement demand constitutes only 5-7% of the total demand. However, four-five years from now, about 30-40% of the total demand may be replacement demand along with demand for spares as the volume for construction equipment has grown significantly in the last four-five years.

Weakness

• ACE is operating in a raw material intensive industry. The main raw material used by the company is MS steel, which constitutes around 60% of its overall cost. Unexpected rise in and volatility in steel prices can adversely affect profit margin.

Valuation

The post-IPO EPS based on FY 2006 earning works out to Rs 7.2. At the offer price band of Rs 110-130, the PE range is 15.2 to 18. The TTM PE of Engineering - Heavy - Material Handling is around 16.6. Annualised EPS based on first quarter earning works out to Rs 8.8. About 45% turnover is derived in the first and second quarters and 55% from the third and fourth quarters.