VA Tech Wabag IPO - Apply or Not ?

Investors with a long-term perspective can consider subscribing to the initial public offer of VA Tech Wabag (VA Tech), an Indian water solutions provider with a multinational presence. Well-entrenched in the high-potential water-treatment business, strong foothold in developing nations, sound financials and debt-free status buttress our recommendation.



Backed by well-known private equity players, VA Tech has the unique reputation in the water industry, of buying out its erstwhile Austrian parent; thereby securing for itself a ready reference point in key markets and, more importantly, the benefit of 157 patents held by the Austrian company Wabag.

For domestic investors, VA Tech may be a unique play in the water treatment sector, a space that holds high opportunities, driven by both government mandates as well as the need to conserve and recycle water.

At the offer price band of Rs 1230-1310, the stock would discount its estimated per share earnings for FY-12 by 12-13 times. The price-earnings ratio for FY-10, at 23-25, may seem higher than other infrastructure plays. However, given that the company is more technology-oriented, and relies less on a brick and mortar model, we believe it may not be strictly comparable. As a holder of intangible assets, similar to infrastructure BOT developers, a price-to-book ratio may be a better metric to compare. At 2.4-2.6 times P/BV, VA Tech's valuations are similar to those of infrastructure players.

As VA Tech is in the process of improving profit margins (given the high cost of operations in Europe) of its foreign subsidiaries, investors may have to stay with the stock for at least 2-3 years to derive the full benefits of the operations synergy.

Business and offer

VA Tech provides water engineering solutions such as sewage and effluent treatment, processed and drinking water treatment, desalination and reuse. The company seeks to raise Rs 125 crore through fresh issue and a part offer for sale by private equity investors for Rs 326-347 crore.

It plans to use the proceeds for working capital requirements even as the over Rs 200 crore of cash in hand (as of March), is sought to be utilised for potential acquisitions. At the offer price band, the company's market capitalisation on listing would be Rs 1,300 crore to Rs 1,380 crore, and this at a very low equity base.

Going global

VA Tech's buyout of Wabag Austria, a leading water solution company, from Siemens in 2007 marked its emergence as a global player. The buyout provided access to key water markets. Equipped with Wabag Austria's technology, VA Tech began utilising the same for its various projects in India and abroad.

Through its subsidiaries, VA Tech has presence in key markets in the Middle East and North Africa; being the most water scarce regions in the world, they have been forced to adopt sea water desalination as well as water reuse programmes. With presence in these key markets, besides parts of Europe, China and South East Asia, VA Tech's track record of completed projects in these regions gives it the technical qualification for future projects. Only few players such as Suez Environment and Veolia Water have such vast presence. With a large number of designs and patents, VA Tech is well-placed to tap the opportunities in the above markets.

VA Tech's businesses have been classified as municipalities, industrials, operations (operation and maintenance) and international business. Given that most of the water treatment projects are initiated by local bodies, close to 88 per cent of the company's order book of Rs 2,780 crore (executable over 1.5-2 years) comes from municipalities, local and overseas; the rest come from industrial clients. As municipal projects characteristically come with price escalation clauses, the company is to some extent protected from cost variations.

Margin challenges

Water projects typically offer high profit margins. However, VA Tech may not always be able to capitalise on this fully as a result of subcontracting the execution work to local contractors. However, for a company specialising in design and technology a focused approach to investing in research may be warranted than locking-up resources for execution of projects. As a standalone entity, VA Tech has nevertheless managed OPMs of over 12 per cent. However, this margin is lower at 9.4 per cent (FY-10) on a consolidated basis.

As is the case with many European buyouts by Indian companies, the foreign subsidiary's profit margins are less attractive than the parent, with higher costs of operation. VA Tech has been introducing changes such as decentralising operations and setting up local offices in key developing nations rather than holding a centralised operation centre. The results of this are evident — with consolidated operating margins climbing 5 percentage points (from 4.8 per cent) since the buyout in FY-08. We also expect operating margins to improve further as the orders from countries such as Africa and West Asia increase. International orders currently account for only about 30 per cent of the total orders, leaving large scope for ramp up.

Besides revenue from contracts, VA Tech is also likely to see increased contribution from the operation and maintenance segment. From a 7 per cent revenue contribution this segment accounted for 17 per cent in FY-10. Going forward, increasing BOOT projects, such as the desalination plant in Chennai are likely to ensure a regular stream of revenues. The margins on these are also likely to be high as the rates are fixed for the quantity of water desalinated.

Over the last two years (since acquisition) consolidated revenues expanded annually at 41 per cent to Rs 1,233 crore in FY-10 while profits jumped at a compounded annual rate of 202 per cent to Rs 49 crore. Profits for FY-10 were dented as a result of providing for full taxes, even as the company is seeking legal recourse for relief under Section 80IA of the Income-Tax Act. VA Tech has remained a company with negligible debt and manages operations with client advances.

via BL