ITI Ltd

Verdict: It’s a Wrong Number

Update (1Feb2020, 11:30 am): Due to poor response of only 58% subscription till close of extended FPO timeline& PSU bank employee strike, FPO closing has been extended to Wed 5th Feb. Price band remains 71-77. Our view of 'avoid' is maintained. 

Update (28Jan2020, 4:15 pm): Due to poor response of only 48% subscription till 4pm on final day, FPO closing has been extended by 3 days to Friday, 31st Jan 2010, with price band lowered marginally to Rs.71-77 (from 72-77 earlier). However, the reduction in price band is only marginally and our advice of 'avoid the FPO' remains unchanged. 

FPO Snapshot:

ITI Limited has entered the primary market on Friday 24^th January 2020, to raise Rs. 1,400 crore, via an FPO (follow on public offer), comprising a fresh issue of up to 18.18 crore equity shares of Rs. 10 each, in the price band of Rs. 72 to Rs. 77 per share. Issue represents 16.85% of the post issue paid-up share capital, with reservation ratio of 75:15:10 for institutions, HNIs and retail investors respectively. Issue is closing on Tuesday 28^th January, with new shares likely to get listed by 6^th February 2020.

How is FPO different from an IPO?

IPO or an initial public offer, is when an unlisted company makes a first public issue of shares. FPO or follow on public offer, as the name suggests, is when an already listed company makes a public issue of share to existing or new set of investors. Thus all subsequent public offering of shares by a listed company (2^nd, 3^rd and so on) are called FPO.

Since ITI is already listed (since Aug 1993 on BSE and Jan 1996 on NSE!), its share price is readily available, with present rate being Rs. 91.

Company Background:

89.97% stake held by the Government of India (GoI), ITI Limited, formerly Indian Telephone Industries Limited, is a Bengaluru based PSU, operating under the department of telecommunications (DoT) offering products and services in the telecommunication, IT, defence security, BFSI, solar energy sectors. It mainly serves other PSUs with high dependence on govt customers – 99% of H1FY20 revenue came from government entities, while 98% of the Rs.11,051 crore order book concentrated in 11 govt projects.

Objects of Issue:

Fresh issue proceeds of Rs. 1,400 crore will fund:

1. working capital Rs.642 crore,
2. repay Rs. 607 crore loans, of total Rs. 1,200 crore outstanding debt
3. balance for general corporate purposes.

Shareholding:

To bring down Government’s shareholding to 75% to comply with minimum public shareholding of 25%, a fresh issue via the FPO is being undertaken.

From March 2001 to June 2018, promoter holding in the company increased from 77.02% to 93.75%, pursuant to fund infusion by the government, to restructure it under BIFR. Subsequently, to comply with the then minimum public shareholding norms of 10%, GoI transferred some of its holding in the company to a ‘Special National Investment Fund (SNIF)’ without any consideration, thereby reducing its holding to present 90%.

As of 31-12-19, excluding GoI’s 89.97%, Karnataka Government’s 0.03%, SNIF’s 7.75%, balance 2.25% is held by 55,000 shareholders. Thus, public float is extremely low, implying current share price in the secondary market is artificially inflated and does not reflect true value. Moreover, liquidity on the counter is extremely low, as stock is very thinly traded, with 3 month average daily traded volume of 15 lakh shares, as against 89.7 crore outstanding equity shares.   

Financials not comforting:

• Company has announced Q3FY20 results on 6 Jan 2020 to the stock exchanges, whereas RHP dated 17 Jan 2020 has presented financials only upto H1FY20. Wonder why the RHP was not updated?!
• Referred to as a ‘sick’ unit under BIFR until last year. In Feb 2014, a revival plan with fund infusion of Rs. 4,157 crore was approved. Until FY19, company was surviving on government grants/aids. Infact even in current fiscal FY20, it has received grant from the government towards capex.
• FY19 accounts has a lot of observations from the Comptroller and Auditor General (CAG) of India, pertaining to outstanding receivables, liabilities, depreciation on assets among others.
• For H1FY20, on revenue of Rs. 580 crore, company reported net loss of Rs. 54 crore. As H2 is stronger than H1, Q3FY20 revenue and PAT surged to Rs. 828 crore and Rs. 168 crore respectively, leading to 9MFY20 revenue growth of 36% YoY to Rs. 1,408 crore, with PAT jumping four-fold to Rs. 114 crore. However, key reason for this surge in profitability was other income of Rs. 85 crore and Rs. 19 crore which are government grants and write-back of a liability respectively.
• Besides profitability, what is worrisome are the receivables. Company’s debtors of Rs. 2,650 crore (30-9-19), majority of which are government entities, are outstanding for over 580 days – yes, you read it correct – outstanding for over 19 months. No wonder then that fresh issue proceeds of Rs. 642 crore will fund working capital needs, implying good money chasing not-so-good money. It is anybody’s guess how much of these receivables will be finally received and how many would turn bad. Since company is facing problem of mounting capital blocked as working capital, financials get strained further.
• Its order book of Rs. 11,051 crore (31-12-19) appears healthy at over 4x revenue run-rate. However, many of these are maintenance contracts for over 10 years. Actual flow of these orders also must be monitored, given sector headwinds. For example, 2 orders included in the above order book worth Rs. 5,600 crore, come from BSNL, which is itself struggling to stay afloat. With competitive pressure facing the domestic telecom industry, company’s order book must not be taken at face value.
• Net worth (30-9-19) is in the negative while net debt is over Rs. 950 crore. With equity expansion and partial debt repayment, the leverage will be more manageable with net debt to equity ratio of 0.3:1.  
• Even if revenue shows an upward trajectory, working capital strain will remain, as fresh capital will not address the problem completely. Moreover, GoI’s resources to support the PSU are also limited, given its own fiscal challenges like lower tax collection, slow progress on the divestment front and ongoing economic slowdown.

Valuation:

At Rs. 91 per share, company’s current market cap stands at Rs. 8,150 crore. Accounting for expanded equity of Rs. 1,079 crore, at FPO price of Rs. 77 per share, valuation may remain close to current levels, at Rs. 8,300 crore.

One may think that shares are being offered at 15% discount in the FPO, hence attractive. But that is not the case. Here’s why -

1. Extremely low public float is causing share price to artificially remain elevated currently. Ergo, share price may crash once new shares get listed, eliminating the ‘scarcity premium’. Share price was already 7% lower yesterday after FPO price band was announced.
2. It is one of those few PSUs, which is not cash-rich. Instead one of the objects of the IPO is debt reduction.
3. Generally, PSUs are attractive for their dividend yield. However, since fundamentals of this company have been strained, it has not declared any dividend last year. Besides, not having declared dividend in the past 15 years, as per the BIFR scheme, company is not allowed to declare dividend until entire outstanding statutory dues cleared in full. Even thereafter, NCLT permission must be sought to declare any dividend. Thus, one can’t play the dividend yield theme here.
4. Telecom sector facing severe headwinds, with crash in optical fibre cable (OFC) prices, slowdown in government orders (as reiterated by results of other companies like Sterlite Tech, Tejas Networks, HFCL in Q3FY20 results). Defence orders for the company can also be fluctuating. Hence, pace of order book materializing remains a key monitorable.
5. Finally, there is no valuation comfort either. Given Q3FY20 and 9MFY20 EPS of Rs. 1.79 and Rs. 1.28 respectively, assuming a very liberal EPS of Rs. 4 for FY20, implied PE multiple stands at 18-19x on the Rs. 72-77 price band, which is very aggressive, given the multiple risks stated above.

Conclusion:

IPO is being undertaken for meeting minimum public shareholding norms and to provide company some financial support. However, fundamentals are seen missing. Hence, we advise an ‘avoid’. Do not get lured by the FPO being priced at a substantial discount to the current market price.

Grey Market Premium (GMP) of ITI: Grey Market Premium of ITI is not applicable as share is already listed and hence price is available in the secondary market. 

Disclosure: No interest.