Verdict: Give this Route a ‘Miss’
Route Mobile is entering the primary market on Wednesday 9th September 2020, to raise Rs. 600 crore, via an IPO of equity shares of Rs. 10 each, comprising a fresh issue of up to Rs.240 crore and an offer for sale (OFS) of up to Rs. 360 crore, by the promoters, in the price band of Rs. 345-350 per share. The issue represents 30% of the post-issue share capital at the upper end of the price band and will close on Friday 11th September, with listing likely by 21st September.
Technically, this is company’s second attempt at IPO, as it has previously filed for a Rs. 1,000 crore IPO in 2018 but did not launch the issue citing market conditions, despite SEBI approval.
Route Mobile is a 16 year old platform as a service (PaaS) company, providing cloud-communication services, such as application-to-peer (A2P), peer-to-application (P2A), rich communication services, voice, email and omni-channel communication, SMS analytics and firewall to enterprises, OTT players and mobile network operators. Over 80% of its nearly Rs. 1,000 crore revenue is generated overseas, mostly Africa, Middle East and Asia Pacific region.
Largest client accounted for 15% of FY20 revenue, while top 5 accounted for 41%. Despite growth in absolute revenue and acquisitions widening product basket/ geographic spread, revenue concentration of few clients is increasing, with top 10 clients accounting for 36%, 46%, 53% and 64% of revenue for FY18, FY19, FY20 and Q1FY21 respectively. Thus, company has not been able to diversify is client base. Client concentration remains one of the key risks for small firms, and this company is no different.
Objects of Issue and Shareholding:
60% of the IPO size comprises offer-for-sale by 2 promoter brothers. They are looking to part-encash their 96% holding, which will contract to 68% post IPO.
Fresh issue proceeds of Rs. 240 crore are proposed to be utilized towards:
- Rs. 83 crore for M&A and strategic opportunities – of this, Rs. 27 crore is due as earn out for 365squared, a company acquired for ~Rs. 150 crore in Oct 2017. Between Sept 2016 to Oct 2017, company has made 4 acquisitions aggregating Rs. 170 crore.
- Rs. 65 crore for purchase of 55,000 sq. feet office in Mumbai. We believe this object needs a re-visit in the post-pandemic world as (i) company’s India employee strength is less than 300 and during the lockdown, its entire team was able to work from home (ii) financially, ownership is more expensive than leasing. Current rental of 4-5% for commercial property is way below cost of equity of 12-15% (ii) it will significantly impact RoE, reducing from current 25% level. Even the 2018 DRHP carried an object of issue as purchase of office in Singapore and London for Rs. 80 crore. On one hand, company is generating healthy free cash flows and on the other, it is diluting equity unnecessarily, impacting return ratio. Thus, timing of office purchase is quite inappropriate and definitely doesn’t warrant a capital raise via equity dilution.
- Rs. 36.5 crore of debt repayment – total debt as of 30-6-20 stands at Rs. 42.5 crore, which is primarily working capital loans. On net worth of Rs. 297 crore, which will rise to Rs. 537 crore post IPO, this debt is quite small. Thus, debt repayment is not a pressing need.
Fresh issue objects do not appear convincing, as the company is not really in need of funds. It has cash and equivalents of Rs. 170 crore (on 30-6-20) and generated over Rs. 90 crore of cash profits in FY20. Thus the IPO looks structured, to make hay when the sun shines.
FY20 revenue stood at Rs. 956 crore, with Rs. 927 crore revenue from messaging services and balance Rs. 29 crore from call centre services. Old DRHP filed by the company in 2018 reveals that it clocked consolidated PAT of Rs. 63 crore in FY16 on revenue of Rs. 367 crore. For FY20, reported PAT stood at only Rs. 69 crore on revenue of Rs. 956 crore. Thus, in 4 years, while revenue grew by 161%, PAT rose by just 10%, implying net margin contraction from 17% to 7% due to lack of pricing power! Cost for purchase of messaging service, which is the raw material, increased from 68% of revenue in FY16 to 82% of revenue in FY20, pulling down margins sharply. This also implies that going forward, company will have to depend on acquisition to achieve growth, as there is limited scope for margin expansion. This is also reiterated by the fact that company is purchasing the office premises to reduce lease expenditure and repaying debt to cut interest expense. While these may boost bottomline, they do lift gross margin, which has contracted sharply from 32% in FY16 and FY18 to 20% in FY20. Another factor boosting company’s bottomline is relatively lower effective tax rate of ~18%, due to major operations undertaken through UK subsidiary, which enjoys lower tax rates. If domestic operations rise, this benefit may also get diminish. Another point to consider here is that industry tailwinds are not very strong, with A2P market expected to grow at only 4.4% CAGR.
For Q1FY20, revenue and PAT stood at Rs. 310 crore and Rs. 27 crore respectively, leading to an EPS of Rs. 5.4, vis-à-vis Rs. 13.8 for FY20, on an equity of Rs. 50 crore and net worth of Rs. 297 crore (30-6-20).
At Rs. 350, company’s market cap will be Rs. 1,990 crore, implying a PE multiple of about 18x and 16x on FY21E and FY22E earnings respectively, which is not attractive for a small cap stock, earning single digit margins, with declining RoE (down from 30% in FY18 to 26% in FY20). Capital allocation strategy is not prudent as highlighted in Object of Issue above, which will keep RoE under pressure.
While there are no comparable peers, if one were to look at smaller software services firms, they earn double digit net margins and are ruling at forward PE multiples in low-to-mid teens. A few broad examples being Cyient, Mastek, Zensar or even a products company like Nucleus Software. Thus, Route Mobile has not left enough on the table in terms of issue pricing.
In view of contracting profit margin, structured objects of fresh issue, client concentration risk and unattractive pricing, one can give the IPO a miss.
Grey Market Premium (GMP) of Route Mobile: Grey Market Premium of Route Mobile is an unofficial figure, against guidelines of SEBI. We strongly recommend investors against following the grey market premium. To know more about grey market premium and how it operates, read our article on ‘grey market premium’ in Pathshala column.
Disclosure: No Interest.