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Birlasoft Ltd
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Ladies and gentlemen, good day and welcome to the Q3 FY '18 Results Conference Call of KPIT Technologies hosted by Emkay Global Financial Services. [Operator Instructions] Please note this conference is being recorded.I now hand the conference over to Mr. Rahul Jain of Emkay Global. Thank you and over to you sir.
Thank you, Vikram. Good evening, everyone on behalf of Emkay Global. I welcome the senior management of KPIT represented by Mr. Ravi Pandit; Chairman and Group CEO; Mr. Kishor Patil, Co-Founder, CEO and MD; Mr. Sachin Tikekar, Board Member; Mr. Anil Patwardhan, Senior VP Head Corporate Finance and Governance; Mr. Sunil Phansalkar, Head IR and AVP M&A.I would like the management to take us through the Q3 FY '18 results. And now I request Mr. Sunil to take it over from here. Sir, over to you now.
Thanks Rahul. A very warm welcome to everybody on the Q3 FY '18 Earnings Call. As you all would be aware, we also had an important announcement yesterday, so we'll cover the Q3 performance and that announcement in today's call. One small change; Mr. Anil Patwardhan, due to the family emergency, is not able to attend the call, so he is not on the call today. All the other management members mentioned are present on the call.As always, we'll start the call with introductory remarks from Mr. Ravi Pandit. And then we'll throw open the floor for your questions. So, once again, a very warm welcome, and now, I will hand it over to Mr. Pandit.
Good evening and welcome everyone. So what I intend to do is that, we will first spend some time going through the third quarter results. And it would be nice if we can have the question-answers on them after my comments, so that we keep that aside, and then we move to the announcement that we made last night.On that announcement as well, we have some initial remarks to make so that should address some of the questions that you might possibly have in your mind. And then we can have a question-answer session on the second part.So turning to the third quarter results, as you would have seen from our investor release, our third quarter revenue was kind of flattish, although we had a year-on-year growth of almost 15% in dollar terms and 10% in rupee term. Although the revenue was kind of flat as compared to the earlier quarter, the growth in the absolute EBITDA was about 9.5%.The growth in the profit on a quarter-on-quarter basis was 3.5%, but as you would notice, it was largely on account of the ForEx changes and if you were to look at the profits -- PAT on a year-on-year basis, there is a decline of 16%, but if you take out the unusual items, then there is actually a healthy growth.So, turning to the question that I'm sure must be in your mind, how is it that if the revenues flat, there is an income -- there is an increase in the EBITDA? So there are 2 factors which are behind it; one is the change in the composition of our revenues and the second thing is the change in our cost structure. So let me first turn to the change in the composition of revenue. As you would notice, our -- in this quarter as compared to the last quarter, our Engineering sales went up by 2.8%Our overall Digital sales went up by about 4% whereas our Product sales went down by about [ 2% ]. So the drop in the Product sales was made up by the increase in the services sales of engineering as well as in DT. Our Business IT services revenues were down by about 0.8%. The profitability of the Engineering services and DT is good whereas the profitability of Products was not good, and therefore, even with flat revenues our profits have gone up.The second thing is the change in the cost structure. As you would have noticed that although the revenues on account of services have gone up reasonably well, the FTE number is practically the same. And we have spoken to you earlier of when we had said that our whole focus over the last 3, 4 quarters has been to bring our FTE numbers in line with our services. We have done reasonably well on that account in the earlier 2 quarters and we have continued to do well on that account and therefore, there has been a change in the cost structure.So it's a combination of the change in the revenues composition and a change in the cost structure that has given us the increase in the profitability. There is also some increase in the SG&A which has also been a feature of this quarter. So this is as far as -- the last point that I would like to make about the third quarter is the DSO's. Our DSO has dropped from 73 days in the last quarter to 71 days in the current quarter. And as you would have noticed from our release, our net cash accruals continues.So this is about the result of the third quarter. Generally, at the end of third quarter, we give an indication about the fourth quarter and our indication is that Q4 should see a moderate growth in the revenues as well as in EBITDA. We believe that in line with the trend of the 3 quarters, our annual rate of revenue growth should be anywhere between 13% to 14%.So these are the preliminary comment that we had on the Q3 and we shall be happy to take any questions if you have on this. And once we are done with that, then we can turn to the other aspect about the announcement that we made recently.We would look forward to your questions.
[Operator Instructions] We have the first question from the line of Neerav Dalal from Maybank.
Just want to know, why the weak outlook for Q4? And the second thing was, wanted the subcontractor number for this quarter.
I think what we've said is, we will have a moderate growth in Q4. So it's not a weak outlook, we'll have growth in Q4 and we'll also have improvement in the margins during Q4, as we have also shown in Q3 and that improvement will continue. So we believe that it's not a weak outlook, it will be a growth quarter with improvement in margins.
Okay. And comment in terms of the Products bit, we see that the Energy and Utilities has increased and there is an increase in the Products. So if we can -- are the 2 related?
No, the 2 parts are not related. We have Services revenues coming from Energies and Utilities. As that market Energy turns around, we are seeing some growth coming from Energy and Utilities. As far as Products are concerned, there is a substantial growth year-on-year. It's just that there was tremendous amount of growth that we reported in Q1 over the last year. So right now it's just normalizing a little bit, but year-on-year there is a healthy amount of growth in products.
No, if I were to just exclude the SI bit from the production platforms, you've done about INR 4.2 million this quarter, which was like INR 2.9 million in the last quarter and I saw an increase in the E&U. So that's the reason I was just matching the 2.
No, no, both are not related.
Okay. So the uptick in the production platforms outside of SI, if you could comment on that and what is the outlook going ahead?
So, we don't comment on individual products & et cetera, but this is largely in the area of diagnostics and that's more to do with our automotive and industrial customers.
Okay. And if you could give the professional services number for the quarter, the cost?
Just give me a minute, I'll pull out -- we can move to other question and I'll come back. I'll just give you the exact number.
[Operator Instructions] We have next question from the line of Apurva Prasad from HDFC Securities.
Could you split out the margin profile across the segments, PES and the other pieces, please? And if you could talk about how it's moved over the past year?
Generally, as we have been saying over the last year, if you see the margins have been steadily improving quarter-on-quarter. If we look at the broad break up, then margins in PES are slightly higher than the overall IT business. But obviously, we have made the majority of the R&D investment, fresher investments have happened in the PES business, where we should see good improvement in margins going ahead because we'll utilize these freshers and we'll see benefits of those investments. So as of now, the Engineering margins are a tad better as compared to IT, as of now, but obviously the growth in engineering margins could be more than the growth in the IT margins going ahead.
So, this would be at about mid-teens now?
It should be around early teens right now.
[Operator Instructions] We have a next question from the line of Sangam Iyer from Subhkam Ventures.
Sir, just a follow-up on the earlier question asked. Just wanted to understand, going forward, when we talk about the levers for our margin expansion, where from are we looking at -- should we see the gross margins expanding significantly from here on, which would lead to our overall margin expansion?
Yes. So we have 2 major levers. One is, we do look forward to improving the gross margins both on account of change in the mix of the revenues, better quality of revenues as well as some operational efficiencies. And the second is we see a significant lever next -- going forward on the SG&A also, where we believe that the growth which we have can be leveraged without any addition, if not little less cost. So I think these are the primary leverage we see.
So from a SG&A leverage perspective, do you see an income -- another say maybe 100 basis points or so or for more leverage that you see there at SG&A front where you can get the -- which can act as a margin lever for us?
So at least 1% or 2% that is possible, depending upon the growth because there is no additional cost which would incur. So that's what we would see next year.
Okay. So that should be visible throughout the year or towards the end of the year where -- when the growth comes back?
I think we have been reporting growth quarter-on-quarter, strong growth. So yes, so as the growth comes in, I think that leverage you will see in that.
And Sir, so this quarter, I was just going back to your explanation on the margin expansion that happened, when we look at it, it was predominantly from the SG&A and this thing wherein we got the margin lever, because at the gross margin level in spite of product mix changing towards more Engineering services, our gross margins did not expand to that extent. It was more on the other expenses, where we have actually seen the leverage coming through. So just wanted to understand -- since you said that Product business has better margins and that's what flowed down in the margin expansion in spite of the revenue remaining almost -- revenue not seeing that kind of a growth.
We said our Engineering margins are a tad better and actually this quarter, the mix changed in favor of Engineering. If you look at Engineering, there was growth in Engineering, so that was one reason. I think the expansion in margins actually happened at the gross margins level, because if you see, the utilization has also marginally gone up and there has been a little increase in the SG&A expenses during the quarter. So the expansion was at the gross margin level, mainly because of a change in business mix and because of better utilization.
Okay, sir.
And just to come back to the earlier question Neerav, the subcontracting cost during the quarter was about INR 940 million.
Ladies and gentlemen as there are no questions in the queue, I would hand the conference over to the management for the comments on the event. Over to you, sir.
Okay, thank you very much. So let me turn to the announcement that we made last night about the restructuring of the company. What I would like to do is to take you through the logic of the transaction. I would also like to take you through the actual transaction steps and the timeline. Then I would like to talk about the reason for this mechanism. I'd talk about why we have chosen the partner that we have chosen; I would like to talk about, at the end of this, what would be the IT company like, what would be the Engineering company like; and then, we will talk about some of the other details on which we have received some questions.So coming to the basic rationale of the transaction. So if you look at the revenue profile of KPIT, we have 2 streams of income. One is the Business IT income, which includes our ERP consulting, which includes PLM, which includes the maintenance work that we do, the IMS [ works ] that we do, the digital work that we do; that is one stream.The second stream is the Engineering, which is predominantly automotive, electronics, embedded software development, and with a little bit of mechanical and some digital. So these are the 2 streams of revenue that we have. So in the first kind, we are more of an IT services company, whereas in the second place, we are more of the ER&D company. The number of customers who receive both these services from us is probably 2%, 3% of our total number of customers, and even within those customers, the buyers are necessarily different, and what we have found is that this mix sometimes confuses our identity, and it does not give any benefit in terms of ability to draw on the customers.On our IT side, we have hardly any automotive customers and on the Engineering side, we have hardly any non-automotive customers. This confusion in the mix of the services also, as you can imagine, affects our valuation. So this has been one of the reasons why we thought it is important for us to segregate the 2. We also believe that if we segregate the 2, we can give adequate management attention to each of the 2 streams, and then we can have 2 separate entities, each of which can grow substantially and be known well in their respective domains. So that has been the basic thought process.The steps that we are looking at are therefore, get in association or get into a merger with a company which is focused on IT services, put the 2 companies together, then demerge the company so that one can be an IT business -- business IT company and the second one can be an engineering company.And with a view to do that transaction, the law requires that before that we have an open offer so that those investors who prefer to go through this would continue and see value in this -- will continue and those who do not will have an option of selling their shares which the promoters can buy.So therefore, we are essentially talking about 3 steps. First is the open offer. So this is for the open offer for the shares of the entire KPIT Technologies as it stand today, that is the first step. The second step is the merger between KPIT and Birlasoft. The third step is that demerger, where the Engineering business is taken out, but it is done by giving almost like a bonus share for every shareholder of KPIT Technologies and that share will be the share in the Engineering business.So there is no swap, it's an extra share issued and the shareholding of the IT company will be reflected into the Engineering company. So this is the mechanism that we are using. This is a mechanism which will be spread over a period of time. We made the announcement yesterday. We are submitting our -- we have submitted our papers to SEBI and the whole initial process of their clearance et cetera would take 2 to 3 months after that the open offer will open, and it will stay open for a few weeks as required by the law. Post that, the open offer will conclude.After that, we will go for the NCLT approval. After the NCLT approval, we will go for the necessary internal mechanisms of AGM or the sanction from the shareholders, and then the actual effect will happen. After the new company has been formed, we will -- after the demerger happens, a new company will be formed for Engineering. That engineering company will be listed and the shareholders of KPIT Technologies will be given the shares of that listed company.The name of the -- current name of the KPIT Technologies business IT area will change to Birlasoft and the ER&D company's name will become KPIT Technologies. So this whole process we expect to take anywhere between 12 to 18 months. So we are looking at the next full year as a continuation of our current wave of doing business. So you would see KPIT Technologies as it is, operating for the next 12 months.The change will happen sometime towards the end of the next year and the change will be fully effective in the year thereafter. So I just thought it would be important for us to put the steps in the place and the mechanism of the steps. We have been advised that this is a more tax efficient and time efficient mechanism, which is why we have gone in for this.Now, I want to turn to the question as to why did we choose and how did we choose Birlasoft. There are a couple of issues that we need to talk about. We believe that from the perspective of our customers as well as from the perspective of our employees a certain type of a company is important for us to merge with. We were not very keen to merge with a very large company, because our customers are used to getting the attention that a mid-size company gives to them. And we thought that we would rather look for a mid-size company than a last company.We have found many merits in working with Birlasoft. First, this is a part of the Birla Group and we believe that it would have long-term interest in the company, which will take care of our customers. Secondly, if we were to look at the offerings that this company has, Birlasoft is a focused IT services company. Within IT services, their offerings are very complementary to us. In our case, the ERP revenues are almost 60% of our total revenues, whereas in their case, the non-ERP revenues, especially the digital and application development revenues are 85% of their revenues.So the 2 companies put together in the business IT area will be giving a complete end-to-end solution on the IT services area. We believe that the knowledge and the depth that they have in digital revenues will add more value to the digital technology revenues that we are growing, and therefore, we can be very well known in that segment also. As we have mentioned in our calls earlier, as far as the ERP are concerned, we are already recognized as very good partners, platinum partners, for some of the major ERP providers, and therefore we are strong on that wicket, but with this, we will be stronger on the Non-ERP wicket as well.Secondly, the verticals of the 2 companies are also complementary. We work largely in the manufacturing and energy domain. Birlasoft also works on manufacturing, but they also work on BFSI. Now the new digital technologies are very relevant to BFSI and we have not been able to take these services to the BFSI customers. We believe we will be able to do that going forward. So this is as far as, the complementarity of the offerings or the verticals are concerned. But as important as what you offer is the persons that we work with. And I would like to here, talk about the leadership that is currently there in Birlasoft.Now, many of us know that Birlasoft has been in operation for many years. Many of us know that GE was one of their major customers, and what I would like to bring out are the changes that have happened in the last 2 years. And I would like to talk about their new leadership team led by Mr. Anjan Lahiri and let me spend a few minutes on Anjan. Anjan started his career with Wipro, then he worked with Cambridge Technology Partners which as you would recollect has been known as a high-end IT consulting, strategic consulting company.He spent 3 years with that and he has an extremely good consulting aptitude and consulting abilities. We believe that the kind of technologies that we have built over the years will get substantial boost if we can give a technology edge to it, and we believe that with Anjan and his team we should be able to do that. Secondly, Anjan after CTP, was the founder member of the MindTree team and we have been always very, very happy about the culture that MindTree has and which is what Anjan reflects. It's a culture of openness, culture of vibrancy, a culture of ambition and also a culture of taking care of the customer and people, and we are very happy with that and we feel comfortable in working with such a leader from the perspective of our customers as well as our employees.So Anjan was -- Anjan led the MindTree operations in the U.S. He then led their operations in Europe. Subsequently, he was the head of all their business IT services and he handled a large chunk of MindTree business. And in each of these areas, he did very well. So we feel comfortable about the leadership, we feel comfortable about their ability to bring results, to work in a consolidative manner with customers, and to work -- to take care of our customers and employees, and that has been one of the major reasons why we think that together the companies can do well growing forward.As a company Birlasoft has done good revenue growth, better than ours, especially in the business IT area over the last 2, 3 years; their margins are better than ours at 15%; they have significant cash on their balance sheet, more than INR 300 crores. So all these things put together, I think give us every reason to be very happy about this partnership, and that is the reason, after looking at multiple companies, after evaluating multiple companies, we have chosen to go with Birlasoft.Now, let me just turn to the question as to what kind of an IT company we will have going forward and what kind of an engineering company we will have going forward? I believe that the IT company, which will be called after the year, Birlasoft, will become amongst the largest mid-cap IT company with a focus on digital. I believe that it will have a proper mix of ERP and digital revenues.We believe that we will be able to service customers both in BFSI as well as in manufacturing. It would have a balanced portfolio and a starting revenue of $500 million, which puts it in the possibility of bidding for decent size contracts in the IT domain. Our engineering company will be sharply focused on the automotive engineering. And as you know, we had been speaking about the automotive world is up for a major change, almost all those changes in that world are driven by software. We are very well known in that domain.We have -- we work with at least 15 out of the top 20 global OEMs. We also work in, practically every cutting-edge area on automotive electronics. We have good potential of growth, and as Sunil mentioned in his earlier comments, better profitability. We also believe that we will be able to do very good brand creation to attract talent globally. We are also attracting talent in that area at a board level and we believe that this provides us with a very sharply-defined, highly-focused entity in the times to come. We are also beginning to see some revenues coming out of licensing as well as product sales.So this is what we think our IT company will be and our engineering company will be. We believe that with these 2 entities, we should be able to provide room for growth in both of them, and we are certain that in both of them there would be a significant value creation.Now, there have been questions asked to us about why is it that when the current market price is in excess of INR 200, the open offer price is at INR 100 -- a little over INR 180? Now the open offer price is determined on the basis of SEBI guideline and that is on the basis of last 60 days average of the highest on each of those days, and we have gone by that. Admittedly, that price is lower than the current market price, but we have to recognize the fact that the actual open offer will take some time before it opens. It might take 3 to 4 months. We don't know what the prices at that time could be and therefore we have gone by what is really legally required. That is as far as the open offer price is concerned.Then there have been questions about the valuation of Birlasoft. The Birlasoft is a private limited company. I talked about their numbers, there about $140 million to $150 million revenue; their growth rates, as I've said, are better, about 13%, 14% on the IT side and totally, of course; their EBITDA margins are 15%; their cash on hand is better. And -- so the valuation of the 2 companies has been done on the basis of A: KPIT valuation on the basis of the market price on the day on which we did it; and Birlasoft on the basis of the valuation of the earnings, after taking into account the variations that are there. The valuation has been done by a Big 4 company and that is how we have arrived at the numbers. The reflection of the share exchange et cetera is actually dependent really on the number of shares that the 2 companies has, but the basic enterprise value is based on this basic principles that I spoke to you about.After the demerger, we will continue to have interest in each other's companies, so one or more of us will continue to be on the Board of Directors of the IT company and some members from the IT group will continue to be on our Boards. We will continue to hold shares in the IT company for a period of time and we want to ensure that this whole transition happens smoothly and over a period of time. We would also like, at the same time, to ensure that our time spent of the management team that comes with the engineering area would get sharply focused on the engineering, whereas the team that goes on the IT side will focus on the IT area. So that should help us achieve the objective of gaining a focus in both of these areas.I would like to close my remark by talking about the timeframes. So the transaction has been announced yesterday, so obviously, nothing will happen during this current year. So you would see us as KPIT Technologies in the way we are, in that year '17-'18 . As I mentioned to you, even next year, the entire operation will continue more or less like the same way for another 10, 11 months. So any change that might happen will happen towards the end of the year '18-'19.So when you look at KPIT Technologies' operations in '18-'19, you might want to say that, for most of the year, the operations will be on the same lines as they are now, and the real merger and demerger will become effective at the end -- almost at the end of the year '18-'19 and thereafter, in '19-'20, these will be 2 separate companies run differently. Our working so far shows that in the year '19-'20, everything that we have done so far will ensure that both the companies will have EPS accretive future.So with that, I would like to close my comments about the overall deal, the structure of the deal et cetera and we'll be happy to take questions from you. Thank you.
[Operator Instructions] We have our first question from the line of Neerav Dalal from Maybank.
I just wanted some clarification on the Birla numbers, because if I were to see the FY '15 and '16 numbers, they are close $160 million - $165 million in those 2, 3 years, and now you're talking about $140 million to $150 million. So just wondered why the difference in the numbers?
Yes. So as Mr. Pandit mentioned, Birla had GE as a main customer. At a point of time, just in the last 2 years, their revenues from GE were about 65%. Last year, they sold back that business back to GE, and basically that's why that significant business actually was sold and they replenished that with the new business. So that's why it is there. So the growth which we are talking about has been consistent on the business -- excluding naturally, the business with they have sold. So the decision regarding terminating GE business was on the basis of the profitability of that area. So in 2 years' time, they brought it down from 65% of their revenues to single-digit revenues and they were rapidly able to ramp up their non-GE business. And we were particularly actually impressed by that, because you know there is another company who shows such courage to reduce the GE business in order to ensure that the right quality of business is brought in.
Okay. So because their margins at that time were also some 13%, EBITDA margins, which now have improved to 15%. So that is the reason the margin improvement as well as the revenue, absolute revenue declined but improvement in other revenues.
Correct.
We have next question from the line of [indiscernible] from SKS Capital.
Thank you, gentlemen, for taking the time to explain in detail the structure of the deal and also your results, really appreciate that. And one question about the IT business or the business IT as you referred to it, the combined entity of Birlasoft and KPIT, KPIT's IT services business that will only cater to application development and maintenance and services and delivery, if I understand, and product side that you are focused right now will completely go with the engineering division which would be renamed or re-listed, newly-listed as KPIT Technologies, if I'm correct.
Yes, and that's true.
So given that your -- so what if somebody could approach the question this way that now you had a more optimized diversified portfolio where you had a mix of more niche product facing division, earning you higher margins that were -- that was outweighing some of your standard or in lines with the industry fairly ordinary results on the IT services side. I'm very cognizant of the pressures that the industry as a whole is going through. So given you had a good mix of product and services, you're completely letting the product side go. How are you planning to meet the headwinds with this combined IT services business going beyond the complementarity between your verticals. As a whole how do you -- what are your plans to improve your margins given rising salaries in India and price pressures from clients abroad the visa backlash and overall anti-outsourcing globalization backlash?
Yes. So, if I understood correctly your question and I'll just repeat it, so that -- so you are basically talking about the IT part of the business which is combining of KPIT's IT business and Birlasoft business, specifically in the line that our product engineering business and products and platform business will be in the demerged -- in the new company. So on the IT side, we believe that the main -- the areas in which we are working, I think specifically led by the digital part will be a broad driver. Now currently, we are largely focused in the digital area and mainly in the areas of IoT, specifically because our focus has been in the manufacturing area. We have very good skills in that area which will remain with the IT company. More so, I think we have got many other digital competencies which are more relevant to the verticals outside manufacturing. In line with the current strategy of KPIT not to go after this customers, that's what we are -- we do not have a go-to-market strategy for those vertical. Now that is what will get -- will be added or will be complimentary from this merger, which will allow us to grow in that part. The second thing as we talked about was the consulting capabilities which will also allow and bring a very good business mix between ERP and the non-ERP revenues. Currently we have very good quality of customers and I think our opportunity to cross-sell into that, digital revenue -- more digital capabilities is also high, that we will be in a position to do it. Also the fact that, in the IT side, there is -- in KPIT, relatively our portfolio is limited in Europe, where Birlasoft has some better presence in the Europe side also. So I think there is a complementary [ wave ] because we have a better presence in terms of KPIT IT in terms of Asia, while Birlasoft has a better presence in terms of Europe for this, and U.S. is a big market for both of us. So I think there are multiple ways in which this can be done. And from the IT margins also we have shown improvement and we believe there is a further room to improve, specifically looking at the areas in which we are. So I think -- in all, I think it will be a better growth engine and a better margin portfolio going forward.
And my last -- tail question is just a clarification, you mention that there is a 2% to 3% overlap between customers, if I didn't hear it incorrectly.
Yes, yes, 2% of our customers where we have, we provide both the IT services as well as the engineering services.
Okay. So you feel that since it's fairly minimal, it makes sense to cut it down through the middle.
Yes.
We have a next question from Ashish Chopra from Motilal Oswal Securities.
Sir, could you just elaborate a little bit more on some of the financials of Birlasoft in terms of, what could be the earnings number for them?
As we said, the EBITDA numbers are about 15%. Their growth has been in the 14%, 15% range over the last 3 years. If you look at the profit numbers, they should be typically in the 8% to 9% bracket.
8% to 9%, okay. So I think -- so the question really here was that, if we look at the kind of dilution that that's being brought about, so it would probably peg the valuations of Birlasoft north of, I think $225 million, $230 million. So just wanted to know what would be the basis for that because it looks like a slightly higher valuation versus our own IT business which is probably $350 million, and that could be a concern from the perspective of minority shareholders.
So Ashish, as we said earlier, the valuation has been done by a Big 4. Now there are 2, 3 areas, while doing the valuation of Birlasoft, we have looked at -- the valuer has looked at the comparable companies of that size what are their valuations. And as we said earlier, their growth rate in the range of 14%, 15% is a high growth rate on the IT side as compared to our growth rate. And also their margin are also higher, a 15% consistent EBITDA margin they have been able to show. So I think the multiples are similar but just because the margins are high, the growth rate is high and also the net cash position. They have no debt on the balance sheet. Cash is in excess of INR 300 crores on their balance sheet. So I think these are the 3 factors; higher growth rate, higher margins, and better cash position with no debt where the valuations have been made.
Okay, INR 300 crores net cash is what you said, right?
That's correct.
And secondly, just on the last bit following the de-merger; so the swap of shares between the promoters on engineering and IT services, Just your thoughts on -- do you expect that to be a one-time exercise or a sporadic ones spread over a period of time, how do we envisage that to take place?
We would do it over -- we would do something initially and we will do other over the period, over next 2 years. And the purpose is basically we have common understanding, common management to some extent where we -- while operationally, we may have little more management bandwidth in the Engineering and they would have more on the IT side. Basically, this will ensure that both companies remain interested in both big parts of the business during the [ part side ], the integration is better and the value creation is consistent. As the second thing, as Mr. Pandit mentioned, we have -- every shareholder will have another share in the engineering side. So absolutely the value creation will be also mirror of whatever will be in IT or engineering in terms of shareholdings.
We have a next question from the line of Mayank Babla from Dalal & Broacha Stock Broking Pvt. Ltd. Please go ahead.
Sir, I just wanted one clarity on the -- as an accounting clarity, what will be the shareholding pattern like between KPIT and Birlasoft as far as both companies are concerned after the deal is done?
As we have said -- as we've said, the swap ratio is about 22 shares of KPIT for every 9 shares of Birlasoft. That is how the merger consideration will happen.
Okay. And in KPIT Tech after this -- as in the engineering company?
So this is what will happen in the combined entity. And since the merger and demerger are simultaneous, mirror shareholding would be there, present in the engineering company initially at the date of the demerger. So every shareholder in the combined entity will get 1 share in the engineering entity. This will be an additional share, bonus share.
We have next question from the line of Vaibhav Badjatya from HNI Investment.
So I have one question on the whole merger scheme. So instead of merging Birlasoft first into the existing KPIT and then converting that company into 2 different listed companies, would it not be -- would it not have been better to first demerge the IT services business of KPIT and then merge Birlasoft into that -- that would have been a simpler process in your view? What is the consideration that has driven the management decision regarding this way of doing than the other way of doing?
So we have been advised by people that the mechanism that we are going through now is more efficient in terms of time as well as in terms of processes apart from a tax perspective. And also, the other part is, once we demerge, we will have to find a home or a partner for our IT business. So this basically takes down that uncertainty. We have a partner in place while we are going through this process. So I think that is -- that makes this whole process more smoother.
We have a next question from Shekhar Singh from Excelsyor Capital.
Just wanted to know like, the promoters of KPIT they have been reducing their stake over the last 2, 2.5 years; so now with this open offer you'll actually be increasing their stake. So just wanted to know like, did this Birlasoft merger, was it there in the works or is it something which just came as a surprise?
Actually, I don't know which date element you are looking at. our main shareholder is Proficient through which we are holding the shares. To the best of my memory, we have never sold a share of KPIT. So you might want to recheck your data point.
So, there could be one thing where earlier, if we look at the promoter holding, the Employee Welfare Trust was included as a part of promoter shareholding. The reporting rules changed and the employee shareholding trust -- the shares held by the employee shareholding trust are not now reported as a promoter group holding, so they are taken out. There is around 4% plus holding in that trust. Apart from that, actually last year in March, the promoters increases their stake. They bought a sake of around 2.2% about 1.5 years before and they have been increasing stake. So there is no decrease in the stake. It's actually just a reclassification of the Employee Welfare Trust if we are looking at that number.
Yes alright, so basically maybe because of that Employee Welfare Trust.
That is correct.
We have a next question from the Rahul Jain from Emkay Global.
So just on the valuation part, can you say that what would be the EV/EBITDA multiple of the respective organization that would be part of the non-engineering business piece?
So, I think, currently as we have said, the ratio which I explained earlier, that is the ratio in which the merger consideration will flow. The EV/EBITDA ratios would be about 9x for both the businesses.
Okay. So you mean to say, if we do the reverse math, it would look like 9x EV/EBITDA on both the businesses?
So, it is based on sustainable EBITDA of FY '18 for both the entity.
And secondly, there is another comment in terms of how the cross holding would shape up and sole ownership would be -- how the stake would move. So any color you could give on that front?
No, as we said -- I mean, we can obviously you can sit and do the math as to, if we have this as the merger ratio what will be the shareholding look like at the time of merger and at the time of the demerger. And as we have said, over a period, there would be change in the shareholding as far as the KPIT promoters are concerned and Birlasoft promoters are concerned where there could be -- there will be majority of shareholding of KPIT promoters in engineering and majority shareholding of Birlasoft promoters in the IT company over the next 2, 2.5 years.
So we have a next question from the line of Dipesh Mehta from SBICAP Securities.
Just one question. How many number of outstanding share are there at Birlasoft and what would be the cumulative sales post the transaction of the combined entity?
So they have about 31.3 million, 31.4 million shares outstanding.
And then, based on same ratio, one can calculate about combined KPIT outstanding?
Correct.
And their face value are the same right?
INR 10 face value for Birlasoft and INR 2 for KPIT.
We have next question from the line of Ritesh Poladia from Girik Capital.
Sir, does Birlasoft has any engineering business?
No.
So after the demerger, in the KPIT, new KPIT there won't be any revenue flow on the Birlasoft?
No, there won't be.
And Just one clarification, new share to be issued would be 7.66 crore share?
Sorry
The new share to be issued to Birlasoft for the merger, the number of shares would be 7.66 crore, is my calculation right?
It will be roughly in that range assuming there is no tendering in the open offer. If there is some tendering in the open offer, that number will change.
So Sir, this entire complex arrangement, can we say that KPIT is actually selling the IT business to the Birlasoft and this is in more a tax-efficient way?
I think the whole thing is meant for 2, 3 reasons; #1 is basically to make sure that the -- as Mr. Pandit mentioned, to do this in a more efficient in terms of time and -- time, tax, and the cost perspective. The second thing, which is very important is when you do this, there is a proper clarity in terms of how the management will be there as there are no uncertainty; #3, a better transition of customers and employees. So this has been done in multiple ways. And fourth, naturally this was run as one business, so whatever the synergies are, they are -- we maximize on these in these years. So that is the main purpose of all this arrangement.
And Sir, after the demerger, I believe KPIT promoter would buyback the Birlasoft share in the new KPIT, is that understanding right?
It would happen over a period, but yes.
So again, at that time, there would be an open offer for the minority?
So it depends on the way in which we purchase. Of course if we do it as a larger stake at one time, it might trigger an open offer, but it all depends on how we purchase it over a period of time.
So is the same thing would happen in the Birlasoft, new Birlasoft where Birlasoft promoter would buy out the KPIT promoter?
Again the same answer, it depends on how that sale purchase happens.
But the promoter would exchange their shares, that is a certain?
That will happen, as we said, but it's not a one-time event. It will happen over a period of time.
We have a next question from the line of Moiz Tambawala from Florintree Advisors.
I have a question on your margins. While you have mentioned the Birlasoft at about 15%, on the KPIT business, several quarters back in one of your investor releases you had mentioned that the product engineering services were a 20% margin business. And I think right now -- earlier you indicated that, that is somewhere in the low-teens, maybe 13%, 14%, 15% odd percent. So the overall margins for the company have sort of remained same, so what exactly has happened? Why has product engineering sort of come down and which other margins have come back up, so that the overall margin are sort of the same? Can you walk us through that?
Absolutely. So if you really look at, we have given this profile how we will improve the margin quarter-on-quarter and we are doing it over the last 4 quarters exactly in line with what we have said. In spite of currency headwinds, we have been in a position to improve the margins. And even during the last quarter now, if you see, we have improved our margin in spite the revenues being stagnant. Now in case of Engineering side, your question, we have 2 parts of the engineering, one is the engineering services and the second is the production platform. Engineering services do not have a 20% margin. What we would have said is, that's what is possible in the services margin to go beyond to do 20% margin. But we are not there at this point of time, but we are much higher than the overall company margin in the IT services. But net of investment into products, those margins are into the low-teens. That's how I would explain it.
And I think 20% number which you might have read is also, I mean, as we said, it's investment into products, investment into normal R&D for the engineering business which is about 3%,4% so -- which is all charged to the P&L and we might have said that number excluding these R&D investments and product investments. And the number which we said today was including everything.
Okay, got it. And the number of business IT would be around the 10% margin as yet, right?
We are looking to improve that. And as we said, every quarter we are showing that improvement.
We have next question from the line of Vaibhav Badjatya from HNI Investment.
Yes, all my question has been answered. Thank you.
Ladies and gentlemen, that was the last question. I now hand the conference over to the management for closing comments. Over to you, sir.
So we thank everybody for participating on the call. I hope we were able to answer your questions, but if you still have any queries, please feel free to write to me. Thank you and have a good evening. Thank you, bye.
Thank you.
Thank you very much Sir. Ladies and gentlemen, on behalf of Emkay Global Financial Services, that concludes this conference call. Thanks for joining us. You may now disconnect your lines.