Allied Digital Services : Invest at cutoff

Investors with a high risk appetite and a three-year investment horizon can subscribe to the Initial Public Offer of Allied Digital Services (ADS) as it has reasonable growth prospects.

The company, which started operations in 1995, provides IT infrastructure management and technical support outsourcing services to a large set of corporate clients. It primarily acts as a support-partner for the infrastructure products — desktops, laptops, servers, network management etc. — of companies such as HP, Dell, IBM, Compaq, Cisco, Microsoft and Symantec. ADS generated revenues of over Rs 156 crore during FY07 and has grown at a CAGR (compounded annual growth rate) of over 50 per cent over the last three years.

Business Outlook

The company generates revenues mainly by providing services related to IT infrastructure, such as incidence-based support, facility management services (FMS), annual maintenance contracts (AMC), project management and consultancy, and network audit services. The prospects for the company over the medium-term appear to be good. First, Allied delivers its services through its own facilities and centres spread across 92 cities and follows a 'direct' model rather than a franchisee model.

This gives it direct control over customers' Service Level Agreement (SLA) and Quality of Service (QoS) level requirements. Second, Allied has taken a vendor-neutral approach, which has allowed it to be a solutions and channel partner for some of the big names in the IT infrastructure space, and develop technical expertise over a vast range of products. Third, the company generates its revenues mainly from the BFSI (banking, financial services and insurance) sector, telecom and manufacturing clients and has announced an increased thrust on these businesses. With increased IT spending by these businesses , Allied is in a reasonable position to translate at least a part of this into business on its books, considering its longstanding client relationships.

Expansion Plans

The company plans to raise about Rs 86 crore (at Rs 190, the upper end of the price band). About Rs 33 crore has been earmarked for starting a Global Service Delivery Centre (GDSC), which is likely serve as a centralised control and monitoring centre for the company's operations around the country.

The GDSC is to host, among others, a technical BPO, an IT services delivery centre and a remote management service centre. The company already runs a customer support centre for a few clients, such as EDS, Unisys and Fujitsu. Upgrading and expanding its existing internal infrastructure and setting up strategic units — a Network Operating Centre and a Security Operating Centre — have been allocated Rs 10 crore and Rs 16 crore, respectively.

All the above units are expected to help Allied expand its service offerings, considering the technical knowledge base it has already acquired. A sum of Rs 35 crore is envisaged to be spent on possible strategic acquisition(s) and the company has indicated that it is looking out for partners in a similar line of business.

Risks and valuation

Allied faces considerable competition (directly and indirectly) from highly established and more integrated players in the field, such as HCL Infosystems, CMC Ltd, CMS Computers, Wipro Infotech, Datacraft and Netsol, among others. The established players are more equipped to handle rapid changes in technology and client requirements. They are also better placed to operate on wafer-thin margins.

Another fact to be considered is that the capex to be funded by this IPO is expected to provide returns only over a two-three year period, as this expansion marks a significant ramp-up in scale.

The fact that it plans to have its Technical BPO to serve potential North American clientele could expose it to currency appreciation risks at a later date.

Last, the efficacy of any possible strategic acquisition remains in the realms of speculation as no company has been specifically identified as a takeover candidate. These factors indicate high levels of execution risks in its operations, which could affect earnings.

Allied Digital is much smaller in scale and breadth of operations when compared to companies that operate in this space. However, Allied has an EBITDA (Earnings Before Interest Taxation Depreciation and Amortisation) margin of 21.2 per cent, which is a clear 10 percentage points higher than players such as HCL Infosystems and CMC. This reflects Allied's status as a pure services and solutions provider, as also its reasonable operating efficiency.

The EV (Enterprise Value) multiple, at the upper end of the price band at 10.1, is at a discount to its peers considering its smaller scale of operations. The offer price (at Rs 190), values the company at a PE multiple (price-earnings multiple) of about 14.3 times the FY07 EPS (Rs 13.3), on diluted equity. This is at a discount to competition. Considering the valuations, one could consider investing at the cut-off price.

Allied plans to issue 45,22,435 shares, representing about a 25 per cent stake in post-offer equity. The price band is Rs 170-190. The offer is open from July 2 to July 5, 2007.