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Spanco Limited
We met the management of Spanco Ltd to understand its business
model and growth plans. Spanco is a mid-sized technology
infrastructure firm executing large projects across government and
power & telecom service providers. The company also offers BPO
services to its customers in India, Middle East, Europe and Africa.
Spanco is among the few companies that have been empanelled as
system integrator with Power Finance Corporation (PFC) for R-APDRP
projects. Noticeably, the company has recently won interesting projects
such as the Nagpur power distribution franchise, the Madhya Pradesh
state border check posts modernisation programme, IT modernisation
project of the Bihar state electricity board and takeover of Zain’s BPO
operation in Africa for five years. Key takeaways are highlighted below.
Distribution losses reduction at Nagpur franchise remain a key trigger
Spanco recently won the power distribution franchise for 15 years from
Maharashtra State Electricity Distribution Co Ltd (MSEDCL) for Nagpur
city, which includes ~4 lakh low-tension residential users and ~200 high
tension industrial users. With 30% distribution losses and ~1.3 billion
units consumption, areas under the company’s coverage in Nagpur
generate monthly revenue run rate of | 38 crore or ~| 450 crore per
annum. The company anticipates revenue growth of 10% annually. This
implies that Spanco bid | 5350 crore, the highest on net present value
(NPV) basis, for the project which could likely generate ~| 16000 crore in
aggregate revenue over 15 years. Further, the project entails ~ | 350
crore investment in the first three years including the | 60 crore (| 12
crore annually for the first five years) provided by the government as
viability gap funding. Finally, we believe reduction in distribution losses
would dictate profitability and cash generation capability of this project.
Analogy to Torrent’s “Bhiwandi model” likely
As you may recall, in December 2006, Torrent Power was awarded the
power distribution license for 10 years in the Bhiwandi area. With ~1.6
lakh consumers and 1/3 of the country’s power looms, Bhiwandi’s annual
power input was ~2.6 billion units. Further, with power looms accounting
for ~50% of total power sales, distribution losses were in excess of 60%
in FY06-07. Subsequent to its ~| 200 crore investment in the first year
itself, to upgrade the distribution system, Torrent managed to bring
distribution losses to less than 20% in the first two years of operation
while consumer payments doubled during the same period.
Revenue visibility improves with long-term contracts
Spanco’s subsidiary in consortium with IL&FS Transportation Networks
(ITNL) (49:51 JV) recently bagged the | 1100 crore Madhya Pradesh
border modernisation project for 12.5 years. Civil infrastructure
constitutes ~70% of the contract value while technology forms the rest.
From a revenue perspective, Spanco, through its subsidiary, would incur
~| 110 crore of capital expenditure and would earn by executing IT
outsourcing contracts. Further, the company is liable to earn 49 paise per
1 rupee of incremental revenue generated through collection of services
charges, parking charges and miscellaneous commercial charges.
Bharti boost to BPO revenues
Spanco entered into a five-year $40 million annual revenue run-rate
contract with Bharti Airtel to manage its captive BPO operations in
Nigeria, Tanzania, Niger, Kenya, Chad and Burkina Faso. Noticeably, BPO
contribution was modest at 13% of FY10 revenues or ~| 180 crore. We
expect meaningful revenue contribution to start in FY12 coupled with a
likely improvement in EBITDA margins, depending on the company’s
ability to derive operational efficiencies.
Management profile suggest strong industry veterans
Spanco’s management is headed by Kapil Puri with individual CEOs for
each business units who have had either worked with or for government
enterprises. Vidhur Sehgal, CEO, Government and power practice, has
worked with Punjab Power Generation Machine Ltd, while Rajeev
Aggarwal, CEO, egov, has worked on several citizen centric initiatives.
Noticeably, Jayant Sinha, who was hired for the power sector foray, has
24 years of work experience in the power sector and has been associated
with implementation of various IT projects under R-APDRP. Finally, most
key executives have experience of more than 10 years in their respective
fields and have stayed with the firm for a long period which could help
place the company in a strong growth path.
Re-rating necessitates superior balance-sheet metrics
Below, we have analysed Spanco’s balance sheet metric given the
inherent debt nature of the business. Generally, Spanco has showed
some weaker trends in our analysis. FY10 accounts receivables as a
percentage of revenues were ~ 50%, implying DSO of ~180 days while
payable days outstanding were ~140. As a reminder, government
businesses typically have high DSOs. This suggests that including
inventory turnover, the company’s cash conversion cycle stands at 100
days. Noticeably, at 2x, interest coverage seems modest. Finally, Spanco
turned free cash flow (FCF) positive with | 5 crore generated in FY10
compared to negative FCF of | (302) crore and | (276) crore in FY09 and
FY08, respectively. We believe PE multiple re-rating will necessitate
superior balance sheet metrics.
Business Overview
Spanco Ltd helps create technology infrastructure to drive governance
efficiency across key sectors. It caters to large complex technology
infrastructure projects across the government, power and telecom service
provider space. Spanco also has a sizeable BPO presence spread over
four continents.
Technology infrastructure division
Spanco has been providing high quality, cost effective scalable
technology infrastructure solutions across India for over a decade now. It
operates under three business units.
• Government business unit. Spanco positions itself as a systems
integrator for transformational projects involving state and central
governments, thus helping them increase their efficiency.
Government units contribute ~50% of the overall revenues.
Within government, broad service areas include e-governance
(30% of government), public sector units (40%), railways (15%)
and defence (15%)
• Telecom service providers: Spanco provides solutions and
services spanning IT/operational support systems (OSS)/ business
support systems (BSS) networks to public, private carriers and
network equipment providers. Areas of engagement cover
integration, application & infrastructure management, business
process outsourcing and network infrastructure solutions for
turnkey systems
• Power business unit. Spanco’s offerings revolve around utilising
information technology to increase the efficiency in the power
distribution business by reducing transmission and distribution
losses. The company is empanelled as a system integrator with
Power Finance Corporation (PFC) and is aggressively participating
in RAPDRP programmes.
BPO division
Spanco’s BPO practice, 13% of FY10 revenues, started in 2000. Earlier,
the company helped companies to set up their BPO operations and later
forward integrated to start its own operation. The BPO arm encompasses
various activities including: domestic (India), international (US and
Europe), Bharat BPO Services, Middle East and African operations.
View
Spanco is currently trading at 6.9x its FY10 EPS of | 21 and 0.3x on the
Mcap/FY10 sales metric. Spanco’s revenues have grown at 44.6% CAGR
during 2007-2010. Spanco is well poised to participate in the RAPDRP
programme and achieve sustainable revenue growth in the next few
years. However, we believe a re-rating of the PE multiple necessitates
meaningful improvements in balance sheet and cash-flow metrics.
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