After a 19-year hiatus, the Tata Group is back with its Tata Technologies IPO. The IPO was subscribed 69.4 times at the close of the issue. Known for a diverse portfolio that spans from salt to software, the Tata conglomerate has been a key player in India's growth story, boasting 17 listed companies and a staggering market capitalization of 25 lakh crore. 

Promoted by Tata Motors, Tata Technologies specialises in engineering services, digital solutions, and product development in the automotive space. Catering mainly to major OEMs and Tier-1 suppliers, the company is a leader in Engineering Research & Development (ER&D), covering the entire spectrum from design to servicing.

The offer for-sale IPO, valued at Rs 3,042 crore, aims to dilute the promoter group’s holdings from 66.8% to 55.4%. The higher price band of Rs 500 per share puts Tata Technologies’ market cap at around Rs 20,283 crore.

Tata Technologies derives major revenue from the Tata group

Tata Technologies operates in the software and services sector with key competitors being KPIT Technologies, L&T Technology Services and Tata Elxsi. As of Q2FY24, Tata Technologies derived nearly 57.4% of its revenue from its top five clients, which include Tata Motors and its subsidiaries (JLR, TAMO, VinFast). However, this figure marks a decrease from 64% in Q2FY23. The company's client portfolio extends beyond the Tata group and includes global giants like AirBus, McLaren, Honda, Ford and Cooper Standard. It is currently engaged with 35 traditional OEMs and suppliers, alongside 12 new energy vehicle (partially or fully powered by electricity) companies.  

The firm’s footing in key automotive manufacturing hubs like Europe and North America gives it access to a broad client base and newer technology. Its presence in emerging markets also plays a crucial role in catering to a large customer base.

India and Europe account for nearly 60% of Tata Technologies' revenue

Massive ER&D expenditure to help Tata Technologies

Tata Technologies is one of the few global companies specializing in Engineering R&D, and it has an impressive portfolio of marquee customers. With its presence in the US and Europe, the company is expected to benefit from upcoming ER&D spending in these regions. The automotive industry in the US alone invested $180 billion in ER&D in 2022, with service providers like Tata Technologies handling nearly $110 billion of this outsourced work. This spending is expected to grow at a 7% CAGR from FY22 to FY26, putting firms like Tata Technologies in the sweet spot.

US set to invest $1,459 billion in ER&D by 2026

Expanding into other industries with high R&D spending will enable Tata Technologies to add more verticals into its revenue streams.

An impressive growth story with good visibility

Tata Technologies derives nearly 79% of its revenue from its service segments. The remainder is split between its other segments: products (9%) and education (12%). It has revenue and profit CAGR of 36% and 62%, respectively, over FY21-23. 

Tata Technologies reports around 35% YoY growth in revenue and profits in H1FY24

As the auto industry shifts to electric vehicles, Tata Technologies looks poised to take advantage. The company is involved in developing new automotive technologies like autonomous systems, hybrid electric mobility, infotainment & connected platforms, safety systems, and traditional powertrain and body engineering. 

Given that nearly 71% of its revenue in FY23 came from the auto industry, and with expected increases in R&D spending by auto manufacturers, Tata Technologies is likely to maintain strong revenue visibility. Also, the firm is looking to venture into the aerospace and heavy machinery manufacturing segments to provide its engineering services.

Margins to expand on lower attrition rates and rising utilisation levels

Tata Technologies has lower margins compared to its peers like KPIT Technologies (18.9%), L&T Technology Services (21.4%) and Tata Elxsi (30.6%). In H1FY24, margins contracted by 130 bps YoY due to higher spending on employee salaries and new purchases in design technologies. However, as these costs stabilise by the end of FY24, margins are expected to expand.

Tata Technologies' H1FY24 margins moderate by 20 bps amid rising employee expenses

The technology sector saw margins contract due to high attrition rates in FY22 and FY23. However, in FY24, the industry is seeing a decrease in attrition rates. Margins are expected to expand as attrition rates settle below 15% and capacity utilisation moderates around 90%. 

Tata Technologies' margins poised for expansion with lower attrition and higher utilisation

Tata Tech has been a leader in technology and product development for the EV industry, a sector known for high margins and growth. Any additional deal wins in this area are likely to further help margin expansion. 

Is the Tata Technologies IPO at an affordable valuation?

Tata Technologies currently holds a price-to-earnings (PE) ratio of 32.5, which is lower than its peers like KPIT Technologies (82.4), Tata Elxsi (66.4), and L&T Technology Services (38.9). This is due to its lower margins in comparison to the industry average and the concentration risk associated with its client base, primarily within the Tata Group. While peer comparisons may not be an exact match, given Tata Technologies’ significant revenue from engineering R&D services for auto firms, the valuation seems modest considering the company’s growth avenues, global presence, and domain expertise

In a recent transaction, Tata Motors offloaded a 10% stake in Tata Technologies to TPG Rise Climate SF Pte and Ratan Tata Endowment Foundation at Rs 402 per share. The IPO's upper price band is set at Rs 500 per share in the current issue, a 25% premium over the recent sale price. Despite this premium, investor enthusiasm is evident, as the IPO was oversubscribed by 69.4 times by the third day of its offering. This indicates market confidence in the company's prospects.

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.