Thoughts about KPIT’s Engineering Business
As you probably know, KPIT, a relatively small IT and ER&D service vendor is engaged in a relatively complex merger with competitor BirlaSoft. Once the merger is finalized in late 2018 or early 2019, newco will spin off its Product Engineering Services (PES) unit along with its Platform and Products (P&P) to form an ER&D service pure-play. The remaining IT services firm will be named BirlaSoft while the ER&D business will be called KPIT.
The transaction is somewhat more complicated: along with it, the promoters had tried to increase their share of KPIT, from 18.9% to 44.9%. However, the promoters offered INR 182 per share, well below the value at which the stock was trading. As a result, they only captured 2.4k shares of the 51m they were targeting.
PES, a high growth unit
Within Newco KPIT, PES is by far the most significant entity, with revenues of approximately USD 193m in FY18 and a margin in the 13%-15% range. PES is a high-growth business: growth was 30% in FY18, and KPIT is expecting similar growth in FY19.
PES is an automotive pure-play, servicing mostly automotive OEMs in Germany, providing electronics service, and embedded software services. PES has some mechanical engineering and digital services capabilities.
KPIT highlights its current traction in automotive ER&D results from past investments around vehicle electrification and autonomous and connected cars. PES has approximately 7,000 FTEs most of which in India (Pune and Bangalore), and about 400 in Germany (Munich). The unit also has some presence in the US (Detroit), Brazil (Sao Paulo), China (Shanghai), and Thailand (Bangkok).
P&P is in reinvention mode
Along with PES, NewCo KPIT will also have its P&P unit, which like PES focuses mostly on the automotive sector. P&P is a smaller unit (with revenues of USD 25m in FY18) than PES. P&P is involved in activities related to IoT and connected vehicles, across commercial vehicles, passenger cars, and two-wheelers. For instance, it has a contract in India with Eicher Trucks & Buses in India to equip electric vehicles with telematics units.
P&P is more of a small, lumpy business, with the significant quarterly revenue variations that characterize product businesses. KPIT is also transforming its P&P business from providing both hardware and software, to software-only and relying on partners for hardware. The company plans to achieve this transition by the end of FY19 and achieve break-even at the same time.
Outside of P&P and PES, KPIT also has other ER&D capabilities: PLM, IoT, and enterprise asset management, which will find their place within NewCo BirlaSoft. It is not clear what the size of this PLM business is, probably below 10% of KPIT’s current revenues.
Short-term future looks good
KPIT has significant ambitions for its automotive ER&D business in the short-term. KPIT highlights that its European client base is helping win new clients in Asia and the US, and also expanding its service portfolio. Profitability will also progress, now that it has completed its investment cycle in its offering, relying on using more freshers, and more offshore delivery. PES should be a USD 250m business by the end of FY19.
In the long-term, NewCo KPIT will have to diversify its service portfolio, and this is where the PLM, IoT, and enterprise asset management units could have been useful. NewCo KPIT will also have to expand its client base from outside of automotive, to reduce its dependency on one client sector. This is the long-term; for now, KPIT must execute on the transaction.