Acquisitions deliver growth at Quess Corp, but are a risk too

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Quess Corp Ltd plans to raise Rs.400 crore through an initial public offering (IPO), which opens on 29 June, in the price band of Rs.310-317. It follows in the footsteps of TeamLease Services Ltd, another staffing services and solutions firm that got listed in February.

The staffing services business has a good growth potential, with Crisil Ltd estimating it to increase from Rs.20,000 crore in revenues in FY14 to Rs.62,500 crore in FY19.

Quess Corp’s strategy has been to grow via acquisitions, completing nine till date which contribute to 20% of its revenues, the management said. It wants more and has set aside 20% of the IPO proceeds for further acquisitions. The company proposes to complete two-five acquisitions by FY17. Some of its past acquisitions such as Avon and Magna Infotech have seen their performance improve, but others such as Brainhunter, MFX, Styracorp and IME Consultancy are loss-making.

Its high working capital needs and appetite for acquisitions have left it with a debt of Rs.390 crore, leading to a debt-to-equity ratio of 1.13 times as of 31 March. Post-issue, this will decline to 0.52 times, assuming debt remains constant. It had a negative cash flow from operations at Rs.44.2 crore, which could be a concern for investors.

Quess Corp plans to use part of the issue proceeds to repayRs.50 crore of debt, and deploy Rs.71.7 crore and Rs.157.9 crore towards capex and working capital needs, respectively. However, if its appetite for growth through acquisitions remains high, and if these acquired firms come with similar working capital needs, then the pressure on its balance sheet may continue.

Margins in the business are wafer thin. The company’s technology solutions business (27% of revenues) earns a better margin compared to the staffing services business (57% of revenues). Out of its total income of Rs.3,442 crore in FY16, salaries and cost of services took away 90%. Its net profit margin was 2.6% while its Ebitda (earnings before interest, taxes, depreciation and amortization) margin was 5%. Annualized sales grew by 67% in FY16 while its net profit grew by 65%.

However, its Ebitda margin is still better than that of TeamLease’s margin of 1.5%. “As far as return on equity (RoE) is concerned, for Quess it is at 25.6% and for TeamLease it is 8%,” said Amarjeet S. Maurya, an analyst at Angel Broking Pvt. Ltd.

Thomas Cook (India) Ltd owns a 69.6% stake in Quess Corp, acquired in 2013. Prem Watsa-backed Fairfax Financial Holdings Ltd is the ultimate owner, as it owns a majority stake in Thomas Cook. While the promoters bring credibility to the table, Mahesh Bendre, an analyst, Way2Wealth Brokers Pvt. Ltd, says this could have been backed by a stronger balance sheet.

On valuations, TeamLease’s FY16 price-earnings ratio is higher at 57x than Quess’s 41.2x, at the higher end of the offer price range. But according to Bendre, this kind of business model doesn’t warrant such high valuations.

The business has potential and Quess is anyway eyeing further acquisitions. The risk is that this strategy may strain its balance sheet. The turning point will be when Quess can improve profitability and the business begins to generate positive cash flows. Till then, it’s a high-growth but also relatively high-risk model on offer that may prove to be a bumpy ride for investors.