r r INDEPENDENT RESEARCH Indra Sistemas 5th February 2009 Defensive qualities are being undermined IT Software & Services Target price € 13 (Price € 15.65) SELL Bloomberg IDR SM Reuters IDR.MC 52-week High / Low (€) 18.9 / 12.9 Market cap (€ m) 2,569 EV (BG Estimate) (€ m) 2,719 Avg. daily 3m volume ('000 shares) 818 Free float 53% EPS CAGR 07 - 10e 8% Gearing (2007) 20% Dividend yield (2007) 3.2% YE: 31st Dec 2007 2008e 2009e 2010e Sales (€ m) 2,168 2,383 2,511 2,624 % change yoy 54.1% 9.9% 5.4% 4.5% Adj. EBIT (€ m) 242.5 274.7 286.2 300.5 Adj. EBIT margin 11.2% 11.5% 11.4% 11.5% Adjusted EPS (€) 0.95 1.08 1.15 1.21 EV / Sales 1.3 1.1 1.1 1.0 EV / EBIT 11.2 9.9 9.5 8.7 P/E (x) 16.5 14.5 13.6 12.9 PEG 2.0 1.7 1.6 1.5 0 40 80 120 160 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Aug-08 Indra Sistemas DJ Technology This report contains closing prices as of 3/02/09 We initiate coverage of Indra with a DCF-derived target price of €13, giving 17% downside potential. This report sets out to show why Indra’s dependency on the Spanish economy is rendering its IT Services revenues (some 85% of total sales) increasingly vulnerable. This is not the only negative. There are also risks of an overhang of stock and a potential acquisition spree from Indra that could see investors willing to pay less of a premium for the Company going forward. SELL. New challenges facing management. FY09 guidance is already known, and whilst management has the means to achieve it, we argue this year will be very tough: 1). Indra has become more cyclical, with increased exposure to the IT Services market and more cyclically oriented clients in Financial Services, Telecoms & Media and Industry; 2). With synergies with Azertia and Soluziona already successfully achieved, there is little room for further significant operational leverage; 3). The Spanish economic slowdown will undoubtedly impact Indra’s Spanish IT business; 4). An increased exposure to emerging economies could become a negative, particularly Latin America. Risks of a share overhang. Union Fenosa could be forced to sell its 16.5% stake in Indra if Gas Natural (which is the process of acquiring Union Fenosa) intends to sell its non-core investments. Of note, Union Fenosa’s lock-up on 11% of the share capital ended in late January 2009, therefore opening up the possibility of a change of ownership. Possibility of acquiring Telvent. Press reports have speculated on Abengoa selling its 63.9% stake in Telvent to Indra. We contend that this move would make strategic sense, but would significantly increase Indra’s net debt position. Demanding valuation. The stock is trading on EV/EBIT multiples of 9.5x 2009e and 8.7x 2010e, 40% above a weighted average of European IT Service and Defence Electronics peers. Factoring a severe 2009-10 recession into our DCF model, we attain a value of €11 per share or 30% downside. Analyst: Gregory Ramirez +33 1 56 68 75 91 [email protected]
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INDEPENDENT RESEARCH Indra Sistemas 5th February 2009 Defensive qualities are being undermined
We initiate coverage of Indra with a DCF-derived target price of €13, giving 17% downside potential. This report sets out to show why Indra’s dependency on the Spanish economy is rendering its IT Services revenues (some 85% of total sales) increasingly vulnerable. This is not the only negative. There are also risks of an overhang of stock and a potential acquisition spree from Indra that could see investors willing to pay less of a premium for the Company going forward. SELL.
New challenges facing management. FY09 guidance is already known, and whilst management has the means to achieve it, we argue this year will be very tough: 1). Indra has become more cyclical, with increased exposure to the IT Services market and more cyclically oriented clients in Financial Services, Telecoms & Media and Industry; 2). With synergies with Azertia and Soluziona already successfully achieved, there is little room for further significant operational leverage; 3). The Spanish economic slowdown will undoubtedly impact Indra’s Spanish IT business; 4). An increased exposure to emerging economies could become a negative, particularly Latin America.
Risks of a share overhang. Union Fenosa could be forced to sell its 16.5% stake in Indra if Gas Natural (which is the process of acquiring Union Fenosa) intends to sell its non-core investments. Of note, Union Fenosa’s lock-up on 11% of the share capital ended in late January 2009, therefore opening up the possibility of a change of ownership.
Possibility of acquiring Telvent. Press reports have speculated on Abengoa selling its 63.9% stake in Telvent to Indra. We contend that this move would make strategic sense, but would significantly increase Indra’s net debt position.
Demanding valuation. The stock is trading on EV/EBIT multiples of 9.5x 2009e and 8.7x 2010e, 40% above a weighted average of European IT Service and Defence Electronics peers. Factoring a severe 2009-10 recession into our DCF model, we attain a value of €11 per share or 30% downside.
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Company description Founded in 1992 and listed on the Spanish Stock Exchange since 1999, Indra is a Spanish IT Services and Defence group, employing more than 24,000 people. The group generates 72% of its revenues in Solutions (Consulting, Systems Integration, Simulation and Defence Electronic Equipment) and 28% in Services (IT Outsourcing, Application management, BPO). By region, Spain represents 66% of sales, the Rest of Europe 17%, Latin America 10%, and North America 2%. Defence (29%) is the largest contributor to sales, followed by Transport & Traffic (18%), Energy & Industry (16%), Public Administration & Healthcare (14%), Banking & Insurance (13%), and Telecom & Media (10%). Major shareholders include Caja Marid 20%,Union Fenosa 16.5%, Casa Grande de Cartagena (del Pino family) 5.7% and CajAstur 5%.
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1. Investment Case
The reason for writing now Since early 2008, Indra’s stock outperformed the DJ Technology index by 69%, on the back of solid figures throughout the period. Thanks to high visibility, with 60% of sales in defensive sectors and effective cost control, the impact of the economic slowdown on the EBIT margin is minimal. However, several hurdles could well change investor perception towards Indra over the next few months: 1). The magnitude of the downturn in IT Services; 2). Low operating leverage (after synergies were extracted from Azertia and Soluziona acquisitions); 3). The threat of a share price overhang should Unión Fenosa’s 15% stake be sold; 4). The potential purchase of Telvent.
Valuation The stock is trading at a 40% premium to peers, on adjusted EV/EBIT multiples of 9.5x 2009e and 8.7x 2010e. Out target price of €13 is underpinned by a DCF methodology over a 10-year forecast period, featuring a mid-term sales CAGR of 7%.
Catalysts FY08 results scheduled for 26th February. The outlook statement released on 20th January confirmed FY08 results in line with Company guidance (sales up 9.8% to €2.38bn, 11.4% EBIT margin), while FY09 guidance (sales up 5-7% and an 11.3-11.5% EBIT margin) matches consensus estimates. For many years Indra benefited from a premium to the IT Services sector, thanks to its ability to beat or match guidance every year since the IPO in 1999. However, the overhang risk and the possible Telvent acquisition may prompt investors to switch into cheaper IT Services plays in 2009. In addition, we cannot rule out that with worsening economic conditions in Spain and emerging countries, 2009 targets could be revised downwards.
Difference from consensus Our 2009 forecasts are a shade below consensus estimates (+5.4% vs. +5.8% for sales, 11.4% for the adj. EBIT margin), but towards the low-end of the guidance. We contend 2010 consensus figures (sales +6% and 11.6% EBIT margin) do not factor in Indra’s new ‘late cyclical’ characteristics.
Risks to our investment case 1). The Spanish government decides to boost public spending, creating a stimulus for Indra; 2). Indra’s greater expansion into nearshore or offshore (Latin America) in order to adjust costs for price pressure, positively impacting margins; 3). Improving macroeconomic backdrop.
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2. Valuation 2.1. Share price performance After a flat performance in 2007, Indra’s stock lost 13% in 2008 and fell 3% (year-to-date) in 2009. This equates to 7% underperformance in 2007 and 54% and 4% respective outperformance in 2008 and 2009 (year-to-date) vs. the DJ EuroSTOXX. Against the DJ Technology index, the outperformance was 1% and 69% in 2007 and 2008, followed by a 3% underperformance in 2009 (year-to-date). Between 2003 and mid-2007, the stock enjoyed an upward trajectory, with recovering IT Services markets and improving EBIT margins. Initial fears caused by the announcement of the acquisitions of Azertia and Soluziona in 2H06 were proved unfounded, by the successful integration of both companies. As for almost all European IT Service companies, the downturn in share price fortunes started in July 2007 with the subprime crisis. However, Indra’s shares significantly outperformed peers, losing only 14% since mid-July 2007 vs. -52% for Capgemini, -61% for Atos Origin, -56% for Logica, and -64% for TietoEnator.
Fig. 1: Indra Sistemas vs. DJ Technology and DJ EuroSTOXX indices
Source: Reuters
Indra’s significant outperformance vs. its peers over the past 13 months stems from:
An atypical positioning. Indra is not a traditional IT Services company, for 2 reasons: 1). IT Services represents an est. 85% of total revenues, while an est. 15% of sales are in Defence Electronics and Simulation, competing with Thales, Lockheed Martin, Raytheon, CAE, Elbit Systems, Cobham and Ultra Electronics. Therefore, the Company is not strictly subject to macroeconomic cycles; 2). Its IT Services business is mostly based on proprietary solutions, rather than the integration of third-party software. Both of these elements contributed to Indra being able to post double-digit margins every year since 2000.
Good visibility on the outlook. During the 2001-2003 crisis, Indra proved its ability to preserve high margins and solid organic growth. For this very reason, many investors in search of security in these current difficult times continue to deem Indra a ‘safe haven,’ justifying a significant valuation premium to its IT Services peers. Admittedly, like Indra, a couple of European IT Services stocks (Capgemini and Sopra for example) are likely to post FY08 results in line or above their initial guidance. In stark contrast however, their respective share prices have underperformed Indra, due to their lack of visibility on the business in 2009 and 2010.
Indra significantly outperformed the DJ EuroSTOXX and DJ Technology indices since early 2008
Indra’s strong 13-month performance is due to its atypical positioning and management track record, as well as its rarity value.
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Indra vs. DJ Technology Indra vs. DJ EuroSTOXX
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Rarity effect. Indra is the only listed IT company in Spain, and its market capitalisation of nearly €2.6bn makes it the second largest IT Services company in Europe, just behind Capgemini and ahead of Atos Origin and Logica. Along with SAP, Capgemini and Sage, Indra is the only IT stock to belong to a major stock market Index (in this case the IBEX 35). The final rarity effect being its management, which benefits from an exemplary track record.
As shown in Fig. 2, until October 2008, Indra’s EPS momentum was positive. Then worsening sentiment towards the IT Sector knocked EPS momentum as of October 2008, with a 5% downward revision from the consensus on 12-month forward EPS. NB. The share price decline was not as pronounced as it was for other IT Services companies.
2.3. Worse-case DCF scenario derives €11 fair value Applying severe recession scenarios to our 2008-10 estimates within our DCF model, we reach a fair value of €11 per share. This offers theoretical downside of 30%. To attain this, the following assumptions (all other things being equal, except a Beta of 1.6, vs. 1.4) would have to be met:
Our worse-case DCF scenario yields a €11 fair value, offering theoretical downside potential of 30%
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Fig. 6: Worse-case DCF valuation assumptions
FY ending 31st Dec 2009e 2010e 2011e 2012-19e
Sales (€m) 2,466 2,540 2,692 -
% chg +3.5% +3.0% +6.0% +7%
Organic growth (%) +3.5% +3.0% +6.0% +7%
Operating profit (€m) 258 275 309 -
as a % of sales 10.5% 10.8% 11.5% 12.0%
Adjusted EPS (€) 1.03 1.10 1.25 -
% chg -3.7% +6.8% +13.6% -
Source: Company Data; Bryan, Garnier & Co ests.
In this worse case scenario, Indra’s shares are valued at estimated 10.6x 2009 and 9.7x 2010 EV/EBIT multiples, far above the levels seen when the stock price hit a low on 25th September 2002 at €5.06 (actual 7.7x 2002, 5.8x 2003 and 4.9x 2004 EV/EBIT multiples) during the 2001-2003 crisis. By comparison, if today’s share price were to fall to €11, Indra’s worse case valuation would be based on est. 7.5x 2009 and 6.7x 2010 EV/EBIT multiples.
2.4. Peer comparisons In our peer group analysis, we compare Indra to seven other large IT Services companies and with seven Defence Electronics groups. On an EV/EBIT basis, Indra’s valuation is far above (40%) the weighted average of both sectors. We calculated this weighted average (70% IT Services, 30% Defence Electronics) based on the assumption that Indra generates 70% of its EBIT in IT Services and 30% in Defence Electronics and Simulation. We contend this premium is difficult to justify, even if Indra benefits from strong visibility on future results.
Source: Reuters consensus; Bryan, Garnier & Co ests.
Applying this worse-case scenario, Indra’s shares would be valued 7.5x 2009 and 6.7x 2010 EV/EBIT
Indra’s shares are trading at a huge premium to peers, which is difficult to justify despite the strong visibility on its future results
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3. More challenging times ahead On 20th January, Indra released its 2008 trading and 2009 outlook statement. Despite a faster-than-expected deterioration in economic and market trends, 2008 results were reported to be consistent with management’s expectations and consensus estimates, with all targets reached in accordance with the 3Q08 results announcement in early November 2008: revenues up 9.8% to approximately €2,380m, order intake up 10.5% to circa €2,580m (ie. a book-to-bill ratio of 1.1), an EBIT margin of 11.4%, and net profit up 22%. Management stressed Indra’s strong performance in International markets, with double-digit growth in both order intake and revenues - the 2008 revenue guidance was +7-8% for Spain and +13-15% for International operations. The 2009 outlook was in line with the consensus average, targeting revenue growth of 5-7% (less for Spain, double-digit growth for International operations), an order intake outstripping revenues, and an EBIT margin of 11.3-11.5%, thanks to ongoing strict cost control.
We were surprised Indra’s shares reacted so positively to this statement (+5% on the day after the announcement), given the Spanish recession may be more acute than initially feared. Indeed, 2009 guidance officially acknowledges that Indra will not be immune to the recession, with its first downturn in organic growth expected since 2001. Finally, even if commercial opportunities arising over the last two years offer a strong buffer from International markets, we cannot rule out that emerging markets (which proved fairly resilient to date), especially Latin America - could be hit hard by the crisis too.
3.1. Defensive qualities to the fore… Since its IPO in 1999, Indra was singular in its long-run of positive performance. Thus, while traditional European IT Service companies (Capgemini, Atos Origin, Logica, etc.) experienced some swings and volatility in their respective organic growth and operating margins (with some of them posting a double-digit revenue decline), Indra was characterised by its stable positive figures over time, even in 2002 and 2003, as shown in Figs. 8 and 9. Since 2001, Indra’s estimated organic growth fluctuated between 9% (2007) and 10.9% (2002 and 2003), and the adjusted EBIT margin range was between 10.7% (2004) and 11.9% (2005).
Fig. 8: Organic growth: Indra vs. European IT Services competitors
Source: Company Data; Bryan, Garnier & Co. ests.
2008 results should be in line with expectations
The 2009 guidance officially acknowledges that Indra will not be immune to the recession
Indra showed significant resilience during the 2001-2003 crisis
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Fig. 9: Adjusted EBIT margin: Indra vs. European IT Services competitors
Source: Company Data; Bryan, Garnier & Co. ests.
This sterling performance to date was explained by several factors:
Exposure to defensive sectors. Indra generated an est. 61% of its 2008 sales in so-called ‘defensive’ sectors, i.e. Defence & Security (est. 29%), Transport & Traffic (est. 18%), Public administrations & Healthcare (est. 14%) and even Utilities. This is very different from other IT Service companies, which do not typically generate more than 40-45% of sales in all of these sectors combined (and virtually no revenues in Defence). In Defence & Security, Indra benefits from the strong visibility of its backlog, representing an average of 2 years of sales, with high entry barriers, given Defence players are very reluctant to outsource parts of their business to ‘untrustworthy’ or foreign suppliers. In addition, the group has a strong competitive position in niche markets (simulators, automatic testing systems and defence electronic equipment) in Spain and in Europe (Eurofighter, Airbus A400M), having also successfully broken into the US (US Navy). In Transport & Traffic, Indra has a strong competitive position in the air traffic management market globally, and a good franchise in road and train traffic management systems and ticketing together with toll roads. In Public administration & Healthcare, Indra is the leader in Spain, working on the modernisation of public services (Justice, record management, balloting projects, modernisation of hospital IT systems).
Focus on proprietary rather than standard solutions. We estimate that around 90% of its Solutions business or 65% of group total revenue is generated from proprietary solutions. Indra generates only 10% of its Solutions business on the integration of third-party solutions such as SAP or Oracle. Thus in the Banking sector, instead of relying on third-party packages such as SAP Banking, Oracle iFlex, Misys or Temenos, it primarily sells proprietary core banking solutions named Itecban, Fides and Topaz. In addition, it also sells private banking, card management, electronic funds transfer and risk management solutions. Within the Utilities sector, through the acquisition of Soluziona, Indra markets its Open Utilities technology (which interfaces with SAP Utilities), and is sold to more than 120 customers worldwide (Portugal, Philippines, Uruguay, Kenya, Bahrain, etc.). The advantage of selling its own solutions rather than standard versions being that pricing pressure is lower, the customer relationship is closer, and recurring revenues and margins are higher (maintenance revenues). One of Indra’s main differentiators compared with traditional IT Services companies like Capgemini, Atos Origin or Logica is that it historically expenses the equivalent of 6-7% of its revenues in R&D.
Defence & Security, Transport & Traffic, and Public administration & Healthcare represent an est. 61% of sales
An est. 65% of Group revenues come from its proprietary solutions
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Low volatility on margins, thanks to a flexible cost base. Indra employs 4,000 subcontractors, representing 15% of its ‘real’ workforce of 28,000. Therefore, if volume, demand or prices fall, the group would be able to adjust its cost base rapidly without massive restructuring. In addition, Indra has put in place a ‘service centre’ organisation in low-cost locations, whether they are ‘close-shore’ (Spain outside Madrid), nearshore or offshore. This organisation has enabled the group to be more competitive in bidding for a number of Outsourcing deals, especially since Azertia and Soluziona became part of the Company. The group has software development centres based on both ‘close-shore’ (A Coruña, Salamanca, Ciudad Real, Lleida, Badajoz, Madrid, Malaga and Gijon) and offshore models (Argentina, Mexico, Brazil, Panama, Slovakia, Moldavia and the Philippines). We estimate Indra has less than 5% of its headcount offshore, which is far below Capgemini (28%) or Steria (30%). However the Spanish market is still immature in offshoring, meaning that Indra has a competitive ‘close-shore’ offer in Spain, in cities where salaries are some 20-30% lower than in Madrid or Barcelona.
Indra is the largest IT Services company in Spain. With an est. 14% share of its domestic market – ahead of IBM Global Services, HP, Accenture and T-Systems - Indra is a supplier of choice for a number of Spanish powerhouses such as BBVA, Banco Santander, Union Fenosa, Mapfre, Gas Natural and Telefónica. Thanks to its domestic stronghold, we deem the group likely to continue to gain market share in its home country, particularly relative to smaller players. This was the case in 2007 when Telefónica reduced its number of application management suppliers to three, including Indra. This also explains why large Spanish customers ask for Indra for IT projects when they develop abroad, for instance when Santander acquired Abbey National in 2004 (with additional opportunities with Alliance & Leicester and Bradford & Bingley), or when Caja Madrid opened a subsidiary in the US.
Solid balance sheet, despite its net debt position. As of 30th September 2008, net debt was €260.5m equating to a net gearing of 33%, and, at 31st December 2008, we estimate these figures were €150m and 18%, respectively. The group has a low net debt/EBITDA ratio of 0.5x, which is far below the usual levels imposed by banks in general (ie. 3-3.5x), enabling a dividend payout of 55%. Only one-third of existing credit lines have been used. NB. 80% of Indra’s gross bank debt is short-term and used as a relay for paying dividends, share buybacks and working capital needs. The remaining 20% is long-term debt, mainly relating to R&D loans (80%) granted by the Spanish R&D Institute (CEDETI) for 10- 15 years at zero interest. We estimate that, thanks to its strong cash flow (the free cash flow/EBITDA ratio was between 43% and 89% during the last 4 years), Indra will reduce its net debt to zero in 1H11 - provided it makes no new acquisitions.
Excellent management track record. Indra never missed any targets since its IPO in 1999. For instance, in 2007 and 2008, Indra revised up its guidance three times and twice, respectively. However, worth noting is that 2008 was the first year since 2004 in which Indra achieved only its initial guidance - admittedly at the high-end of the range - rather than exceeding it, and therefore we expect 2009 will represent a higher risk of non-delivery, given the worsening economic backdrop in Spain. That said, Fig. 10 shows Indra’s impressive track record in terms of achieving results.
Significant recourse to subcontracting and ‘close-shore’ service centres provides Indra with significant flexibility on its cost base
Its leadership in the Spanish market gives Indra a significant advantage in terms of supporting large Spanish groups in their expansion projects abroad
Indra has little debt in its balance sheet, offering significant flexibility when making acquisitions or paying dividends
Indra has systematically exceeded or achieved its targets since the IPO in 1999
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Fig. 10: Indra achieved or exceeded initial guidance every year (2000-2008)
Initial guidance Actual year-end figures
2008 Sales +8-10%, Order intake +9-10%
EBIT margin 11.3-11.5%, Net profit +18-22%
(3Q08 guidance) Sales +9.8%, Order intake +10.5%
EBIT margin 11.4%, Net profit +22%
2007 Sales +9.5-10.5%, Order intake >+0%
EBIT margin >10%
Sales +11%, Order intake +8%
EBIT margin 10.3% (11.1% before integration costs)
2006 Sales +9-10%, Order intake >+0%
EBITA margin 12%
(ex-Azertia) Sales +11%, Order intake +13%
EBITA margin 12%
2005 Sales +11%, Order intake >+0%
EBITA margin >11.5%
Sales +11.4%, Order intake +16%
EBITA margin 11.8%
2004 Sales +9-11%, Order intake >+9-11%
EBITA margin >11.1%, Net profit >+15%
Sales +10%, Order intake +18%
EBITA margin 11.4%, Net profit +19%
2003 Sales >+10%, Order intake IT >+10%
EBITA margin 11%, Net profit growth > sales growth
Sales +12%, Order intake IT +29%
EBITA margin 11.1%, Net profit +25%
2002 Sales +12-15% on IT (ex-balloting) and >+15% in
SIM/ATS/DEE, EBITA margin >10.8%, Net profit +15%
Sales +15% on IT (ex-balloting) and +17% in SIM/ATS/DEE
EBITA margin 11.1%, Net profit +20%
2001 Sales +18% on IT (ex-balloting) and +15% in
SIM/ATS/DEE, Net profit +18%
Sales +28% on IT (ex-balloting) and +26% in
SIM/ATS/DEE, Net profit +25%
2000 Sales +20-25% on IT (ex-balloting) and >+15% in
SIM/ATS/DEE, Net profit +25%
Sales +28% on IT (ex-balloting) and +15% in
SIM/ATS/DEE, Net profit +32%
Source: Company Data; Bryan, Garnier & Co ests.
3.2. … but Indra is now facing new challenges Indra is more cyclical than ever before In late 2006, Indra acquired Azertia and Soluziona, two IT Service companies with respective 2006 revenues of €208m and €411m, for est. 13.3x and 11.1x 2006 EBIT multiples, respectively 12% and 34% discounts to Indra’s average multiples. Thanks to these acquisitions, Indra increased its revenue by 45% and its headcount by 125%. Whilst bolstering its leadership position in Spanish market, the group also significantly increased its exposure to promising Latin American markets (to 10% of sales from 4%) where synergies with large Spanish customers were evident. However, the downside being, that Indra’s revenues have become far more cyclical than they were in the previous crisis of 2001-03. Indeed, the group has increased its exposure to Banking & Insurance (est. at 13% in 2008 vs. 10% prior the acquisition), and reduced its exposure to Defence & Security (est. 18% vs. 23%) and Transport & Traffic (est. 29% vs. 38%).
Fig. 11: Indra’s revenue split in 2005 (before Azertia/Soluziona) and 2008e
2005: 61% in Defence and Transport 2008e: 47% in Defence and Transport
Source: Company Data; Bryan, Garnier & Co ests.
The acquisition of Azertia and Soluziona in late 2006 increased Indra’s exposure to IT Services and sectors more sensitive to a recession
Defence & Security38%
Transport & Traffic23%
Telecom & M edia11%
Finance & Insurance10%Public Sector &
Healthcare9%
Energy & Industry9%
Defence & Security29%
Transport & Traffic18%
Telecom & M edia10%
Finance & Insurance13%
Public Sector & Healthcare
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Energy & Industry16%
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We also attempted to reconcile Indra’s exposure to pure Defence activities (ie. simulation, automated testing services or ATS, and defence electronics), as the group stopped reporting revenues with this level of detail since 4Q06. In 2005, IT revenues represented 76% of total sales (vs. 14% for Defence Electronics, and 10% for Simulation & ATS). As neither Azertia nor Soluziona were in the Defence business, we estimate that the share of Indra’s revenues generated in IT increased to 85% (vs. 9% for Defence Electronics, and 6% for Simulation & ATS).
Low operating leverage going forward The integration of Azertia and Soluziona was successful, delivering higher-than-initially-expected cost savings (€9-11m, vs. €6-7m). In 2006, Azertia and Soluziona generated EBIT margins of 5.4% and 6.5% respectively, significantly below Indra’s, which was 12% on a stand-alone basis. The deals initially diluted the EBIT margin by 2ppt, given Indra’s 2006 pro forma EBIT margin of 10%, but the group succeeded in returning to an est. 11.4% EBIT margin in 2008, which is, in our view, close to its normative level. We estimate that, given its current business model, Indra is unlikely to exceed a 12% EBIT margin mid-term. On the other hand, its defensive positioning and good cost control imply that Indra should not see significant erosion in its EBIT margin during the current crisis, which has clearly underpinned its stock market outperformance relative to peers since the start of the crisis. As a consequence, if we believe current valuations for Capgemini, Atos Origin and Logica reflect ‘dark’ scenarios in 2009 and beyond and ignore the ability of these groups to see their margins recover when market conditions improve, we also deem that Indra, for its part, will not enjoy such a significant degree of operational leverage.
We estimate that the share of revenues in pure Defence activities was reduced to 15%, vs. c.25% before 2006
At current scope, Indra’s EBIT margin looks unlikely to exceed 12% mid-term, ie. only 0.6ppt above 2008’s level
Fig. 13: Estimated adj. EBIT margin: Indra vs. competitors (2008e-2011e)
Source: Bryan, Garnier & Co. ests.
The Spanish economic slowdown Indra has to contend with Spain being in a recession since 2H08. This country represents Indra’s main market, with 66% of est. 2008 group sales – and on our numbers, more than 70% of IT sales. By sector, we estimate that its revenue exposure here is around 20% in Defence & Security (7-8% in Simulation, ATS and Defence Electronics, 12-13% in IT Services), 15-20% in Transport & Traffic, and 60-65% in other sectors (Telecoms & Media, Energy & Industry, Financial Services, and Public Administration & Healthcare).
Spanish GDP. According to the IMF, Spain’s GDP saw 3%+ annual growth between 2003 and 2007, but this slowed to 1.2% in 2008 from 3.7% in 2007 and is expected to decline by 1.7% in 2009 and 0.1% in 2010. This gloomy environment should impact all sectors of the economy, and, in our view, is likely to weigh on Spanish IT spending from 1Q09. In order to reduce the public deficit, the Spanish government has implemented a rigorous 2009 budget with a 3.7% forecast reduction in Defence spending, and a cost cutting programme for public administration expenses (-1.7%). In terms of public expenditure, Transport & Traffic (roads, infrastructure, etc) will be spared, with a budget forecast to increase 7.5% in 2009. However, we expect the tougher economic conditions in 2009 (unemployment could rocket to 15-20% from 8% in 2007) to prompt the government to slam on the brakes in this area in 2010.
Spanish IT Services market. According to AETIC (the Spanish Association of Technology Companies), the IT market grew 9% in 2007 (+11% for IT Services & Software), vs. +9% in 2006 and +8% in 2005. These rates were roughly twice the European average, as Spain was still in IT catch-up mode relative to more mature countries such as the UK, Germany and France. Indra’s growth was roughly in line with AETIC’s figures. Based on our forecasts for the leading companies in the sector, we expect the European IT Services market to contract some 2-5% in 2009, and the Spanish market to be slightly negative as a consequence of the economic turmoil.
As shown in Fig. 14, Indra’s organic growth in Spain tends to be a correlated to Spanish GDP growth, with a one-year lag. However, thanks to its exposure to the Defence & Security and Transport & Traffic markets (est. 35-40% of Spanish revenues), we forecast that Indra’s 2009 organic growth in Spain will remain positive, at a modest +2% (est. +1% in 2010) which nevertheless implies flat or declining IT Service revenues (up in Outsourcing ex-Mortgage BPO, down in Consulting, Systems integration and Mortgage BPO).
Indra is 66% exposed to the recession in Spain
According to the IMF, Spain will be in recession during 2009 and 2010
A likely contraction in the Spanish IT Services market in 2009
Indra’s organic growth in Spain seems to be more or less correlated with Spain’s GDP growth, with a one-year lag
9.6%
8.6%8.1%8.5%
7.1%6.2%5.6%5.1%
11.9%11.5%11.4%11.5%
8.4%
7.5%7.0%
7.4%
5%
6%
7%
8%
9%
10%
11%
12%
2008e 2009e 2010e 2011e
Capgemini Atos Origin Indra Sistemas Logica
Indra Sistemas
14
Fig. 14: Indra Spain organic growth vs. Spanish GDP growth (2000-2010e)
Source: IMF; Company Data; Bryan, Garnier & Co. ests.
Emerging economies represent a Damocles sword for Indra. The International business represented an est. 34% of Indra’s sales in 2008, split between Europe (17%), Latin America (10%), North America (2%), and Other countries (i.e. Asia-Pacific, Middle-East and Africa, 6%). In Europe, Indra is mainly exposed to defensive businesses, as an est. 35% of revenues are generated in Simulation, ATS and Defence Electronics – primarily driven by the Eurofighter programme – while the rest of the business is mostly in Transport & Traffic (air traffic control). In North America, we estimate that 80% of revenues are in Defence & Security, with the US Navy framework contract running at least until 2010. The remaining 20% is derived from Transport & Traffic (toll roads and trains). By contrast, Indra’s revenues in Latin America are almost 100% in IT, with defence contracts still in their infancy.
The acquisition of Azertia in September 2006 and Soluziona in January 2007 enabled Indra to strengthen its presence in Latin America (to 9% of sales from 5%). In Latin America, Indra is mostly exposed to Mexico, followed by Chile, Argentina, Venezuela, Brazil, Colombia and Panama. In addition, since 2005, the group continued to increase its revenue share in other emerging countries such as China, Kenya, Uganda, Morocco, Mongolia, Thailand, Indonesia and Kazakhstan, mainly through Transport & Traffic contracts. Fig. 15 shows that between 2005 and 2008 Indra raised its revenue exposure to emerging countries to 15% from 9%, thus increasing its risk profile in a period of economic crisis.
Fig. 15: Indra’s geographical revenue breakdown in 2005 and 2008e
2005: 9% in emerging countries 2008e: 15% in emerging countries
Source: Company Data; Bryan, Garnier & Co ests.
With the additions of Azertia and Soluziona, Indra almost doubled its exposure to emerging countries
Indra’s growth in Latin America over the past two years benefited from synergies with Azertia and Soluziona, IT projects from large Spanish customers in Latin America, numerous air traffic management contracts and transport projects and contracts in the Public sector. Recently the company won several new contracts in Latin America including the deployment of a CRM platform for a Telco carrier in Colombia (ETN, US$16m), the modernisation of El Salvador’s land registry (€11.3m), the implementation of motorway traffic management, toll and tunnel control systems in Chile (€8.7m) and Brazil (€10m), and the maintenance of the ticketing system for the Santiago de Chile underground (US$3m over 5 years).
However, after strong GDP growth (+5.4% in Brazil, +5.1% in Chile, +7.5% in Colombia, +8.4% in Venezuela, +3.3% in Mexico, +8.7% in Argentina in 2007, according to OECD and the World Bank data), a number of these countries may encounter more difficult economic and political conditions going forward. According to the IMF, growth in Brazil should slow to 1.8% in 2009 from 5.8% in 2008, while Mexico will enter a recession in 2009 (-0.3% after +1.8% growth in 2008). NB. In 2002, Indra’s revenues in Latin America fell 35% (excluding balloting projects) due to the devaluation of the Argentinean currency, with Argentina remaining one of the countries where there are still concerns over inflation and devaluation. In addition, if economic conditions worsen, revenues in Latin America could be hit, with a number of projects will be put on hold due to the lack of funds. That said, Indra’s exposure to Latin America’s macroeconomy is moderated by its ability to sign deals in the Public sector and in Transport & Traffic.
Other emerging economies are likely to face tougher times, such as Russia, Eastern Europe, the CIS countries, and those of South-East Asia (except China and India – which at present appear to be maintaining strong GDP growth, according to the last IMF report). As a consequence, even though the number of project opportunities is growing at an honourable pace, Indra is nevertheless likely to experience a slow-down in 2009 and 2010 – at least non-military projects.
Growth in Latin America was boosted by positive synergies with Azertia and Soluziona
2009 is seeing a recession in Mexico, with slowdowns or significant risks in other LatAm countries
4. The need for more cautious forecasts For 2009, our revenue forecasts are at the low end of the +5-7% guidance, at +5.4%. International operations should lead the growth at 12% (vs. an est. +13-15% in 2008), while we expect Spanish sales to increase by a more modest 2% (vs. an est. +7-8% in 2008), in line with management’s outlook statement released on 20th January 2009. We estimate Transport & Traffic will maintain its high 9% growth rate, with Telecoms & Media, Financial Services and Defence & Security remaining solid, despite slowing growth. On our numbers, flat revenues are on the cards in Energy & Industry and Public Administration & Healthcare. Fig. 17 below, resumes our revenue assumptions. Note that we do not have detailed sales forecasts for balloting projects, as Indra typically receives orders at the last minute. Of note, the group will conduct the general elections for the Autonomous Community of Galicia in Spain in March, so some balloting revenues will be booked in 1Q09.
Fig. 17: BG revenue forecasts on Indra by sector (2008-2009e)
4.1. Transport and Telecoms remain solid Transport & Traffic (est. 18% of 2008 revenue) Our est. 9% growth estimate for 2008 (+8.7% in September year-to-date) is based on the significant number of new contracts signed in 2007 and 2008 in Air Traffic Management (NATS in the UK for €67m, Lithuania for €11m, Mongolia for €10m, Colombia, Ukraine, Morocco, etc.) and road traffic control (General Directorate of Traffic in Spain for €8m, motorways in Santiago de Chile for €8.7m), together with an application management contract for Renfe (Spanish railways) for €11.5m. For 2009 we expect 9% revenue growth in Transport & Traffic: 1). The Spanish government is unlikely to cut infrastructure investment in 2009, particularly in roads; 2). Indra will benefit from contract wins with leading Spanish infrastructure groups, like Acciona, Cintra and Grupo Ferrovial in road traffic, toll and railway management; 3). The air traffic management systems market is likely to remain healthy thanks to the stimulus, for instance, from the Single European Sky initiative and the SESAR programme for 2020 and beyond, requiring a modernisation of existing ATM systems. However, with the recession expected to worsen throughout the year, we expect the Spanish government to look to cut costs further, and reduce spending in 2010.
Indra’s growth in Transport & Traffic should be sustained in 2009, at an est. +9%
Indra Sistemas
17
Significant orders received in 2008 and continuing in 2009 include: 1). Three road traffic management and toll systems in Brazil (€10m through to late 2009); 2). The Da Vinci railway traffic management system for FEVE in the North of Spain (€13.4m until mid-2010); 3). A number of air traffic management contracts in Lithuania (Kaunas and Palanga), Bosnia and Herzegovina (Mostar), Russia (Rostov-on-the-Don), Mongolia, Morocco, and the NATS contract.
Fig. 18: Transport & Traffic – some examples of recent contract wins
Customer Country Nature of contract
OHL Brazil Brazil Traffic management and toll systems in Litoral Sul and Planalto Sul motorways (1Q09)
FEVE Spain Da Vinci railway traffic management system (4Q08)
Toluca Airport Mexico Access control security system (3Q08)
DG de Trafico Spain Traffic management systems for the A-66 and A-7 motorways (3Q08)
Oro navigacija Lithuania Rollout of the air traffic control system for the Kaunas and Palanga airports (3Q08)
Mumbai underground India Implementation of a complete access control system (3Q08)
ONDA Morocco Development of 3 air traffic simulators (3Q08)
PAŻP Poland Improvement air traffic management Warsaw, Katowice and Gdansk airports (3Q08)
LYCAA Libya Surveillance radar for air traffic management and radio navigation aid (3Q08)
MCAA Mongolia Modernisation of air traffic management and control systems (2Q08)
AENA Spain Maintenance of the operational platform for air traffic control systems (2Q08)
San Sebastian Spain Installation of an access control system at the S. Sebastian commuter train hub (2Q08)
Santiago de Chile Chile Traffic and toll management for Santiago’s northeast access motorway (2Q08)
Source: Company Data.
Telecom & Media (est. 10% of 2008 revenue) Our est. 13.6% growth estimate for 2008 (+14.9% in September year-to-date) is underpinned by market share gains in Spain - as mentioned in professional press reports (Computing España, August 2008) – with Telefónica reducing its preferred supplier list for Applications Development and Management to three companies (Indra, Accenture, and Everis), but also by contract wins in Latin America (Telefónica in Chile and Peru, and Telefónica Móviles in Chile, Colombia Telecom, Telesp and Vivo in Brazil, Radiopolis in Mexico, etc.). For 2009, despite the economic crisis, we expect 9% growth in the Telecom & Media division, as we believe Indra should continue benefiting from its referencing effect, as well as the ongoing flow of projects undertaken by various Telco carriers in Spain and abroad.
Fig. 19: Telecom & Media – some examples of recent contract wins
Customer Country Nature of contract
Telefónica Spain Development and maintenance of network systems applications (3Q08)
Peru Convergence for fixed and wireless operators with a single ERP model (3Q08)
Chile Convergence for Telefónica Empresas CTC with a single ERP model (3Q08)
Brazil Rollout of the latest version of SAP for Vivo (3Q08)
Brazil Multi-channel strategy to optimise commercial results for Telesp (3Q08)
Chile Mid-range infrastructure management for Telefónica and Telefónica Móviles (2Q08)
Spain Support for the billing, HR and accounting systems of Telefónica Móviles (1Q08)
Spain Data centre and mail services outsourcing of Telefónica Soluciones (1Q08)
Radiopolis Mexico Implementation of corporate scorecard and rollout of SAP system (3Q08)
Telecom Kenya Kenya Development, installation and maintenance of a roaming server (3Q08)
Colombia Telecom Colombia Support application maintenance service (2Q08)
Telecom Italia Italy Deployment of a sales force management system for 8 contact centers (1Q08)
Jazztel Spain Development of a customer management system (1Q08)
Source: Company Data.
Air traffic management and road traffic and toll systems remain healthy markets
In Telecoms & Media the ongoing project flow should help
Indra Sistemas
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Financial Services (est. 13% of 2008 revenue) Our est. 14.5% growth estimate for 2008 (+15.7% in September year-to-date) is based on a significant level of investment by Spanish financial institutions – we estimate Indra generates around 60% divisional sales from 6 key customers (BBVA, Grupo Santander, Banc Sabadell, Caja Madrid, Banco de España, Mapfre) in both domestic markets and internationally. For instance, Indra benefited from Santander’s various acquisitions over the past few years in Brazil (Banespa, Banco Meridional, Banco Noroeste), Mexico (Banco Mexicano, Banco Serfin), and the UK (with Abbey National, Alliance & Leicester, Bradford & Bingley). Likewise BBVA, notwithstanding the business contributed by Azertia (which generated one-third of its sales c. €65m per year with BBVA) accounting in our view, for around 20% of Indra’s Financial Services revenues. For 2009, we expect 6% revenue growth for the Financial Services division, even though Spanish and International banks are likely to slow or reduce IT spend and create pricing pressure. In our view, Indra should suffer less than traditional IT Service players, given its greater focus on proprietary solutions and its International exposure.
Fig. 20: Financial Services – some examples of recent contract wins
Customer Country Nature of contract
La Caixa Spain Implementation of a new personal banking model (3Q08)
Spain Installation of a project management office to co-ordinate the opening of branches (3Q08)
BBVA Spain Document management systems (3Q08)
Latin America Rollout of a corporate electronic banking platform (3Q08)
Mexico Software development and maintenance for BBVA Bancomer (2Q08)
Colombia Loan processing outsourcing (BPO) (2Q08)
Zurich Spain Implementation of management modules for billing for medical care (3Q08)
Toyota Spain Communication platform for Motor and General Insurance (3Q08)
IBM Mexico BPO for IBM Mexico (2Q08)
Mexican State Mexico Maintenance of systems for the National Com. for Retirement Savings (2Q08)
ING Spain Implementation of an advertising management system for ING Direct (2Q08)
Mapfre Spain Software maintenance for Mapfre Automoviles (1Q08)
Source: Company Data.
Defence & Security (est. 29% of 2008 revenue) Our est. 7.4% growth estimate for 2008 (+7.8% in September year-to-date) is consistent with previous years, with revenues coming from the Eurofighter programme in Germany, the Spanish armed forces, and the US Navy. However, as of mid-2008, due to the US presidential elections, the awarding of some US Navy contracts was delayed until 2009. For 2009 we expect revenue growth in Defence & Security to slow down slightly to +5%, underpinned by the following: 1). Defence and security remaining a top priority for governments, as shown by budgets voted for 2009 in France and the US. Despite the 3.7% reduction voted in Spain, we estimate Spain represents less than 50% of Indra’s Defence business with half its revenue focused on maintenance; 2). Orders from the US Navy are likely to resume in 2009 with the new Obama administration entering office; 3). Current order flow - even if a slowdown occurs in Spain.
Significant orders received in 2008 and continuing in 2009 include: 1). The Eurofighter, with 15 new simulators for the EF-2000 aircraft (€29m until 2011); 2). The Spanish Armada, with surveillance and defence systems for the F-105 Frigates (>€40m) and four BAM action ships (>€15m until end 2010); 2). The Spanish army, with self-protection systems for 23 Cougar and Chinook helicopters (€20m until early 2012); 3). Romania’s Ministry of Finance, with the Black Sea border surveillance system (€18m until mid-2009); 4). The French army, with the ground section of Pleiades earth observation satellites (€13.7m until 2011). Some contracts signed in 2007 were also ongoing, such as
Banks are likely to slow or at least reduce 2009 IT spend, but Indra should resist well
Indra’s growth in Defence & Security should be resilient in 2009
Significant orders from Eurofighter and Spain’s armed forces
Indra Sistemas
19
the modernisation of the US Marines’ AV-8B Harrier flight trainers (US$23m until 2011) or Latvia’s border surveillance system (€18.2m until mid-2009). In addition, Indra was jointly awarded with Thales the development of Airbus A400M full flight simulators through to 2011.
Fig. 21: Defence & Security – some examples of recent contract wins
Customer Country Nature of contract
Eurofighter Germany 15 simulators for the EF-2000 aircraft (4Q08)
French armed forces France Dual band touch screens for satellite communications (3Q08)
Spanish army Spain SATCOM maintenance (3Q08)
US Navy USA Automatic maintenance systems for the US Navy’s F/A-18 aircraft (3Q08)
Spanish Armada Spain Design and implementation of a range of systems for the BAM action ships (3Q08)
Design and implementation of a range of systems for the F-105 Frigate (1Q08)
Ministry for the Interior Spain Maintenance of gunsights and optical sensors of the Coastal Artillery Command (3Q08)
Ministry of Defence Spain Adaptive software maintenance for pilotless aircraft IT systems (2Q08)
Spain Integrated surveillance system in Murcia, Ibiza and Almeria (1Q08)
Chilean Navy Chile Fully Integrated Tactical System (FITS) for the Navy’s maritime patrol aircraft (3Q08)
EADS Spain Controlled avionics motor systems for Airbus A319, A320 and A321 (2Q08-3Q08)
Spain Development of EC-225 helicopter flight simulator for Eurocopter (2Q08)
Ministry of Finance Romania Integrated surveillance system of Romania’s Black Sea border (2Q08)
Spanish Air Force Spain Maintenance and engineering support for electronic war game systems (2Q08)
Spain Maintenance of automatic testing systems for the C.15 (2Q08)
Source: Company Data.
4.2. We expect flattish sales in other sectors Energy & Industry (est. 16% of 2008 revenue) Our est. 7.8% growth estimate for 2008 (+9.4% in September year-to-date), is driven by the Energy market in Spain and manufacturing industries in Latin America, even though the worsening of the Spanish economy is likely to impact negatively revenues from manufacturing customers from 4Q08. We expect a significant share of business (around 15% in our view) to be generated with Unión Fenosa, which signed a €350m 7-year outsourcing contract with Indra in early 2007. In Latin America, Indra benefited from solid growth in Mexico in 2008. For 2009, we expect 3% revenue growth for the Energy & Industry division, taking into account cuts in IT spending in the Industry segment.
Fig. 22: Energy & Industry – selected recent contract wins
Customer Country Nature of contract
NEK Bulgaria Installation of Indra’s Geographical Information Systems for Dams & Cascades (3Q08)
ENEL Italy Maintenance of integrated plant management systems (3Q08)
EDP Portugal Maintenance of energy management applications (3Q08)
Endesa Spain Installation of fuel management systems for Endesa Servicios (3Q08)
CNE Spain Installation/maintenance of payment guarantee system for Energy Commission (3Q08)
Gecal Spain Strategic renewable energy plans for wind energy (3Q08)
Ecopetrol Colombia Installation of a risk management and energy transactions solution (3Q08)
Gas Natural Spain SAP-based corporate systems application management (2Q08)
EVN Vietnam Roll-out of Oracle E-Business Suite finance, supply and payroll modules (2Q08)
Unión Fenosa Spain New developments for power line modules for Unión Fenosa Distribución (2Q08)
Spain Implementation, maintenance and support of Unión Fenosa Generation’s CCGTs (1Q08)
Spain Update of the supervisory electricity network systems for UF Distribución (1Q08)
Red Eléctrica Spain Development of the non-mainland operating system (1Q08)
Source: Company Data.
Expect IT spending cuts in Industry
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Public Administration & Healthcare (est. 14% of 2008 revenue) Our est. 12.2% growth for 2008 (+14.2% in September year-to-date), including €32m of revenue from balloting projects (general elections and Andalusia regional elections in Spain, the election of London’s mayor in the UK, and legislative elections in Angola), vs. €30.3m in 2007, stems from a large number of contracts with regional governments and the digitalisation of civil registries in Spain (€19.4m), as well as projects like digital passports in Mexico. Until 2001, Indra’s business in the Public sector in Spain (ex-balloting projects) was pretty limited, as most of the business was in balloting projects in Spain and Latin America. Indra has since significantly developed and diversified its business with central, regional and local administrations, together with hospitals. In 4Q08 no revenue is expected from balloting projects (vs. €2.7m in 4Q07), meaning a 4% negative base effect on 4Q08 revenues. For 2009 we expect 3% revenue growth for Public Administration & Healthcare. With the economic crisis in Spain, we expect competition to become tougher in 2009 for IT contracts in the so-called defensive Public sector, generating increased pressure on prices. Against this backdrop, Indra already indicated it will be more selective on deals in order to avoid those with low ‘mark-ups’, and this should translate into a voluntary slowdown in revenue growth in Public administration.
Hospital (Jaen) Spain Integrated clinical management system for the Alto Guadalquivir Hospital (3Q08)
ISFAS Spain Electronic prescription system for the Armed Forces Social Institute (3Q08)
Hospital (Almeria) Spain Picture Archiving & Communication System (PACS) for La Inmaculada Hospital (3Q08)
Dept Foreign Affairs Mexico System for issuing passports (2Q08)
Supreme Court Philippines Management and systems model for the modernisation of the justice (2Q08)
INSHT Spain Rollout of a web environment for the Institute of Workplace Safety (2Q08)
Quirón (hospitals) Spain Rollout of a clinical history documentation system (2Q08)
Ministry of Health Spain Development of systems for managing healthcare abroad (2Q08)
Comm. of Navarra Spain New tax system (1Q08)
Comm. of Baleares Spain Implementation of digital administration solutions (1Q08)
Min. for the Interior Spain Ballot counting for the general elections and regional elections in Andalusia (1Q08)
Prov. of Santa Fe Argentina IT systems for the judicial powers of the province (1Q08)
Source: Company Data.
More deal selectivity in Public Administration & Healthcare
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5. Other clouds on the horizon 5.1. Risk of a share overhang In August 2008, Gas Natural announced its intention to acquire the Spanish utility Unión Fenosa, which holds 16.5% of Indra’s shares. In order to finance this €17bn deal, Gas Natural intends to sell €3bn of non-strategic assets in 2009, which could well include its 16.5% and 5% stakes in Indra and Cepsa respectively, according to a public statement from Repsol’s management (Repsol has a 30% stake in Gas Natural).
In January 2007, in exchange for Soluziona, Unión Fenosa (which was Soluziona’s parent company) received 11% of Indra’s shares, with a two-year lock-up ending in January 2009. For strategic reasons, Unión Fenosa signed a pact with Indra by which the former could increase this initial stake to 16% in year one and to 20% from 2008 onwards.
Therefore, today there is a serious risk of an overhang occurring on Indra’s stock, with more visibility over the next few months. In addition, due to the financial crisis, the situation of mid-sized Spanish ‘cajas de ahorros’ (savings banks) has become more fragile, and there is real concern that some could sell some of their investments. CajAstur has a 5% stake in Indra. In total, this equates to some 21.5% of Indra’s shares susceptible to changing hands.
Fig. 24: Indra’s shareholders (as of 15/12/2008)
Source: Company Data
That said, we believe that such a move would ultimately be a real positive for the stock, as it would create a more independent set of shareholders: Unión Fenosa is also a customer of Indra through a €350m 7-year outsourcing contract signed in January 2007.
An acquisition of Union Fenosa by Gas Natural could precipitate the sale of Union Fenosa’s 16.5% stake in Indra
Union Fenosa’s stake in Indra was locked up until end January 2009 for 11% of shares
No insurance on Cajastur’s stake
Who could buy Union Fenosa’s stake?
Caja M adrid20.0%
Union Fenosa16.5%
Casa Grande de Cartagena (del Pino
family)5.7%
CajAstur5.0%
Free float52.8%
Indra Sistemas
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5.2. Possible acquisition of Telvent On 16th January 2009, the Spanish newspaper Expansión suggested that Indra, together with Thales and private equity firms Cinven and CVC Capital Partners, were preparing binding offers to acquire Telvent, the 63.9%-owned IT subsidiary of Abengoa (the Spanish group specialised in renewable energy technologies). Expansión reported that the bidders were seeking financing for the operation, and were prepared to offer US$600-700m (€450-520m) for Abengoa’s stake on an enterprise value basis. This would equate to an EV/EBIT multiple of an est. 6-8x, while Abengoa reportedly looking to attain US$1bn (€740m) or an est. 11x 2009 EV/EBIT multiple. Based on its US$14.73 share price (on Nasdaq on 29th January 2009, the market value of this stake was approx. US$502m (€594m on an EV basis) or an est. 6.5x 2009 EV/EBIT multiple. Telvent’s net debt as of 31st December 2008 was approximately €208m, following the acquisition of DTN (a US-based business information service provider) for an EV of US$445m.
Fig. 25: Telvent key figures
€m (FYE 31/12) 2007 2008e 2009e
Sales 624.3 695.0 870.0
Gross margin 22.2% n/a n/a
Adjusted EBIT 41.4 68.0 92.0
Adjusted EBIT margin 7.9% 9.8% 10.6%
Net profit 24.9 37.2 n/a
Net debt 35.9 208.0 n/a
Source: Company Data; Reuters; Bryan, Garnier & Co ests.
We believe that, as long as the situation is not clarified, there is a potential negative overhanging Indra’s stock, given a deal of this nature would be rather expensive. On the one hand, Telvent would reinforce Indra’s presence in the US (30% of Telvent’s sales), as well as in strategic sectors such as Transport & Traffic (40% of sales) and Energy (28%). In addition, if we assume a 20% premium over Telvent’s last price (ie. an EV of €808m for 100% of Telvent or €591m for 63.9% of Telvent), this deal would be broadly neutral for Indra’s 2009 EBIT margin before any synergies. On the other hand Indra would lay out approximately €591m in cash, resulting in group net debt at the end of 2009 soaring to approximately €800m. This would equate to net gearing of close to 80-85%, while the net debt/EBITDA ratio would attain a hefty 2x.
Fig. 26: Impact of a Telvent acquisition scenario at €17.5 per share
Repayment of loans 9.5 20.5 -18.5 46.4 26.9 2.0 2.1
Net increase in cash 64.2 -136.8 -99.0 -42.0 0.2 10.8 79.3
Source: Company Data; Bryan, Garnier & Co ests.
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7. Appendices - Indra Sistemas basics Company background Indra Sistemas was founded in 1992 as the result of the Spanish government’s ambition to consolidate the Spanish Defence industry, with the merger of several companies, including CESEL and INISEL. Originally 100% state-owned, Indra’s share capital was opened in 1995 to Thomson CSF (now Thales), which acquired a 25% stake. The group was fully privatised in 1999 with its IPO on the Madrid Stock Exchange. This involved the Spanish state selling its entire stake to the public, Thales reducing its stake to 10.5% and Caja Madrid and Banco Zaragozano becoming shareholders with 10.5% and 3.9% stakes respectively. In 2002, its capital structure evolved further, with Thales reducing its stake to 2.5% (and then to zero in 2003) and Banco Zaragozano exiting the capital. In 2006, Caja Madrid raised its ownership to 15% and CajAstur and Casa Grande de Cartagena (the holding company of the del Pino family –Ferrovial’s founder) acquiring 5.6% and 5% of the shares respectively.
Revenues Indra reports its revenues in two categories: Solutions (72% of sales) and Services (28% of sales):
Solutions (72% of sales and 75% of gross profit). Indra’s Solutions division includes Consulting, Systems and Network Integration, and Own solutions. We estimate 90% of the Solutions business stems from Indra’s own solutions, and only 10% from the integration of third-party solutions (ERP, CRM, Business Intelligence, IVR -interactive voice recognition- servers).
Services (28% of sales and 25% of gross profit). Indra’s Services division includes IT Infrastructure Outsourcing, Application Management and Business Process Outsourcing (BPO).
Fig. 27: Indra’s revenue split (est. 2008)
Source: Bryan, Garnier & Co. ests.
Solutions (Consulting,
Systems Integration, Products)
72%
Services (Outsourcing)
28%
Indra Sistemas
27
Fig. 28: Indra’s margin contribution – Solutions and Services (2004-2008e)
Source: Company Data; Bryan, Garnier & Co. ests.
On a parallel basis, Indra is also organised into six sectors, inside which Solutions and Services are developed:
Defence & Security (est. 29% of sales). We deem 50% of the revenues of this division to be non-IT, namely Defence Electronics Equipment for an est. 30%, and Simulation & Automatic Testing Systems (ATS) for an est. 20%. The group has expertise in three areas: National Defence (protection of air and land space, coastal border surveillance, defence of strategic facilities), deployment of missions outside the national territory, and crisis management. In Defence Electronics Equipment, Indra designs and manufactures air defence, naval and terrestrial command and control, electronic intelligence, electro-optic sensors, night vision, integrated logistics, navigation, and satellite-based communications (Satcom) systems. In Simulation, the group designs aircraft, helicopter and naval simulators for armed forces, with the ability to deploy training centres. In IT Services, Indra intervenes in projects like operation centres for the State Security Forces, e-learning and document management platforms, homeland security and teledetection, as well as maintenance.
Transport & Traffic (est. 18% of sales). Indra provides solutions in air traffic management, land traffic, and railroad traffic. In Air Traffic Management (ATM), Indra estimates that a full one-third of the world’s civil air traffic is controlled with systems developed by the group. These systems include electro-optic sensors, voice communication, radar and flight data processing systems, as well as simulators for control towers. In Land Traffic, the group develops traffic management and supervision, tunnel control and toll systems for motorways, toll bridges and tunnels, and provides services such as simulation, management support systems (HR, finance, accounting, CRM, logistics, maintenance), as well as Outsourcing and BPO. In Land and Railroad Traffic (train, metro, buses), Indra’s expertise ranges from ticketing, access control, new means of payments, traffic management, outsourcing and BPO.
20.1% 19.0%20.2% 19.6%
21.1%19.7%20.6%
15.6%
20.5%
17.3%
0%
5%
10%
15%
20%
25%
Solutions Services
FY04 FY05 FY06 FY07 FY08e
Indra Sistemas
28
Energy & Industry (est. 16% of sales). Indra works with major water, gas and electricity utilities, and provides them with complete solutions in order to comply with regulations, via solutions like Open Utilities/OCEN (operational support system for plants and energy trading activities), monthly settlements, electricity metering equipment and software, inventory maintenance, data exchange, and EDItran (software enabling communication between various computer programmes). For the Industry segment (manufacturing, retail, business services, real estate and construction), the group provides vertical business management solutions, EDItran software, production workflow systems, as well as ERP implementation (SAP).
Public Administration & Healthcare (est. 14% of sales). In the Public Administration segment, Indra provides front and back office services and solutions for national, regional or local public authorities (web portals, call centres, identification and security, budgeting, healthcare, infrastructure, tax, and social security management solutions, document exchange platforms (EDItran), geographical information systems, etc. This also includes solutions for balloting projects (this segment represented around €30m revenues in 2007 and 2008), where Indra has a longstanding expertise in this area (more than 280 electoral processes around the world to date), which includes voting machines, Internet vote as well as vote counting. In Healthcare, the group provides solutions for modernising hospitals, like healthcare systems (Healthcare Card management, databases, hospital management software, electronic prescription, digital medical image management (PACS), healthcare portals, etc), guarantee systems (waiting list management, temporary disability control), remote solutions, and public health systems.
Financial Services (est. 13% of sales). In Finance, Indra’s offering includes solutions for banks to report to the Banco de España (SIIOF), treasury banking (fixed income, equity, derivatives, etc), investment funds (FITS), pension plans, employee beneficiary management, procurement, fixed assets and general expenditure management, personal and private banking, means of payment (CARDplus, NETplus), risk management, foreign trade, factoring, core banking (Itecban, Fides, Topaz), credit institutions and securities. In Insurance, its offering includes insurance company management systems, production systems, document management, corporate portals, consulting on processes for efficiency management.
Telecoms & Media (est. 10% of sales). In Telecoms, Indra develops or integrates CRM and billing systems, network management, business process integration, middleware, operational support systems…
Indra Sistemas
29
Acquisitions to date Since its IPO, Indra made 20 acquisitions, mainly in IT Services. The two most important ones being Azertia (September 2006, purchased for €140m in cash), and Soluziona, Union Fenosa’s IT Service division (January 2007, acquired for €329m in shares). Fig. 29 sums up all the transactions made by Indra since 1999:
Fig. 29: Indra’s acquisition history
Date Company Country Métier Price Sales Op margin Valuation
Feb. 2008 Longwater UK Navigation equipment n/a n/a n/a n/a
(100%) Spain Systems Integration €17.5m n/a n/a n/a
Mar. 1999 Indra SI
(100%) Argentina Outsourcing €0.2m n/a n/a n/a
Source: Company Data; Bryan, Garnier & Co ests.
Indra Sistemas
30
Bryan Garnier stock rating system For the purposes of this Report, the Bryan Garnier stock rating system is defined as follows: Stock rating BUY Share price expected to rise in excess of 20% from initiation over a 12 months
investment horizon, outperforming the market & peers on an unweighted basis. This rating takes into account improving fundamentals and valuation, with a target price derived using one of the following methods: DCF, SOTP, peer comparisons and EVA. Unless specified, all quoted prices on research reports, are closing prices of the prior business day to publication.
SELL Share price expected to fall in excess of 20% from initiation over a 12 months investment horizon, underperforming the market & peers on an unweighted basis. This rating takes into account deteriorating fundamentals and valuation, with a target price derived using one of the following methods: DCF, SOTP, peer comparisons and EVA. Unless specified, all quoted prices on research reports, are closing prices of the prior business day to publication.
Distribution of stock ratings In the last quarter, Bryan Garnier research ratings comprised: BUY ratings 67% SELL ratings 33%
Indra Sistemas
31
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11 Analyst has short position The investment analyst or another person involved in the preparation of this Report has a short position in the securities or derivatives of the Issuer.
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