May 08, 2018 PICK OF THE MONTH VOL-4, NO-5 Zen...

OVERVIEW: Industry- Simulators: Simulators may be defined as machines or rather environments which are designed (for training purposes) to replicate or imitate a scenario to help the user learn the controls or operation of costly affairs like flying an aircraft, operating satellite or create a dummy military warfare. Simulations have various applications in different context that helps the user with testing, performance optimization, safety engineering, training, etc. The concept of simulators are extensively used for aviation training purposes, weapons training, robotics, satellite navigation & maintenance, operating power plant, bridges, ships, etc. If the sim-ulation training programs are merged with conventional training, then the outcomes are fantastic and the complexities which are other-wise involved are lesser. Moreover, there are many economic benefits which can be achieved via the use of simulations. Simulations help in creating a feel of realistic surrounding and responses to complex situa-tions without the necessity to go outdoors and use equipments. So what simulations and allied processes do is; enhance the safety levels (while handling weapons) and at the same time save cost of transportation and ammunition. Simulation is gradually emerging as an effective way to train at various levels of responsibilities and accordingly different levels of difficulties. This is generally seen in aviation industries as well as defence & homeland where the intent is to reduce the spending. Many countries across the globe are trying to find ways to reduce defence spending and thus defence simulation and training will be one of the apt answers. In the current scenario, in many countries where the weapons are becoming more and more sophisticated and expensive, the use of actual rounds or equipment for training will become extremely unaffordable. Simulators in defence training can be broadly classified into Constructive Simulation, Live Simulation and Virtual Simulation. The defence simulation and training market is growing and gradually becoming a significant sector in the defence industry. Of the total global defence simulators market; Asia and Europe account for nearly 17% and 14% respectively. Asian countries like Russia, China and India are anticipated to spend more on simulators in times to come. Moreover, countries of LATAM, Africa and the Middle East are also expected to see increase in military simulation expenditures. The market size for simulations in India as far as the defence domain is concerned is somewhere in the range of USD2bn and as per Prnewswire, the global military simulation and virtual training market is estimated to be worth USD20bn by 2027; thus same will be growing at a CAGR of around 3.4% (forecast period 2017-2027). Some of the critical changes in the approach of GOI towards defence related scenarios and business is anticipated to be beneficial for many of the domestic players. With a view to reduce the imports of defence related products, the GOI has a keen focus on promoting indigenous manufacturing of many such products, thus clearly emphasizing and creating conducive environment for Make in India for exports. With a view to achieve the same, many global defence players are also allowed to partner with Indian manufacturers with specific terms and clauses. Moreover, the concept of MAKE II procedure in the DPP 2016 will also send a stimulus for companies in the Indian defence segment to grow. The concept of IDDM, i.e. Indigenously Designed, Developed and Manufactured goods will also prove to be beneficial for the Indian companies. The Indian defence training and simulation market can be classified as (a) Naval Sea Based training Simulation which occupies nearly 24% of the market share, (b) Land-based Training & Simulation which occupies 26% and (c) Flight/Air based Training & Simulation which enjoys nearly 50% market share. The Indian Armed Forces are gradually moving towards modernization programs which are anticipated to continue for another decade or so. Thus, this clearly gives an idea about the growth potential in the defence training and simulation market.

CMP: Rs. 115 TARGET PRICE: Rs. 170 TIME : 12 months

SNAPSHOT

52 week H / L Mcap (INR mn)

158 / 47 8843

Face value: 1

BSE Code NSE CODE

533339 ZENTEC

Annual Performance

(Rs mn) FY16 FY17 FY18E FY19E

Sales (Net) 526 617 527 1,186

EBITDA 41 114 42 142

EBITDA (%) 7.9 18.4 8.0 12.0

Other Income 55 36 34 35

Interest 24 23 12 24

Depreciation 43 36 43 58

PBT 29 90 21 96

PAT 23 72 16 77

Equity ( Rs mn) 77 77 77 77

EPS (INR) 0.3 0.9 0.2 1.0

Ratio Analysis

Parameters (Rs mn) FY16 FY17 FY18E FY19E

EV/EBITDA (x) 206.3 75.6 205.6 61.9

EV/Net Sales (x) 16.2 13.9 16.5 7.4

M Cap/Sales (x) 16.8 14.3 16.8 7.5

M Cap/EBITDA (x) 213.7 77.9 209.8 62.2

Debt/Equity (x) 0.3 0.1 0.1 0.3

ROCE (%) 4% 9% 3% 9%

Price/Book Value (x) 7.9 7.4 7.3 6.9

P/E (x) 381.5 123.4 537.9 115.4

Share Holding Pattern as on 31st March, 2018

Parameters No of Shares %

Promoters 45,867,340 59.4

Institutions 233,982 0.3

Public 31,058,738 40.3

TOTAL 77,160,060 100

Quarterly Performance

Parameters (Rs mn) Mar-17 Jun-17 Sep-17 Dec-17

Sales (Net) 176 85 82 89

EBITDA 19 (15) (15) 8

EBITDA (%) 10.7 (17.7) (18.6) 9.1

Other Income 4 4 5 9

Interest 3 3 4 7

Depreciation 7 7 7 7

PAT 11 (20) (21) 3

Equity ( Rs mn) 77 77 77 77

Note: All the data is calculated as per Market Price on 07th May 2018

Page No 1

Zen Technologies Limited BUY

May 08, 2018 PICK OF THE MONTH VOL-4, NO-5

Please Turn Over

TM

Source: Annual Report

About the company: Incorporated in 1993, Zen Technologies Limited (Zentec) is involved in designing, developing and manufacturing world-class, state-of-the-art training simulators. These training equipments and simulators are basically used for defense and military applications. The company is chaired by Mr. Ashok Atluri who is a post-graduate diploma holder in Applied Computer Science from CMC. He is also the co-chairman of Defence Innovators and Industry Association. The company has AS9100C from DQS Inc., ISO 9001:2008 (QMS), ISO 14001:2015 (EMS), ISO/IEC 27001:2013 (ISMS) certifications. As of April 2018, the company has 8 copyrights, 29 trademarks, 33 designs and has also filed for 92 domestic and global patents out of which 23 are granted.

Zentec thrives by applying new technologies and developing new products. The company is dependent on constant R&D and has been pooling skills on creating IPR which is a niche business. They have been in the same business since last 25 years. All the products designed by the company are indigenously made. The main customers for the company are from the Defence domain including the Indian Armed Forces, State Police Forces & Para Military Forces. The company can provide tailor made solutions for its client as per their requirement. INVESTMENT RATIONALE (A) Why Simulate: Some of the major requirements for training the armed forces include continuous preparation or training for operational and impromptu preparedness as well as specialised training to combat conflicts or terrorist activities. The difficulty which generally arises in any country is to create an elaborate infrastructure for training with keeping precision in mind and creating scenarios for training like hostage situ-ations, war fronts etc. Moreover, post the training, it is important to assess the objective and maintain records of the progress of creating a benchmark for objective assessment. While at the same time while giving training to the armed forces, cost is another major factor which has to be kept in mind; as the spending are limited and target oriented. Thus, to cater to all these necessities the industry as a whole will need increased role of technology in modern warfare with the help of simulators. Simulators provide a number of advantages for e.g., they are faster in providing immediate feedback and all the results can be recorded for further assessment or grading. The data or records can be saved and can be tracked over a long period of time. Simulators are also cost effective measures where the overall cost of training is reduced by 60%-75% as it is without wastage of actual rounds. While using simulators for training it is also possible to customise the difficulty levels and modify the entire training session as well. While manipulating the course of training session, it is also possible to create a comprehensive and multiple training scenarios as per the requirements of the user with least possibility of accidents. In simple language all the factors mentioned above make the entire simulation training exercise fruitful and beneficial for the user. If one tries to find competitors in this domain, there are a handful of companies on a global scale which have started or which are providing these kinds of services and Zentec is one of them in the niche business. Needless to say, there is immense value added to the training sessions for the forces with simulated wargames.




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Exhibit: Zen Technologies Limited Time-line

Source: Investor PPT April 2018

Exhibit: Advantages– Simulator

Source: Investor Presentation

INVESTMENT RATIONALE (contd.)

(B) Zen CTC: About1-1.5 years ago, the company has started the concept of Combat Training Centre (CTC). Zen CTC is a unique training solution which is created for the Armed forces. This integrated training procedure is a one stop solution for higher combat readiness. The entire idea is designed, developed and maintained by Zentec. Zen CTC offers specialised training to enhance individual’s skills and at the same time it also helps augment the skills of a sub-unit for conventional and special operations like counter-terrorism tasks etc. CTC is more or less an amalgamated facility which addresses the needs of providing training for latest equipment training via use of simulators. This training infrastructure is organised to conduct skilled training with small arms and infantry-support weapons, close quarter battle (CQB) engagements and tactical training. It also consists of simulators and live training solutions such as smart ranges (that may be outdoor or indoor), tactical ranges, baffle ranges, shoot-houses, anti-terrorist live fire facilities etc. The CTC is designed, developed and maintained by Zentec at a location of user's choice. With the use of this model, there is a possibility of providing customized Modules as per training requirements and specifications from user. The entire concept appears to be a cost saving scheme created by the R&D team of Zentec. A large number of challenges related to combat training can be mitigated via ZenCTC. As per the recent presentation by the company (April 2018) the potential order size for a single installation is in the tune of nearly USD50-100mn. Zen CTC some a number of advantages as it helps, quantifying the skill level of each soldier identify where skill level has to be improved achieve higher combat readiness in savings training costs by about 50 to 80% curtail the training time by a fifth Management is seeing this new offering as a large opportunity for the company in times to come.





TM

Exhibit: Advantages- Zen CTC

Source: Annual Report 2017 Recreated

Exhibit: Zen CTC– LIV Integration

Source: Company PPT April 2018




INVESTMENT RATIONALE (contd.) (C) Products: The company has an experience of more than 25 years in the same domain i.e. simulations; they have first movers’ advantage over their competitors. The portfolio of Zentec has more than 30 products which can be simply classified into four broader categories namely a. Virtual simulators: which are indoor sim-ulators modeled on the lines of actual military equipment, b. Live simulators: which are outdoor simulators used for live combat training, c. Constructive simulators: which are computerized war gaming simulator which are used to correspond to the dynamics of combat training, d. Live firing simulators: which provide the familiarity of live fire in realistic scenarios.

Zentec enjoys a good market share in the Indian industry since it is a 100% Indian company in the IDDM category which the GOI is also asking many players to imbibe in their operations to promote Indian products and reduce the import burden. In order to survive in the industry it is imperative to win orders from some of the most critical and demanding clients like the defence forces. Some of the international competitors are Saab, Thales, Cubic Defense, Megitt Elbit, Lockheed Martin, CAE, Saab, L-3 Link Simulation and Training etc. These companies are known to focus either on specific domains of virtual, live or constructive simulators; however, Zentec appears to be the only company offering all the simulator solutions in one basket. The product offering by Zentec is amplified by after sales support which includes AMC contract which provides the company an additional source of income. The revenue drivers for the company have been (a) the simulator products where they enjoy the first mover advantage (b) combat training centre (CTC), (c) Annual Maintenance Contracts (AMC) which has the potential to fetch 1.2 times the amount of the order over a period of time and (d) exports where the focus will be tap those smaller regions which the larger players will not enter. In times to come Zentec intends to continue its focus on areas like Combat Training Center, Armor Combat Training Simulators, UAV Sim T, Tactical Engagement Sim, Infantry Weapons Training Sim, Driving Sim, AGL & MMG Sims,81mm Integrated Mortar Simulator etc. Barriers to entry: Some of the major barriers to entry which favour Zen include the technical skill, its customers and IP ownership. Since the company has been in the domain of simulation for almost 25 years now, they are well versed with the technical, mechanical, electrical and hardware skills which are required. The key customers of the company are from the defence forces; and it is difficult to crack a deal with a customer who is as disciplined as the defence or armed forces. There are specific approvals, licences and quality standards which are supposed to be matched; which are definitely not easy to achieve when working with MoD (Ministry of defence) as its prime customer. IP or intellectual property and rights play a very critical role for driving the revenues. Zen has filed for 92 domestic and global patents out of which 23 are granted. There is a myth in the industry, if the company has the necessary IP, then they are most eligible to achieve and become the single order based source for the customer for long term procurement. Zentech can fit well into this criterion.


TM

Exhibit: Timeline- AMC


Exhibit: Zen Product Complexity Pyramid


INVESTMENT RATIONALE (contd.) (4) Going forward: By now it should be known to all that the business in which Zentec is present is extremely volatile with inconsistent growth. Majority of the orders are from the Indian armed forces which has compelled the management to look at securing new international clients. The target areas for new clients could be the Middle East, some parts of Africa and the ASEAN market. In addition to the boost to the sales from international customers, the customer base will become diversified; at the same time the company will mitigate the risk of dependency on one client base and reap the benefits of reduction in time lag for order confirmation from clients abroad. In general, the order cycle time frame in India with the new DPP ranges from 16-18 months, while the same for international customers is 9-11 months. Moreover, if the company is able to secure repeat orders from client, then the time spent for approvals is next to zero, while the time span for the orders is reduced to 6 months, for e.g. the order from the Egyptian army which Zen secured. the global markets can be a big potential for generating revenues for Zentec.

Financials: The revenues generated by the company have always been erratic and will continue to be the same till the exports market is explored to the full potential. Nearly 30%-35% of the revenues is spent as R&D expenditure. Of the total revenues, nearly 79% is achieved from sale of products and 21% is achieved from sales of services or AMC. There are certain cues; the company has the capability to sell its services at comparatively cheaper rates as compared to the foreign competitors. If one carefully studies the AMC component, then the segment has the potential to earn nearly 1.2 times of the sale of simulator over the products life. In December 2017, Zen had received an order from GOI for 104 T72 & T90 driving simulators valued at Rs2240mn where Rs1560mn is occupied for those of sale of equipments and Rs680mn is AMC for 5 year + warranty for 2 years. As on 30th Oct 2017, the order book consisted of Rs680mn for an export order and Rs650mn for AMC (tenure of 4 years at an average of Rs162.5mn per year.) thus summing the total to Rs1330mn. For 9M2018, the total order book stood for the company stood at Rs3570mn.




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TM

Exhibit: Sales (Rs mn) Exhibit: Net Profit (Rs mn)

Exhibit: Operational Performance

Exhibit: Total Order Book (Rs mn)


Exhibit: AMC Order Book (Rs mn)


Source: Annual Report

Source: Annual Report Source: Annual Report

Risks and concerns: If one follows the pattern, after every 2 years, there have always been big orders for the company which is followed by a lull period. Thus, this makes the sales as well the orders received by the company extremely unpredictable. There is no consistency or reliability on the inflow of orders. Hence, the financials of the company cannot be compared on q-o-q or y-o-y basis. The company is more or less dependent on defense orders which are subject to delays and or cancellations. However, the company is working to mitigate the same, which is also evident from the recent export orders. In the long run, in order to cater to the exports demand, the company will have to spend on setting up an office abroad as well as spend more on sales & marketing and allied services. The company has a long term borrowing in the form of a loan from Technology Development Board (TDB), Ministry of Science and Technology, GOI, for Rs 116mn where it has utilized part financing the project Development and Commercialization of Unmanned Aerial Vehicle Mission Simulator with interest rate @ 5% (simple interest) per annum, repayable in 9 half yearly installments commencing from 01 October 2015. The loan is secured by equitable mortgage of immovable properties and other fixed assets pari-passu with Indian Bank. The loan is also guaranteed by the company’s via pledging of 15,000,000 equity shares of Rs 1/- each which is nearly 19.44%. Outlook and valuations: Zen has been focusing on IPR development and intends to continue. The beauty of the business is there is minimum capex involved and the entire operation works on an asset light model. Once, the cost of a new innovation is incurred, with the inflow of orders- the revenues earned directly collect at the bottom-line. None the less, the company is heavily dependent on orders and many a times when the orders do not flow, the quarterly results can be really sluggish; however, the company intends to mitigate the issues via exports and adding new customers in new geographies with times to come. It appears that the company in future could overcome the pattern i.e. good performance in a year followed by a lean couple of years as one can expect decent flow of orders in immediate and distant future. The current order book for the company looks really very strong which gives a visibility of nearly 2 years to come and thus we initiate a Buy on the stock with a target price of Rs170 for a horizon of 12 months.




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TM

Exhibit: Zen Technologies vs Nifty

Source: Ace Equity

TM

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May 08, 2018 PICK OF THE MONTH VOL-4, NO-5 Zen...

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