Russia's Luxoft successfully IPOs despite difficult conditions

By bne IntelliNews June 27, 2013

Ben Aris in Moscow -

With global stock markets volatile and Russian shares among the least popular in the emerging markets, the timing of Luxoft Holding's IPO seemed poor. Yet this spin-off from Russian software developer IBS Group managed to price the shares on June 26 in the middle of the range at $17, and the shares rose as much as 23.5% on their first day of trading on the New York Stock Exchange.

The deal values Luxoft, which provides software and consulting services to international clients such as Boeing and Deutsche Bank, at around $684m. And the surge in price could be partly explained by the deal being priced at an approximately 20% discount to EPAM Systems, another software developer that is mostly based in Belarus and listed last year on the NYSE, whose shares have almost doubled since then.

Luxoft issued 4.1m of class A shares on the NYSE, which is approximately 12.5% of the company's capital, raising about $35m. IBS sold the remaining 2m shares, and will retain control of 72% of the economic rights of Luxoft and 83% of the voting shares after the IPO. Investment banks Cowen & Company, Credit Suisse, JP Morgan, UBS and Russia's VTB Capital, which acted as the underwriters of the IPO, have received a 30-day option to buy additional 613,800 shares of Luxoft.

Pulling off the IPO of such a technology company might have seemed difficult given the state of the global economy and world markets. Yet Anatoly Karachinsky, the founder and president of the parent group IBS, told bne that the crisis has actually been good for business. "The slowing global economy is not a big issue, as a slowdown drives management to dramatically cut costs looking for more efficiency. Software is an easy way to cut the costs in most businesses," Karachinsky said in an interview on the sidelines of the St Petersburg International Economic Forum on June 20-22.

Karachinsky is a pioneer of software engineering in Russia and set up IBS in the late 1980s during Perestroika. He computerised much of the Soviet administration and many of the leading Russian companies as they attempted to move into the 20th century. But thanks to the Soviet educational emphasis on hard sciences, his low-cost but high-quality engineers quickly found a market overseas; Luxoft was established in 2000 to handle the growing volume of international contracts. "Our engineers are two- to four-times cheaper, but work twice as hard," says Karachinsky.

The decision to separate Luxoft from IBS's largely Russian business is necessary to crystalise the differences between the two companies, says Karachinsky. "There is widespread interest in Luxoft, as it is a totally western business. But some investors don't understand what IBS and its Russian business is doing in there and it confuses and distracts them," says Karachinsky. "On the other side of the coin: if you are an investor with an emerging market mandate, then they don't like investing into an emerging market operation with a lot of business in the US."

Luxoft's biggest markets are in the US and Europe, which accounted for 39% and 32% of last year's revenue of $314m. Germany accounts for another 13% of Luxoft's revenue and Russia 9%. Revenue was growing by 28% a year (CAGR) until the current slowdown hit in 2013. This year, Karachinsky thinks revenue growth will slow to about 12%. Though this is still better than the parent company IBS' expected growth of 5%, he is confident that business will pick up again next year. "We have not been as affected in the international business - all is good in the American market and all is okay in the European one," says Karachinsky.

Software for financial services accounts for half of Luxoft's international business (and Deutsche Bank is the single biggest customer), with automotive and aviation sectors being second and third biggest earners.

As international banks recover from the 2008 crisis, they have refocused on improving efficiency and so have been investing heavily into their IT systems, which remains a mainstay of Luxoft's business.

The automotive sector is becoming increasingly important for Luxoft, which already supplies all the major European manufacturers with software services. And in September last year, Luxoft broke into the US market, signing a "very interesting system" deal with Ford, according to Karachinsky, to build an integrated platform covering everything from in-car entertainment systems through navigation and control of the engine.

Energy is another potential source of work for Luxoft and the company is already heavily involved in writing software to control the European grid that is part of the EU's energy liberalisation programme. However, more interesting is the US market, which recently put a new green energy law in place, which Karachinsky says, "lays out a vision for local energy companies and managing power consumption using technology."

Karachinsky believes the prospects for both Luxoft and IBS are good for many years to come. "Everyone understands we are on the border of a great technology revolution with everything moving into the cloud. That means that the last 30 years of code will have be entirely rewritten. On top of this everything will get a chip and be interconnected, which also needs a mountain of code to manage it. In effect societies infrastructure will move into the cloud too and all this needs to be built."

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