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Persistent Systems IPO review and analysis by Angel Broking
By Angel Broking
Persistent Systems Limited (PSL) is a Pune-based IT company engaged in niche Offshore software Product Development (OPD) services, employing about 4,639 employees (including over 3,700 software professionals). The company is trading on economical valuations, at a P/E of 10.4x and an EV/Sales of 1.5x on its FY2012E estimates. Hence, we recommend a Subscribe view to the IPO.
Niche Offering: PSL is one of the leading OPD service providers in India. The company designs, develops and maintains software systems and solutions, creates new applications and enhances the functionality of its customers' existing software products. The company provides various services such as designing, testing and product development, and is involved in the entire product life-cycle, which helps it ensure long-term relationships with the clients and a large portion of repeat business (91.5% of the business was from existing clients in 9MFY2010). The company is a leader in its space and has successfully rolled out over 3000 products in the last five years, signaling its success ratio and domain expertise. The company is working for 37 clients with over US $1bn in revenues.
Strong Global Opportunity: OPD is an emerging category in the outsourced software industry and has clocked a CAGR of 10% over 2005-2009, and is likely to reach US $65bn by 2013E (expected growth of 14% during FY2009-13E). The opportunity is likely to expand as offshoring helps the developer in reducing the time to market, reduces the risk of failure, reduces management bandwidth; thus, it helps the developers focus on their core competency. According to IDC estimates, the revenue growth for offshore OPD is set to grow at a 19% CAGR over 2009-2013E. This assumes that the share of offshoring as a percentage to worldwide R&D/Product engineering spend will improve from 22.5% in 2009 to 24.5% in 2013E.
Newer Initiatives: The Company is making early strides in new areas like Cloud Computing/SaaS, Analytics, Enterprise Mobility and Enterprise Collaboration Services, and has business relationships with leading global players, which would help it maintain its differentiating factor.
Investment Arguments
Niche Offering - only pure-play OPD offshore player
PSL is the one of the few pure-play OPD services player in the domestic market, in the large ADM-services dominated Indian IT services industry. The company's business model is different, as it has always concentrated on the OPD segment, carving a niche for itself. The company is a leader in its space and has successfully rolled out over 3000 products in the last five years, signaling its success ratio and domain expertise. The OPD service segment is different from traditional IT services, as in the case of OPD offshoring the time to launch is fixed whereas the business requirements are variable. This results in a high level of vendor stickiness, as the offshore company continues to work on newer versions, keeping in mind the time to market by the client (the software company). The company's client portfolio includes 37 clients with overUS $1bn in revenues, which displays its strong capability.
Strong Industry Opportunity
OPD is an emerging category in the outsourced software industry and has clocked a CAGR of 10% over 2005-2009, and is likely to reach US $65bn by 2013E (expected growth of 14% during FY09-13E).
The opportunity is likely to expand as offshoring helps the developer in reducing the time to market, reduces the risk of failure, reduces management bandwidth; thus, it helps the developers focus on their core competency.
The opportunity is likely to expand as the offshoring helps the developer to reduce time to market, reduces risk of failure, reduces management bandwidth and thus help them to focus on their core competency. Additionally, offshoring is high in the segment, as there is a shortage of high-tech engineering talent in the developed market. This, coupled with the proactive infrastructure investment by offshoring services providers, would influence customers to relocate their own R&D product development and innovation centers to be delivered from low-cost geographies.
The industry is divided between four types of players: Captive Centres of Developers, Small Fragmented players, Traditional IT players and Pure-play OPD vendors. The traditional IT services players consider the segment as part of the bouquet and do not engage in lower size deals. Captives have started going for increased offshoring to fill in the white gaps, whereas fragmented players lag in capability and domain expertise. These factors cumulatively create better a business landscape for a pure-play OPD Services Company like PSL. According to IDC estimates, the revenue growth for offshore OPD is set to grow at a 19% CAGR over 2009-2013E. This assumes that the share of offshoring as a percentage to worldwide R&D/Product engineering spend will improve from 22.5% in 2009 to 24.5% in 2013E.
Company Background
Persistent Systems (India), promoted by technocrat, Dr Anand Deshpande, is one of the leading players in outsourced software product development services. The company designs, develops and maintains software systems and solutions, creates new applications and enhances the functionality of its customers' existing software products. The company's offshore development centres are located in Pune, Nagpur, Bangalore, Goa and Hyderabad. The company owns most of its development centres. The company has a high offshore effort mix by the virtue of the nature of the business, which grants it the benefit of higher margins. Almost 84% of its revenue is derived from the USA and Canada region, followed by Europe at 9% and Asia Pacific at 7%.
The company is largely focussed in servicing three major verticals: Infrastructure and systems (61%), telecom (primarily handset makers, 24%), and healthcare and life sciences (15%). PSL works on improvising on the launched software product to develop newer versions (V1, V2, V3.... Vn), which helps in faster development and testing.
The company derives a majority of its revenue (77%) from time and material contracts, where it bills per employee on per hour basis for preparing software products for its clients. In case of fixed price contracts, it bills the employee on milestone basis. The most profitable segment, which is IP licensing and revenue sharing arrangements, contributes only 15% currently. PSL plans to engage in these projects going forward, as it will help in augmenting its profitability and in driving its revenue growth. The major differentiating factor is that, unlike the typical IT service provider, where the work and number of employees deployed are variable factors, in PSL the number of employees do not vary with the amount of work offshored, as the same set of technicians work on a particular development. This factor provides the company with a degree of non-linearity, ahead of its peers.
Client Profile
PSL caters to clients that are independent software vendors (for example, Microsoft and Oracle), and companies that focus on developing software products for verticals such as telecom and life sciences. Apart from this, the company also works with companies that are engaged in developing products around newer platforms such as SaaS (software-as-a-service) and cloud computing, which are witnessing enormous growth. It has a total of 251 clients, with its top client contributing 10% of the revenue, followed by the next four with a combined 20% contribution. All of these five clients have an annual billing of over US $3mn each. Thus, PSL has a healthy client concentration, with the Top 10 clients contributing only 41% to the revenue.
Financials
Strong financial performance during FY2005-09 PSL's consolidated revenues have grown at a CAGR of 42% in rupee terms and 38% in US dollar terms during FY2005-09, on the back of the emerging offshoring trend by clients in the OPD segment. Impacted by the slowdown, the revenue for the nine months period ended December 2009 was down 8.5% in US dollar terms and 3.4% in rupee terms. The revenue growth has been lower on account of across-the-board pricing cuts in the last year; however, revenue growth is picking up in the current year.
High Profitability: PSL's EBITDA has grown by 42% yoy in FY2010 (YTD), after growing at a CAGR of 19.5% over FY2005-09. The EBITDA margin came down sharply to 15.4% in FY2009 from 30.5% in FY2005, due to the increased competition in the Indian OPD market (from large system integrators), as well as the recessionary global environment in FY2009. However, these margins have rebounded to 23.5% in FY2010 (YTD), with the improving business environment translating into higher volumes and a stable pricing environment. The company has reported a strong PAT of Rs75.3cr, with a 45% yoy growth in FY2010 (YTD), translating into an annualised EPS of around Rs25 per share. We believe that the PAT margins are likely to sustain at the currentlevel of 16%.
Issue Details
The company plans to raise Rs157cr to Rs168cr from the issue offer of 0.54cr shares, priced in a band of Rs290 to Rs310 per share. The issue includes an offer for sale of about 0.128cr shares by former employees of the company. Of the net proceeds of the issue, about Rs76.02cr would be used towards expansion of the existing facilities at Nagpur and Hinjewadi, Pune, taking the total capacity at the two locations to 4,200 seats; about Rs2.96cr would be used towards fit-outs at the premises leased in SEZ at Hyderabad; and Rs20.45cr towards hardware at the facilities. After commissioning, the company would have a seat capacity of about 7,500 seats. It currently owns over 5 lakh square feet of office space, with the capacity to seat approximately 3,800 people.
Outlook and Valuation
PSL is well placed in the OPD offshoring space and is likely to benefit from the increased opportunities in the segment. The company is one of the few pure-play OPD services players, and is likely to deliver better-than-segment growth (expected to grow at a CAGR of 19% till FY2013E), on account of its large client contacts and sustained business relationships. Early strides in the next generation technology like cloud computing, analytics and Enterprise services would supplement the revenue traction in the coming period. The company has also started dealing in the IP licensing business, where it purchases the IP and generates licensing revenue, which would help it create better visibility at the user end.
PSL is the only pure-play OPD company in India; however, there are other competitors such as Mindtree, Wipro, HCL engaged in some of the product engineering services. Although the competition is from larger players, the company has strong domain expertise and normally operates in a relatively lower size of the deal (between US $1mn and US $5mn), which eases pricing pressure.
PSL is trading at an economical PE of 12.2x on its expected FY2010E EPS of Rs25.3 (on post-issue capital), as against the mid-tier peer average band of 12-14x. The company is likely to register an EPS CAGR of 8.6% over FY2010E-12E, even after adjusting for the impact of a high tax rate in FY2012E. At the upper price limit of Rs310, the stock is trading at 10.4x its FY2012E EPS of Rs29.8, and EV/Sales of 1.5x on its FY2012E estimates, which we believe is attractive on a relative basis. Hence, we recommend a Subscribe view on the IPO.
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