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Persistent Systems IPO review and analysis by Keynote Capitals

Contributed by Keynote Capitals

By Keynote Capitals

Highlights

Price Band : Rs290 - 310 per share

IPO open during : March 17 - 19, 2010

Book Running Lead Managers : Enam, JP Morgan

To list on : NSE & BSE

IPO Grading : 4 / 5 (CRISIL)

Market Cap post-listing : Rs12.4bn or $273mn (based on the cap price)

Market Cap of Free Float : Rs7.6bn or $167mn (based on the cap price)

Executive Summary

-  Persistent Systems Ltd. (PSL) was promoted by technocrats Dr. Anand Deshpande and Mr. S. P. Deshpande in 1990 as an outsourcing software product development company. The company provides product development services across the entire value chain of the product development to independent software vendors and telecom industry. The company has around 220 customers, of which top 10 account for around 41% of its revenues.

-  Outsourced software product development (OPD) is an emerging segment in the outsourced software industry. OPD companies build software products for their customers. The US is a major market for OPD companies.

-  IDC which defines R & D / PE services as the taking over of the R&D of a product company’s value chain (in part or full) by a third-party services organization, forecasts a 5-year CAGR of 14% for R & D / Product Engineering (PE) services, size of which will reach an estimated $65.7bn by 2013.

-  PSL is a leading player in outsourced software product development services, with a track record of almost 2 decades. It designs, develops and maintains software systems and solutions, creates new applications and enhances the functionality of existing software products of customers. Over the last five years, the company has contributed to over 3,000 product releases for its customers.

-  OPD services are differentiated from IT services in terms of client requirements, and involvement of time and money. As client requirements are fixed in IT services, time and money spent thereon are variables while it is the reverse in OPD services.

-  The company’s hold on the niche product category is evident from its revenue growth at 40% CAGR over the last 3 years, which outperforming the leading IT players in India.

-  PSL’s clientele comprises of several global software companies and fast-growing early-stage companies. Around 1/6th of its customers (37 nos.) have annual revenues of over $1bn.

-  We view the company’s client and geographical concentration as concerns. Its top 10 clients account for 41% of its revenues while the US contributes 87% of total revenues. We note that the company could not remain insulated from problems in the US during FY09, since it reported a reduction in EBITDA margin and bottomline in spite of reporting topline growth. However, the company has bounced back in the period of 9 months to December 31, 2009, with margins returning closer to earlier levels, and robust bottomline in spite of increased tax liability.

-  Another peculiarity of the company’s business model is its dependence on investments in gross block. Revenue growth is largely driven by investments in development facilities. Of its proposed investment of Rs175Cr in development facilities, it has already deployed Rs99Cr. With the balance Rs76Cr to be deployed primarily till FY11, we believe the company may see tremendous revenue growth in FY11 and FY12. Again, with increasing gross block, depreciation too will increase, eating into the bottomline.

-  The company has a strong balance sheet, with near zero debt. However, it has a large working capital requirement as a result of growing scale.

-  Priced at 9.9x FY11E EPS and 7.9x FY12 EPS, the IPO appears expensive vis-?-vis peers Hexaware Technologies and Sasken Communication. However, we believe the valuation premium is justified on account of the superior business model and strong growth prospects of PSL.