Recommendations » India

Persistent Systems review and analysis by Keynote Capitals

Contributed by Keynote Capitals

By Keynote Capitals

Investment Rationale

- Established in 1990, PSL has grown to a 5000+ strong organization as of date. It is backed by team with extensive experience of working in product development firms at the top and middle management levels. With over 3000 on-time flawless product releases in the last five years, PSL has demonstrated impeccable OPD capabilities.

- We believe PSL has a head start over new entrants in OPD, due to entry barriers primarily consisting of IP protection (since PSL’s customers would be averse to sharing IP with new vendors) and customer relationships. On account of risks related to IP theft, new players may find it extremely difficult to penetrate PSL’s clientele. On the other hand, PSL can leverage its existing network to penetrate the procurement gatekeepers of large organizations and increase deal sizes from the current $300K-1mn range.

- PSL has identified opportunities in SaaS Cloud, Analytics and Enterprise Collaboration and Mobility to fuel growth in the long run. Estimates by IBM, IDC, Forrester and Gartner indicate market size of $100bn, $39bn and ~$15bn respectively for these segments by 2013. Based on PSL’s proposed ramp up, we expect revenues to grow at CAGR of 18.8% over the next 3 years.

- PSL enjoys value chain superiority with significant R&D engagements. PSL has leveraged this further by designing continual R&D and training programs through collaboration with academia and other institutes of excellence for sustainably, increasing IP related (non-linear) revenues (~7% of FY10 revenues), which has been instrumental in margin expansion. PSL may also consider IP acquisition, for instance, its acquisition of PaxPro from MeadWestvaco.

- The Company has 37 $1bn+ firms as customers on master service agreements, incl. marquee clients Google, Microsoft, IBM etc.; over 50% of its 195 customers are startups. This unique positioning reduces technological risk, as PSL will be an active participant in creative destruction with access to knowledge from the best of both worlds.

- We note that the company will be investing ~Rs100Cr during FY11 -in creating assets on the ground, partly funded via the IPO route in March 2010. Also, historical revenue growth seems to have been driven by investments in development facilities (see table ‘Revenue growth vis-?-vis investments in gross block’ in appendix). However, with its capex plan likely getting completed during the current year FY11, we believe the company may see tremendous revenue growth in the future. The management informs us that the ongoing capex will support the company’s growth at least till FY13.  Accordingly we expect substantial generation of free cash flows (FCF), post FY11.

- The company has a strong balance sheet, with near zero debt. We believe PSL is well positioned to explore inorganic growth.

- The stock trades at 11.9x and 10.1x FY12E and FY13E EPS respectively. We have determined fair value of PSL at Rs585 per share, assuming revenue CAGR of 18.8% (TTM basis from C10Q2-C13Q2) and 14% cost of equity.