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PENNY WISE

With Sasken's E series getting its first customer in Lenovo, the products business looks firmly on track for a turnaround in FY08.

What would be a mobile phone without its screen beaming out colourful images or reflecting scores of messages. Well it would very much be in technical jargon, hardware without its software. And if telecom software is really something which gets the investor in you interested, then you needn't go far beyond Sasken Communication Technologies.

Over the past year, the scrip has had a great time at the bourses rising over 38 per cent y-o-y as compared to the BSE Teck index which has risen about 27 per cent and the BSE Midcap index which has actually fallen nearly three per cent in this same period.

And while services, contributing about 95 per cent of the revenues at present, have been the major growth driver so far; the Lenovo deal announced last week along with other trends suggest that the beleaguered product business may be finally raising its head to support future margin growth.

The E series foray

With Sasken's telecom software product, Sasken Application Framework being chosen by Chinese Lenovo mobile as its application solution of choice for the development of its feature phones, the much touted "E series" has finally made a splash in the international market.

The E series refers to an integrated framework of mobile software applications including video record and play, touch pad, bluetooth, audio streaming etc.

"While these not only affirm the credibility of the product, it marks the introduction of a high royalty bearing product," says Rishi Maheshwari, research analyst, Networth Stock broking.

Estimates suggest that while the E series phones enjoy royalties of more than $1 per phone; its other product series like the M series (modem related software for 2.5G to 3G technology) and S series (multimedia codex for smart phones) earn royalties of anywhere between 40 cents to $1 dollar. Though the actual roll-out of the phones could take anywhere between 7-12 months, the deal spells good news for what has been in the past couple of years a loss making products business.

In recent times, the products business has been the Achilles heel for Sasken mainly due to the segment being in an investment cycle with burgeoning R&D expenses and not commensurate product design wins.

For example, even as R&D expenses have risen from nine per cent of sales to nearly 11 per cent of sales in FY06, the product segment reported losses of Rs 4.4 crore in FY06. For the first nine months of FY07, the segment losses were Rs 13.4 crore.

Analysts predict substantial revenues from the Lenovo deal given the reputation enjoyed by the OMAP Vox platform and the Lenovo's standing in the Chinese market.

Between FY04 and FY06, while domestic Chinese mobile companies saw their combined market share nose-dive from 50 per cent to 29.8 per cent, Lenovo was able to sustain its marketshare at around seven per cent.

The E series deal is however just one part of the slow transformation in the products business. For example, royalties as a proportion to product revenues which had stagnated to about 10 per cent in FY06 has risen significantly to 24 per cent in the first nine months of FY07.

And while the company witnessed two design wins (when the end product is launched and royalty starts kicking in) in FY07, it is expecting two more in the first quarter of this fiscal. Currently, the company has eight design ins (when the agreement for the software is signed) of which four appear to be on a sure footing. Overall however analysts do expect the product business to turnaround in FY08 and contribute significantly to the margins in FY09. 

FINANCIALS
Rs crore	FY06	FY07E	FY08E	FY09E
Revenue	308.1	484	706.6	954
Operating profit	48.2	80.8	131	183.4
OPM (%)	15.6	16.7	18.5	19.2
EPS (Rs)	10.6	17.4	31.2	42.5
P/E at Rs 521.25	49.2	30	16.7	12.3
Source: Analysts estimates

Servicing growth

In the difficult days of Sasken's product business, it was however the services segment with present margins of around 23 per cent which proved to be the manna for bottomline and topline growth. In the December quarter, service revenues grew about 72 per cent y-o-y, supporting a 73 per cent growth in total revenues. 

PEER COMPARISON
	OPM(%)	P/E(X)
Infotech Enterprises	25.70	25.40
KPIT Cummins	17.70	21.40
Hexaware	19.50	17.90
Sasken Communications	14.80	38.21
Operating profit margin (OPM) for 9MFY07 P/E: Trailing 12 months ending Dec '06

Overall for the nine months period, the topline expanding by about 48 per cent while operating margins hovered around the 14.8 per cent mark in this period. The company's domain viz R&D services and solutions is also beset with tremendous opportunities.

"With all major telecom OEMs (original equipment manufacturers) facing cost pressures and R&D being a major element of costs, a large number of global companies will shift to low cost locations," says Harmendra Gandhi, research analyst, BRICS securities.

Estimates suggest that while R&D offshore services outsourcing to India would increase by 16 per cent CAGR between 2005 and 2010 to reach $ 6.6 billion, a significant chunk of this would accrue to the telecom segment.

Sasken's presence across network infrastructure, handsets, semiconductor and terminal devices have made it develop a strong working relationship with a range of Tier I companies from Nokia and Alcatel in the equipment space to Texas instruments and Philips in the semiconductor arena.

Moreover Sasken's strategy of near shoring or setting up a strong geographic presence near manufacturing centres of global giants should also stand it in good stead.

"For example the acquisition of Finnish Botnia in June last year has not only brought in complementary expertise in the RFID and hardware design space but also given access to lucrative Nokia contracts which account for 92 per cent of Botnia's revenues", opines an analyst tracking the sector.

Similarly the company is in the midst of a massive ramp up at its Mexico centre as the traction with one of its key clients Texas instruments continues to grow.

For example the employee strength here which was merely five at the beginning of FY07 increased dramatically and stood at 57 by the end of 2006. Overall most analysts expect the services revenue to grow at a CAGR of 40-45 per cent in the next two years.

However key challenges remain too. The company is plagued with an attrition rate of 21 per cent, one of the highest in the industry. Moreover the rupee appreciation is bound to hurt. For example, this was responsible for at least a three per cent impact on operating margins in the December quarter FY07.

As regards valuations, Sasken's trailing twelve month valuations at about 38 times is at a premium to peers (see table).Estimates for the standalone service division ranging from 10-12 times FY08 EV/EBITDA however appear more reasonable.

But though the company's margins remain lower than peers, analysts believe that the benefits of the R&D focus on the products side and increased traction in the services segment support strong future prospects.