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IPO REVIEW

IT services company Zylog Systems seems reasonably priced for the growth it offers.

In the midst of concerns over the rising rupee and its adverse impact on IT companies, Zylog Systems a mid size global IT service provider is raising Rs 126 crore through its initial public offer.

The company is believed to be less affected by the rupee appreciation due to its onsite presence in its export markets. Its foreign currency loan provides significant cushion as its interest expenses will be lower in rupee terms.

One of the fastest growing technology companies Zylog is expanding its existing infrastructure and investing to grow inorganically. Zylog offers technology driven business solutions such as application development, enterprise infrastructure management, quality assurance, warehousing and web services.

The company is well diversified across the different verticals with the BFSI segment accounting for 34 per cent of revenues followed by telecom, retail and manufacturing.

Zylog has four wholly owned subsidiaries in UK, Singapore and India including offices in the US. Its clients include some prominent names like Barclays Capital, MCI Communication, FTI Consulting, and Pfizer.

Since its top client contributes only about four per cent of revenues, there is no risk of overdependence on any single client. In the past two years, it added 117 clients to take the total to 259 in FY07. Its top 10 clients contributed 52 per cent to revenues last fiscal.

United we grow
Besides, the company follows a business model, whereby it offers solutions in collaboration with other IT services firms. Zylog generates about 33 per cent of the total revenue from collaborative sales model.

This has helped the company service large clients, which are usually dependent on certain systems integrators and value added resellers. It services many such products or solution providers such as Admin Server, FTI Consulting, Volt Telecom and Field Power.

Along with this strategy of collaboration, Zylog has been looking to grow through acquisitions. It has done five acquisitions in the past and these constituted about 28 per cent of its total revenue last fiscal. Through these acquisitions, Zylog acquired the technology, technical professionals and existing client base of these companies and spread its presence in the growing technology market.

The company intends to grow inorganically even in the future and will deploy a part of the issue proceeds for acquiring companies mainly in the US and European market. Zylog has been looking for companies that would fit into its scheme of things and has identified a couple of acquisitions to be made this year.

Going forward, Zylog intends to transfer some of its existing business from the US and European markets into India. For this purpose, the company is investing Rs 67 crore in setting up of two offshore development centre (ODC) with a total capacity of 2050 seats in the country.

Besides, it believes that there is a significant opportunity to convert existing onsite clients into offshore business. About 92 per cent of its total 259 clients have not leveraged the offshore delivery model yet.

Zylog currently generates about 18 per cent of its revenues from the offshore business, which is expected to increase to about 28 per cent by FY09. As the offshore business yields higher margins, operating margins are expected to improve by 200 basis points by next year from 17.1 per cent last year.

To finance its offshore development centres, the company also did a preferential allotment of 43.8 crore shares to UTI Investment Advisory and Argonaut Ventures in February 2007 at Rs 270 per share. 
 

FINANCIALS
Rs crore	FY06	FY07	FY08E	FY09E
Total income	270.00	407.48	552.00	745.00
EBITDA	49.38	69.68	99.36	143.04
OPM%	18.30	17.10	18.00	19.20
Net profit	40.12	54.70	81.14	111.75
EPS	24.46	33.35	49.48	68.14
PE(X) @ 330	13.49	9.89	6.67	4.84
PE(X) @ 350	14.31	10.49	7.07	5.14
Mcap/Sales @ 330	2.00	1.33	0.98	0.73
Mcap/Sales @ 350	2.13	1.41	1.04	0.77

Small but growing
Zylog's net profit over the last four years grew at a CAGR of 55.89 per cent while its total income grew at 58.41 per cent. At the offer price of Rs 330-350, the issue is valued at 9.8-10.5 times FY07 and 6.6-7 times its FY08 estimated post-issue fully diluted earnings.

On the post-issue equity, the price to book value works out to 1.5-1.6 times. Considering that Zylog is growing really fast, the issue seems fairly priced and leaves room for further appreciation.

Surely, the future looks bright since there is a huge demand for Indian IT services mainly from the US and Europe market. The Indian IT-ITES exports are set to grow at CAGR of over 27 per cent to $60 billion by 2010. The rising rupee is a cause for concern but then the impact will be less compared to several other players because of its predominant onsite business currently.

As the company increases its offshoring business, margins are expected to improve and perhaps the currency effect will get neutralised in the end. One key risk however is that the company is heavily dependent on the US market which accounts for 98 per cent of its total income. Any slow down in the US market will negatively impact IT companies, especially the mid-sized companies like Zylog.

Issue opens: July 20
Issue closes: July 25