Persistent Systems’ ability to grow its earnings at a steady rate and improving fundamentals make its offer investment worthy.
With the western markets stabilising, prospects of Indian IT vendors is looking brighter. Likewise, with higher outsourcing on the cards, players like Persistent Systems that provide outsourced software product development (OPD) services could benefit. Apart from catering to leading independent software vendors (ISVs), the company offers end-to-end solutions to smaller software product companies. It provides services across the value chain of product development – product conceptualisation, design, development, testing and support.
At present, the company has offshore development centres located in Pune, Nagpur, Goa and Hyderabad. In view of its growth plans, Persistent Systems plans to construct two new development centres and hardware requirements. To fund these plans, the company proposes to raise Rs 120-128 crore (excluding Rs 37-34 crore offer for sale included in the present offer) through the IPO.
Business perspective
Persistent Systems has managed a foothold in the OPD space by virtue of its ability to offer solutions across each stage of product development. This has led to a well-diversified customer base amongst ISVs and smaller software product companies. The company looks at deal sizes of around $2-10 million, which normally the bigger players don’t concentrate on. It positions itself to reduce overall costs and the likely time-to-market and releases the software products for its clients. In the process, it mitigates any failure risk during the product development process and enables global software vendors and enterprises to focus on their core business activities.
Given the nature of services offered and the upfront investments received from clients, stickiness of clients (around 85-90 per cent of the clients give repeat business) is relatively higher as compared to IT services. Notably, the company has been able to gradually reduce the client concentration risks, which is visible in the declining revenue contribution of its top 10 customers –down from 47 per cent in 2006-07 to about 37 per cent in 2008-09.
The company derives most of its business from independent software vendors (contributes 47 per cent of revenue), life sciences and healthcare (15 per cent) and, telecom (24 per cent). The company is focusing on augmenting business in emerging technologies/new initiatives such as cloud computing, analytics, enterprise mobility and enterprise collaboration services in the days to come. As product companies spend more to upgrade their systems to match new business models, it would have a positive impact on OPD players like Persistent Systems, which is channelling efforts towards R&D to offer value to its clients.
Healthy financials
Persistent Systems clocked healthy growth rates of over 40 per cent in revenues during the last five years, largely driven by an increasing trend of off-shoring among ISVs. Nevertheless, delays in product release and upgrade by few large ISVs and closure of some small ISVs put pressure on the revenue front in the first nine months of 2009-10, which slipped 3.3 per cent to Rs 436 crore.
Rising wage inflation and operating expenses have been reasons for concern in 2008-09. Additionally, forex losses of Rs 87.4 crore put pressure on net profit, which fell 20 per cent year-on-year in 2008-09. Consequently, EBITDA margins on a consolidated basis fell sharply, lower than its usual margins of about 24-26 per cent. However, things have improved thereafter; cost control and better efficiencies helped EBITDA margins to jump to around 25 per cent for the first nine months of 2009-10.
A track record of churning net cash accruals in the range of Rs 70-100 crore in each of the past three years, due to its sustained top line growth, debt-free position and low effective tax rates lends solidity to the company’s ability to meet future fund requirements. Besides, cash and investments together stand at over Rs 150 crore as of the December 2009.
The company plans to use part of the IPO proceeds to fund the construction of its two new development centres - one in Pune and the other in Nagpur, with a capacity to seat 3,000 and 1,200 employees, respectively, which is estimated to cost Rs 175 crore. With the commissioning of these, its total employee strength will almost double from 4,400 currently.
| MARGINS BACK ON TRACK | ||||
| in Rs crore | FY08 | FY09 | FY10 ^ | % chg ** |
| Revenues | 450.5 | 600.6 | 581.1 | -3.3 |
| EBITDA margin (%) | 25.9 | 16.4 | 24.6 | -- |
| Net profit | 83.5 | 66.9 | 106.1 | 58.6 |
| EPS (Rs) * | 23.3 | 18.7 | 29.0 | 55.2 |
| P/E (x) @ Rs 290 | — | 15.5 | 11.0 | — |
| P/E (x) @ Rs 310 | — | 16.6 | 11.7 | — |
| ^ Annualised figures based on 9 mth period ending Dec 09 * EPS for FY10 is on pre-IPO equity; on post-IPO equity it is Rs 26.5 ** year-on-year Source: RHP | ||||
Conclusion
In the recent past, the OPD space has seen an uptick in volumes and pricing power, translating into increased sourcing from ISVs. Besides, an expanding services bouquet would also serve well for the company. However, its over-dependence on outsourced projects from the US market (as most of the product companies are from US), which contributes 87 per cent of the revenues, is a visible risk. Nevertheless, Europe and Asia Pacific regions contribution to the revenues is on the increase in the last two years. Besides, rising wage inflation and unfavourable currency fluctuation could be some impediments in the future.
While there are no strict comparable peers, Hexaware Technologies and Sasken Communication are similar in size—the service profile and the space that Persistent operates in are different. At the upper price band, the IPO is priced at a PE of 11.7 times based on the company’s annualised 2009-10 EPS'. Considering its product profile, management traction and reasonably sound financials, investors with a long-term perspective can consider the issue.
