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Sunday, March 04, 2007

Polaris Software: Buy


Investors with a high-risk appetite can consider an exposure in the Polaris Software stock taking advantage of the recent weakness. At the current market price, the stock trades at a price-earnings multiple of 16 times its likely per share earnings for 2006-07. We have a buy recommendation outstanding on the stock, made in end-November at Rs 123.

Given its good order pipeline and overall improvement in the execution, the robust growth momentum of the past three quarters is likely to be sustained over the next year or so. Its growth engines, particularly an increased contribution from the IP-led intellect product, may add to the operating profit margin in the coming quarters.

On the downside, however, Polaris will have to contend with stiff competition across the banking products space and efficacy of cross-selling its testing/ERP solutions to the existing product clients. Any scaling down of revenues from Citibank, its key client (accounting for 44 per cent of revenues), or a slowdown in order flows from the US or Europe, poses additional risks. The impact of the introduction of the Minimum Alternate Tax and Fringe Benefit Tax in the latest Budget may not materially alter the per share earnings projections for 2007-08. sConsidering the sharp run-up in the stock since our earlier recommendation, investors need to moderate their return expectations to 15-20 per cent. But the returns are likely to be steady and linked to financial performance in the coming quarters.

Improving fundamentals

At the broad level, the six sub-verticals created within the BFSI space — retail banking and credit cards; consumer finance and mortgages; insurance; capital market and wealth; corporate banking and cash and enterprise solutions; and mainframe — will be Polaris' engines of growth. The three variables that inspire confidence in its fundamentals over the next year are:

Order pipeline: The traction on the order front has been encouraging. As of the third quarter ended December 31, 2006, Polaris had 55 strategic accounts, with 13 AAA (potential to generate revenues of $ 10 million), 15 AA ($5-10 million) and 27 A ($1-5 million). The Polaris management has also indicated that of the top 25 financial institutions, 11 are their customers and 11 are prospects. In the latest conference call, the company stated that it has nine $5-million accounts (compared to seven in 2005-06), six have moved in the $3-5 million basket (from four last year) and 16 are in the $ 1-3 million bracket (from eight last year).

Contribution of intellect: The contribution from the high-margin IP-led intellect core suite has been rising steadily. In the latest quarter, it accounted for 18.5 per cent of revenues, up from 16.6 per cent and 14.9 per cent in the two previous quarters. As the contribution from this stream increases, it is likely to impact positively the overall margins and create good scope for downstream revenues from services. The sustained investment in sales and marketing is likely to yield good results.

Balanced geographic mix: The fairly balanced geographic mix among North America, Europe and Asia-Pacific is a positive. In the latest quarter, North America accounted for 35 per cent of revenues, with Europe and Asia Pacific accounting for 31.6 per cent and 21.6 per cent respectively. The successful penetration of Europe is likely to work to its advantage in the next few quarters.

It is a combination of these variables that have helped the Polaris management talk in terms of a 5-7 per cent sequential growth over the next few quarters.