3i Infotech: Buy

Investors with a one-two year perspective can consider buying the shares of 3i Infotech in the light of its good business prospects and reasonable valuations.

At Rs 126, the stock trades at 13 times its current year earnings and 10 times its estimated FY-09 earnings. This is a discount to MindTree Consulting and Polaris Software, but a slight premium to Zylog Systems and Hexaware Technologies, all of which have substantial banking and financial services industry (BFSI) exposure. But a niche BFSI focus and superior earnings before tax, depreciation and amortisation (EBITDA) margin (25 per cent) make the stock an attractive ‘buy’ among Tier-2 IT players.

3i Infotech has a robust business model because of a high-margin product-driven business, a healthy geographic spread that includes a significant domestic focus and selective acquisitions to tap new clientele.

A lower dependence on the US and a presence in the critical aspects of the BFSI industry will lead to 3i Infotech being minimally affected, certainly less than its Tier-2 peers, due to the sub-prime crisis.
Business drivers

Products expand margins: 3i Infotech has a near-equal products-services mix in its IT offerings. Product software generates higher margins than traditional volume-based services such as application development and maintenance.

The company also offers products and services spanning the entire gamut of IT requirements for financial services companies to cater to banks, insurance companies, mutual funds and capital markets. It also has offerings in the enterprise resource-planning segment.

This 50-50 mix (between products and services) and end-to-end offering for the BFSI segment gives 3i Infotech an edge over other Tier-2 IT services companies in terms of service offerings and margin profile.

Increasing presence in domestic e-governance and telecom: In domestic markets, 3i Infotech has been able to increase its presence in Government-initiated projects, going by the large-scale deals that it has managed to win recently. The company has won a Haryana Government project for the establishment of e-Disha Ekal Seva Kendra Project.

As a part of the project, the company will set up over 322 citizen service centres. Single-window delivery of services such as issue of land record certificates and ration cards, pension schemes, public grievance redress and payment of telephone and electricity bills, among other services, are envisaged to be provided. 3i Infotech will provide the IT infrastructure and a Web interface to enable these services.

This deal follows a similar one from the Goa Government that entails the setting up of 208 citizen service centres by the company.

The nature and scale of these projects mean that 3i Infotech can be expected to generate a stable revenue stream over a multi-year period. Considering that government spend on providing IT and IT-enabled services is on the rise, scaling up of operations in these service centres can provide the company with additional revenues.

Also, the company has won deals in the telecom space in India. These include provision of IT and BPO services. Although this segment is a small contributor to revenues, a presence in the fastest growing mobile services market in the world makes it well-placed to scale up operations and become a key revenue driver.

Geographic spread: The company has a wide geographic spread in its revenue mix. It generates as much as 56 per cent of its revenues from India, Asia-Pacific and West Asia. The US contributes to about 25 per cent of its revenues, which is significantly lower than other peers in this space.

The company claims that its exposure to banking clientele in the US accounts for only 5 per cent of its global revenues and, even here, its presence is in the cheque and payment processing areas, which are essential operations for banks.

Overall, this spread may help 3i Infotech to be minimally impacted by the appreciation of the rupee against the dollar. West Asia and the Asia Pacific regions are also fast growing ones in terms of IT infrastructure spending and offer opportunities that 3i Infotech may be well-placed to tap.

Acquisitions to enhance growth: 3i Infotech’s acquisition of the US-based J&B Software (J&B) Inc signals its move to expand inorganically and augment its software products offering.

The deal is valued at $25.25 million and 3i has indicated that the acquisition would be immediately EPS-accretive.

J&B is a product software company for functions such as processing and managing automated electronic payment transactions of banks, insurance companies, mutual fund providers, credit-card processors and even telecom companies.

This acquisition creates several advantages for 3i Infotech. First, it would enable the company to expand its North American footprint by tapping J&B’s clientele.

Second, J&B’s product software would be a significant addition to 3i Infotech’s product portfolio in the BFSI segment.

Third, with J&B’s offering, which is mainly on open architecture platforms, 3i would be better placed to tap other high-potential markets such as Asia-Pacific.

3i had earlier entered the European markets through the acquisition of Rhyme Systems in late 2006. This appears to have worked for the company as Europe now contributes significantly to 3i Infotech’s revenues.
Risks

Though the company’s direct exposure to the US loan market is limited, vulnerability to the sub-prime crisis could arise from an indirect exposure, what with investment banking players across the US and Europe announcing huge write-offs.

Operating in the Asian region, especially India, could lead to deal sizes and margins being lower compared to other geographies such as the US. An increasing governmental client base could extend the receivables cycle.