Thinksoft Global Services IPO Analysis

Investors can avoid the initial public offering of Thinksoft Global Services, a software testing company, given the concerns that surround its performance and global trends in the IT deal landscape. Its niche offerings may also force it to rely on a smaller universe of clients.

At the upper end of the price band of Rs 130, the offer discounts its 2008-09 per share earnings by about nine times on an expanded equity base. Most mid-tier IT companies, even those of much larger scale than Thinksoft, trade at about the same valuation, suggesting that the offer is not cheap compared to peers.

Thinksoft is a niche player, in the sense that the company offers software testing services to clients only in the banking financial services and insurance (BFSI). This limited offering of relatively lower value services, and to a single vertical, could stunt scalability.

To achieve the scale of even existing mid-tier IT companies, a blended offering of application development and maintenance, software testing, BPO and a small portion of high-end services catering to two-four verticals may be necessary. Reinforcing this is the fact that despite 11 years of operation, Thinksoft continues to have relatively small revenues of Rs 95.7 crore in FY09. Over the last four financial years (2004-09), revenues and profits grew by 44.1 per cent and 74.6 per cent, respectively, on a compounded annual basis. The company derives over 80 per cent of its revenues from clients based in Europe, West Asia and other Asian countries.
Business and macro concerns

Thinksoft derives nearly 93 per cent of its revenues from its top 10 clients making for very high client concentration levels. This is accentuated by the fact that its largest clients contributed 26 per cent to its 2008-09 earnings.

Any cancellation or reduction in volumes of projects from its top clients can thus significantly dent revenues. The company derives nearly 62 per cent of its revenues from services delivered onsite making for a sub-optimal cost structure. Mid-tier IT companies typically derive 60-80 per cent of their revenues from offshore locations and are thus able to maintain wage and cost structures to manageable levels.

Nearly 88 per cent of the company’s revenues come from projects that are billed on a time & material basis. This means that the company is all the more susceptible to cuts in pricing affecting most IT players.

Then there are the industry concerns. Testing as a service has seen a decline in contribution in revenues for top tier IT players over the last one year, which should serve as a lead indicator on the demand environment for such services. Mid-tier IT players such as Hexaware and MindTree have strong presence in the testing practice and are more integrated in terms of offerings, thus adding to the competition.

Recent deals, at least larger ones, have been awarded after considerable vendor consolidation by clients. This means that a number of small and medium-sized vendors who were taken for their ‘niche’ offering are done away with as large vendors can anyway offer all those services. Recent deals won by Indian majors suggest that lower-end services such as application development and maintenance could be the ones to increase volumes. Any software testing component in these deals could be catered to by existing large or mid sized IT players, what with ‘more for less’ being the fiat from clients.

Finally, being present in one service and one vertical seriously limits future growth prospects, both in terms of scalability of business or climbing up the value chain of service offering.
The Issue

At the upper end of the price band (Rs 120-130), the company hopes to raise Rs 47.4 crore. Of the 3,646,000 shares on offer, nearly 63 per cent of it is an offer for sale by an existing shareholder — Euro Indo Investments.

Of the Rs 17-odd crore that would remain with Thinksoft, the company is looking to build a new software testing centre with an additional seating capacity of 400. The company has 360 employees offshore in its existing facility in Chennai.

via BL