Infinite Computer Solutions IPO Review

Investors can give the initial public offering of Infinite Computer Solutions, an IT services provider, a miss considering the relatively high valuation that it demands and the several business challenges that the company faces.

At the upper end of the price band (Rs 155-165), the offer is priced at 16 times its 2008-09 per share earnings and about 14 times its likely 2009-10 earnings, both on a post offer equity base.

This is at a premium to most small- and mid-tier IT companies. Although larger in size, Sasken Communications, which also has a telecom focus, trades at 12 times trailing earnings. Others mid and small IT companies such as Zylog Systems and Sonata Software trade at single digit PE multiples.

Infinite has seen its revenues grow at a compounded annual rate of 13 per cent over 2005-09 to Rs 495.8 crore. The profit growth has been inconsistent and top-line growth has been lower than other mid-tier IT companies. Much of even these figures of Infinite is distorted by the FY09 numbers when it registered a 45 per cent growth in revenues and more than doubled its profits over FY08, thanks to ramp up of one client and signing up another large one.

From a loss recorded at the net level in 2005-06, the company reported small profits in the subsequent year and a spike in the year after. Net margin has remained in the 2-5 per cent range for most of the last few years, spiking to 9 per cent in 2008-09.

From a business perspective, high client concentration, heavy US dependence and dollar dependence and a service-mix that largely tends towards low-margin ones are key negatives. A high onsite component also makes for high costs, reducing the edge over competitors.

Among macro trends in the IT industry, vendor consolidation undertaken by clients could result in several smaller players such as Infinite losing out to top-tier players. In the low-end services segment, the number of players vying for deals is large , which brings in pricing and other competitive pressures on the company.

Business Challenges

Infinite provides IT services to a limited set of verticals. Telecom (59.4 per cent of revenues) and healthcare (16.6 per cent) are its largest verticals. Its top five clients contribute close to 80 per cent of revenues, with its top-client (IBM) accounting for nearly 40 per cent of revenues. Though smaller companies do have higher client concentration, these levels seem quite high.

In recent interactions with the media, many large IT services players have indicated that telecom and manufacturing are not yet out of the woods.

This means that Infinite, with its heavy dependence on telecom, faces added risks on volume growth on this front.

The presence of players such as Tech Mahindra and Sasken Communications with greater execution capabilities, especially on the R&D front, a key to success in the telecom vertical, as well as top-tier IT layers puts heavy competitive pressure on Infinite.

The presence in the healthcare vertical though is welcome, especially as activity on this from clients may improve when the US passes the healthcare reforms Bill. The company also delivers lower-billed services such as application development and maintenance and testing, which account for over three-fourths of revenues. This space is a highly crowded one, what with companies of all sizes and especially the mid-tier ones looking to tap these non-discretionary deals from clients. These services are also exposed to pricing pressures.

Macro factors skewed

Another point of concern for the company is that the US contributes nearly 90 per cent of the company's revenues. With the rupee appreciating against the dollar from 51 levels to 45.6, and a weak dollar predicted for some time to come, smaller companies such as Infinite would be hard hit on the realisation front.

From a cost perspective, the company derives over 70 per cent of revenues from services delivered from onsite locations.

This creates a sub-optimal structure as these are high-cost revenues and would significantly affect margin.

The proportion of offshore revenues has increased in recent years, but it is still quite a way away from the ideal proportion.

Vendor consolidation undertaken by several large clients in recent times, where they restrict their projects to two or three large Indian vendors apart from a few global ones, has also meant that smaller players such as Infinite may find the equation skewed against them.

The Issue

Infinite is offering 11.5 million equity shares to raise about Rs 190 crore (at the upper end of the price band) which includes an offer for sale of about 5.76 million shares by existing shareholders.