Persistent Systems IPO Analysis

Investors can consider subscribing to the initial public offering of Persistent Systems, an outsourced software-products development player, considering the company's strong performance in key operating metrics and its sound positioning and growth prospects of the segment where it operates.

At Rs 310 (upper end of the price band), the share would trade at 12 times its likely 2009-10 per-share earnings on a post-offer equity base.

This is at a discount to mid-tier IT companies such as Infotech Enterprises, Sasken Communications and KPIT Cummins, which are partly comparable to Persistent Systems.

A highly favourable offshore-onsite mix, a strong base of clients, many of whom have ramped up contribution, increasing repeat-business and a strong focus on the reviving US market — the largest for IT services — are key factors in favour of the company.

Persistent Systems has enjoyed net margins in excess of 16 per cent consistently over the last several years, barring 2008-09, when it was hit by a 170 per cent increase in operating and other expenses. This was due to a combination of forex losses of close to Rs 87 crore and a higher provision for doubtful debts.

Over a three-year time frame, Persistent Systems has seen its revenues grow at a compounded annual rate of 40 per cent to Rs 600.6 crore in 2009, while net profits grew at 22.3 per cent to Rs 66.9 crore.

The growth in net profits would have been much higher, but for the above mentioned losses in 2008-09.

In FY-2010, the company seems to be back on track as far as profitability is concerned with profits growing by over 60 per cent for the nine months ended December over last fiscal, though revenues are likely to end flat.

Niche offerings

Persistent Systems is different from the conventional IT services companies in that its offerings and client-base are different.

It caters to clients who are independent software vendors (for example, Microsoft and Oracle) and companies that focus on developing software products for verticals such as telecom and life sciences.

Apart from this, the company also works with companies that are engaged in developing products around newer platforms such as SaaS (software as a service) and cloud computing, which are witnessing enormous growth.

Essentially, the company offers development and product engineering services for these companies from offshore (mainly India) locations.

Persistent Systems has a well-balanced revenue proportion accruing from these offerings. Independent software vendors contribute 47 per cent of the overall revenues; telecom accounts for 23.9 per cent, with other practices, enterprises and solutions accounting for the rest.

As witnessed by its growth rate, the outsourced, especially the offshore product development model, is quite scalable. Software product companies were hit by the economic meltdown over the last couple of years, with lower licence sales.

But even as their customers demand more for the same billing, the enhancement of features and release of newer versions requires substantial product engineering, which companies such as Persistent Systems are well-positioned to offer.

A report from IDC indicates that R&D and product engineering services are set to grow from $40.1 billion in 2010 to $65.7 billion by 2013.

The size of the offshore market within that is set to grow at a much faster clip from $8.9 billion in 2010 to $16.1 billion by 2013. A recent Forrester report suggests that although software product companies have cut their R&D budgets, offshoring would still remain the key for quicker releases and cutting costs.

Persistent Systems, with a strong offshore presence, is well-placed to benefit from this trend as in addition to providing services, it adds its own IP to software products of companies, while creating an additional revenue stream in the form of IP sales or royalty revenues.

Strong operating metrics

The company derives over 89 per cent of its revenues from services delivered from India, which creates an optimal cost-structure for the company. This is a better than what most mid-tier companies enjoy. Because the company does not implement product at clients' location, it is not required to have a significant onsite presence. Persistent Systems derives over 41 per cent of its revenues from its top 10 customers, which is quite normal for mid-sized technology players. But what is more important is that it has a client base of over 200. This means that the risk of client concentration is minimised significantly.

The company has also witnessed a significant ramp-up in revenues of its top-clients and increased levels of repeat business (over 90 per cent) which suggests that volumes and client-mining are witnessing a fair revival.

Persistent Systems derives 83.9 per cent of its revenues from US-based clients, as many software product development companies and those involved in developing platforms are based there.

With the IT spends in the US reviving, as evidenced by increased contribution from this geography to Indian IT companies across-the-board over the last couple of quarters, the company's concentration may be more desirable than being an impediment.

This apart, the company has seen increased contribution from fixed-price contracts (compared to the traditional time and material billing mode), which should augur well for the company's realisations.

Risks

With the expiry of the STPI scheme by March 2011 and the increase of MAT announced in the Budget, the company's tax incidence, which is at 8.4 per cent currently, may go up considerably, until operations migrate to SEZs.

The issue

Persistent Systems is offering about 5.4 million shares, including an offer for sale by the promoter of 1.28 million shares, in the price band of Rs 290-310, would raise around 167 crore at the upper end. The funds are to be predominantly used for establishment of development facilities in Pune and Nagpur and to procure hardware.

The issue is open from March 17-19. Enam Securities and JP Morgan India are the book running lead managers to the issue.