India Research Sector: Information Technology

Persistent Systems Ltd. Date

4th July 2012

CMP

`399.00

Target Price

`450.00

52 week High / Low

`404.00 / 280.80

Equity Cap (current)

`40.00cr

Face Value

`10.00

Mkt. Capitalization

`1580cr

Avg. Daily Vol. (lakh) (12 M)

9580

BSE SENSEX

17425.71

NSE - NIFTY

5287.95

NSE Code

PERSISTENT

Bloomberg Code

PSYS IN

BSE Code

533179

Accumulate

Persistent is one of the leading and the listed Indian player in the outsourced software product development (OPD) space and primarily caters to the large Independent Software Vendors (ISVs), Telecom and Enterprise clients, such as, Citi Bank, Wells Fargo, Samsung, Nokia and Motorola. The company has service offerings across the various stages of product lifecycle. Persistent designs, develops and maintains software systems and solutions, creates new applications and enhances the functionality of the existing software.

Promoters

38.95%

DI/MFs

30.30%

Foreign Institutions

2.67%

Based on our recent interaction with the management, we believe, though the overhang of macro-economic uncertainty on client spending still remains and the linear OPD business is under some pressure, the ISVs are investing in new technology areas to stand in competition and also gain new market share. Persistent’s niche presence and expertise in the software engineering space, marquee clientele and focused approach in new technological areas would help them to register better growth in tough times. Moreover, higher revenue contribution from the IP-led initiatives would aid better growth and higher margin profile in the medium to long term. We upgrade our EPS estimates for FY13E to accommodate higher IP contribution and INR depreciation against USD and consequently revise our recommendation upward to ACCUMULATE.

Public & Others

28.08%

Acceptance Of Cloud Computing Rising Globally

Shareholding Pattern @ 31-03-12

3-MTS

6-MTS

1-YR

Persistent

21.83%

24.33%

5.15%

CNX IT

-6.92%

-3.76%

-9.20%

Nifty

-0.66%

11.33%

-6.00%

Sensex

-0.34%

9.72%

-6.95%

(` cr) Y/E Mar FY10A FY11A FY12A FY13E Net Sales($Mn) 127.30 170.23 207.39 232.68 Net Sales 601.16 775.84 1000.31 1238.68 EBIDTA 146.37 158.31 232.40 330.71 PAT 115.02 139.57 141.78 181.25 EPS 28.76 34.89 35.45 45.31 PE 14.13 11.38 9.87 8.72 EBITDA Margin 24.35% 20.40% 23.23% 26.70% PAT Margin 19.13% 17.99% 14.17% 14.63%

Debashish Mazumdar Tel: +9122-66638952 [email protected] Nilesh Doshi Tel: +9122-66638950 [email protected]

The acceptance of cloud and mobility among the global companies are rising rapidly. Companies in the retail and consumer space already acknowledge the benefit of cloud and mobility; now the companies in the BFSI and Telecom space have also started looking at it in a positive way. Persistent management feels there are enough evidences of data security in the cloud system but banks were not aggressive to accept the new systems as regulatory regime was not updated. With the improvement in the regulatory systems the acceptance of cloud would increase to the data critical verticals, like BFSI and Telecom in the near to medium term. Mobility & Collaboration Are At The Point Of Inflection We feel that new technology areas, like Cloud, mobility, collaboration and big data are at the point of inflection. Apple launched its next operating system for i-phone and i-pad whereby it offered maps, music, movies on iTunes, all tied via the Internet to Apple’s cloud servers. Microsoft demonstrated the ‘Surface’ tablet, which interacts with both the Web and Microsoft’s cloud, called ‘Windows Azure’. And very recently Google introduced its newest cloud-connected phone and tablet, as well as a media player called ‘Nexus Q’. The player works with the devices, the Internet and the Google cloud. The concept of using hardware and software is changing very fast both in personal and commercial levels where consumer electronics would be working as hardware and cloud would be working as software and storage system.

ISVs Are Actively Investing To Beat Competition Although, overhang of the macroeconomic uncertainty on overall IT spending still remains and companies are taking more of short term decision to avoid uncertainty, but, the investment interest of the ISVs in the new technology areas is very high. Global giants, like, IBM, Microsoft and Google are investing in the new technology areas, like, cloud, enterprise mobility, social enterprises and Bigdata to beat the competition and create more active client connectivity. The launch of ‘NEXAS Q’ by Google to compete with Apple’s I-pad, Microsoft’s’ recent buyout of ‘Yammer’ at $1.2bn to succeed in its social enterprise effort, IBM’s bigger push for its Big-data initiatives and HPs activity related to private cloud are the few examples of the global players’ interest in new technologies. Enterprises are also investing more money to understand and use new technologies to increase efficiency and reduce cost. Persistent Marching Ahead Differently We believe that Persistent is able to position itself differently as compared to the other big and medium size Indian IT service providers in areas of cloud, mobility, collaboration and data analytics. Other IT players are mainly focusing on the Infrastructure part of cloud and mobility whereas Persistent is focusing on the product and solution side of the game. The company’s expertise in the traditional product engineering space and understanding about these new areas are helping global giants to penetrate them differently. Persistent’s engagement with Salesforce.com for both development and implementation of CRM products, its engagement with IBM and HP for Big-data and private cloud areas respectively and engagement with Samsung in the Galaxy product lines are providing enough evidence about the company’s capability. The company’s clients in the cloud space include IBM, HP, Salesforce, Microsoft and VMware. Volume Traction In Traditional OPD Business Getting Better Persistent’s volume growth in the linear OPD segment witnessed a sharp drop in the second half of previous financial year driven by unscheduled ramp-downs witnessed in two clients (Q3 volume de-growth- 0.59%; Q4 volume de-growth0.30%). However, the lagging impact of these ramp-downs is over and the company is expected to register low single digit sequential growth in Q1FY13e. Despite volume pressures and rupee depreciation, the management indicated that it has not witnessed any pricing pressures so far. Rather blended pricing in FY13 is expected to be higher as new projects are coming at better realizations. IP-led Revenue To Bring Growth and Margin Improvement Persistent’s new initiatives over the last one and half years across developing and acquiring new IPs, creating partnership with clients to give business specific solutions and creating expertise in the areas of cloud, collaboration, big data and mobility seems to be started yielding results. IP led revenue contributed 12% to the total revenue in Q4FY12 and 8.8% for the full year of FY12. The company’s acquisition of ‘Openwave’ in the previous quarter and winning of a revenue sharing deal of $9-10mn from IBM would provide the needed boost to the IP led revenue in FY13. These deals will also provide a strong visibility and stability to lumpy nature of IP-led business. Higher share of IP led revenue would also helps to improve the realization and thereby would improve margins.

Persistent Systems Ltd.

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Quarterly IP Revenue Trend

2%

0.00

0% FY07 FY08 FY09 Total Revenue % of Total Revenue

FY10

FY11 FY12 IP Related Revenue

IP Related Revenue

Source: Company Data, Techno Research

14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00%

Q4FY12

50.00

Q3FY12

4%

7.60% 6.10%

Q2FY12

6%

100.00

8.10% 7.50%

9.20%

Q1FY12

150.00

8.90%

Q4FY11

8%

12.10% 10.30%

Q3FY11

200.00

7 6 5 4 3 2 1 0

Q2FY11

10%

Q1FY11

250.00

% of Total Revenue

$ Mn

IP Revenue On A Growth Path

% of Total Revenue

Source: Company Data, Techno Research

Persistent’s IP Portfolio Name

Purpose

Paxpro

Asset Lifecycle Management Solution

ChemLMS

Smoothening Laboratory Process

View MOR

Email Message Organizer & Retriever

Enterprise Community Portal

Internal & External Data Management

e2g Monitor

Series of Mobile Apps To Connect All Devices

Klisma

E-Commerce Platform

Cloud Assessment Tool

For Assessing Cloud Compatibility Of Existing Apps

Driver Control

Instrument Driver Searcher

TLALOC

A Large-scale On-demand Load Generation Tool ool For Amazon EC2

CLAP

Load Testing Framework To Leverage Cloud

eMee

Employee Engagement Platform

Device Monitoring

To Monitor New devices

Source: Company Data, Techno Research

Inorganic Initiatives To Increase Strength Over the last one-two two years Persistent’s management is continuously focusing on small inorganic initiatives to increase expertise in traditional OPD space and acquire new IPs. We believe, these acquisitions would help the company to increase expertise in the areas of product engineering. Persistent’s Latest Acquisitions Company Infospectrum

Revenue $ 6.00mn

Headcount 200

Geography US

Service ISV

Agilent

$1.50mn

-

France

Life Science

Openwave

$6.00mn

-

-

Telecom

Source: Company Data, Techno Research

Strong Growth Outlook Within Top Client Persistent’s revenues ues from its top client, IBM (16% (16 of revenues on a trailing 12 months basis) has grown at a 33% CAGR over the last six years. IBM is a classic client in so far as it showcases Persistent’s sistent’s client mining skills. Persistent initially worked with only IBM’s Tivoli software product (Tivoli is widely used for monitoring and management of infrastructure ucture remotely). Over a period of time, time Persistent has been able to penetrate rate other areas within IBM’s software division (Rational, Lotus, content management, business analytics and Web Sphere) and also

Persistent Systems Ltd.

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4th July 2012

ramp up its newer service offerings (cloud related services: 30% of revenue, professional services: 25%, IP-related: related: 30%). Interestingly, Int most of the business is self initiated and not driven by request for proposals which positions it differently as a thought leader as compared to other vendors. Our discussions with the management suggest that IBM is likely to grow strongly with wit cloud-related services and IP-led led business being the primary growth drivers. Incidentally, IBM itself expects incremental cloud revenue growth to be $3bn by2015. Persistent given its strong relationship and early investments in new technology areas is well w positioned to capitalize it. Strong Pipeline; Management Confident Of FY13 Growth Persistent management is cautious about the overall macroeconomic scenario and IT demand in the near future. They are experiencing some volatility and uncertainty in the overall demand environment due to delay in decision making. Clients are committing for the short term which reduces long l term growth visibility. However, management seems to be confident on the overall pipeline of the company and is expecting to achieve higher quadrant of the average industry growth expectation for FY13E. We believe, USD U term topline of the company would register 12%-13% growth in FY13E against the industry average of growth expectation of 11% - 14% as per NASSCOM. Employee Utilization Rate Likely To Trend Up Slowly In Q4FY12, The company was working on a capacity utilization of 71.70% as compared to their target limit of 76-77%, 77%, mainly because of higher campus hiring of 600 people and sudden drop in business with two large clients. But, with the better volume traction and low fresher intake (campus offers for FY13E is 350 people; 150 joining in August and 200 joining in December), the company is expected to work at 73-74% 74% utilization levels to achieve our expected growth target of 12%-13% in FY13E.. Although low campus hiring makes Persistent vulnerable in times of sudden demand pick up, but, we believe, in tough times justjust in-time time hiring would be sufficient to meet any such sudden revival in demand.

Sudden Volume De-growth growth Put Utilization Under Pressure 78% 76% 74% 72% 70% 68% 66% Q4FY12

Q3 FY12

Q2 FY12

Q1 FY12

Q4 FY11

Q3 FY11

Q2 FY11

Q1 FY11

Q4 FY10

Q3 FY10

Q2 FY10

Q1FY10

64%

Utilization… Source: Company Data, Techno Research

Persistent Systems Ltd.

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4th July 2012

Lower Wage Hike & Attrition Rate Also Tapering Off One of the primary concerns related to Persistent margin performance was its limited ability to absorb the impact of wage hikes and consequent impact on the margins. Given the highest offshore exposure compared to its peers, it expected to get more impacted by any wage inflation in offshore. o But, this concern has reduced off-late as at overall industry levels wage hike would be muted in the current financial year and we also heard about no salary hike (Infosys), delay in salary hike (Wipro) due to pressure on business volume and macro economic uncertainty. We expect, offshoree wage hike at Persistent would be in range of 910% in FY13E as compared to 15-17% 17% in FY12 which is comparable to the other industry peers. Moreover, due to lower manpower demand in the overall IT sector, especially at lateral levels, attrition over the last two – three quarters came has down to a comparatively comfortable levels. Attrition Tapering Off 25% 20% 15% 10% 5% Q4FY12

Q3 FY12

Q2 FY12

Q1 FY12

Q4 FY11

Q3 FY11

Q2 FY11

Q1 FY11

Q4 FY10

Q3 FY10

Q2 FY10

Q1FY10

0%

Attriton Rate (LTM) Source: Company Data, Techno Research

Well placed to benefit from INR depreciation Outside of operating parameters, the company is likely to see a higher benefit of INR depreciation than its peers. This is again due to its high offshore leverage (80% of revenue vs. 50-60% 60% for most other vendors). A 1% depreciation of INR against USD improves operating margin by 50-60bps, 60bps, as per our estimates. estimates As of 31 March 2012, the firm had outstanding hedges of $100mn spread over the four quarters of FY13 at an average USD/INR rate of 50.33. This translates into 42-43% 43% of the company’s revenue for FY13E being hedged. Higher USD exposure and lower hedge position would help Persistent to get more benefit of INR depreciation. Strong Levers Exist For Margin Improvement As discussed, Persistent has very strong levers present for margin improvement in the near to medium term. o

As the company is working on very low levels of utilization, improvement in utilization levels would help to improve margins.

o

Low wage hike in FY13 of 9%-10% 10% as compared to 15%-17% 15% in FY12 would aid margin improvement.

o

INR depreciation against USD and low hedge position would also help to improve margin in a time of low volume growth.

We believe, at a constant currency levels, the company would be able to maintain stable margins. But based on our INR assumption of 53 against agains USD, operating margin is expected to reach 26.70% in FY13E against 23.23% in FY12.

Persistent Systems Ltd.

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Yearly Margin Performance Graph 35% 30% 25% 20% 15% 10% 5% 0% FY07

FY08

FY09

FY10

Op. Margin

FY11

FY12

FY13E

Net Margin

Source: Company Data, Techno Research

Upgrade Our EPS Estimate; But Expecting QoQ Slippages We believe, Persistent would be able to register 12-13% 12 growth in revenues in FY13 backed by comparatively better volume traction, higher IP led revenue and some recent inorganic initiatives. Persistent’s expertise, partnership with global technology giants and lower product lifecycle fecycle would help the company to grow its traditional OPD business in tough times. Newly ewly developed IPs would also help to grow non-linear linear businesses simultaneously. But, due to the project specific business model and increasing dependence on non-lineari linearity QoQ aberration is expected going forward. We revise our EPS estimate for FY13E to accommodate the benefit of INR depreciation and is expecting EPS for FY13E would reach to `45.31levels against our previous estimate of `41.50.

Upgrading From “Hold” To “Accumulate” At the current market price of `399.00,, Persistent Pers is trading at 9x of FY13E EPS of `45.31. Based on our analysis of the strong presence of Persistent in both the traditional OPD and new technology areas we are recommending ACCUMULATE at the current levels. Persistent & Nifty Comparison

Persistent & CNX IT Comparison

550

550

500

500

450

450

400

400

350

350

300

300

250

250

Persistent

Persistent Systems Ltd.

Nifty

Persistent

6

CNX IT

4th July 2012

Financial Projections (` Cr)

Income Statement Net Sales ($ Mn) Net Sales Other Op. Income Total Op. Income Expenses Personnel Cost G & A Expenses S&M Expenses Total Expenses EBITDA Depreciation & Amortization PBIT Interest (Incl. Forex Gain & Loss) Other Income PBT Tax PAT Before Minority Less: Minority Interest PAT Before Extraordinary Extraordinary (Inc) / Exp PAT After Extraordinary EPS (` `) Margins (%) Operating Margin Net Margin

FY09 127.92 593.83 0.00 593.83

FY10 127.30 601.16 0.00 601.16

FY11 170.23 775.84 0.00 775.84

FY12 207.39 1000.31 0.00 1000.31

FY13E 232.68

1238.68 0.00 1238.68

332.43 80.61 2.04 415.08 178.75 29.68 149.07 87.40 6.85 68.53 0.97 67.57 0.00 67.57 1.47 69.04 18.43

368.74 84.55 1.50 454.79 146.37 33.52 112.84 -3.16 8.08 124.07 9.05 115.02 0.00 115.02 0.00 115.02 28.76

512.30 103.51 1.73 617.53 158.31 42.39 115.92 -17.32 17.12 150.36 10.79 139.57 0.00 139.57 0.00 139.57 34.89

564.00 135.00 68.91 767.91 232.40 61.10 171.31 0.00 25.56 196.87 55.09 141.78 0.00 141.78 0.00 141.78 35.45

705.48 140.56 61.93 907.97 330.71 81.64 249.07 30.00 32.67 251.74 70.49 181.25 0.00 181.25 0.00 181.25 45.31

30.10% 11.63%

24.35% 19.13%

20.40% 17.99%

20.40% 17.99%

23.23% 14.17% (` Cr)

Balance Sheet Share Capital Share Option Outstanding Reserve & Surplus Minority Interest Less: Misc Exp Written Off Total Networth Secured Borrowings Unsecured Borrowings Total Borrowings Deferred Tax Liability (Net) Total Liabilities

FY09 35.86 2.07 356.86 0.00 0.00 394.79 0.00 0.00 0.00 -2.05 398.63

FY10 40.00 3.20 595.79 0.00 0.00 638.99 0.00 0.00 0.00 3.83 637.01

FY11 40.00 3.48 703.63 0.00 0.00 747.11 0.00 0.00 0.00 -2.98 749.14

FY12E 40.00 3.20 815.63 0.00 0.00 858.83 0.00 0.00 0.00 0.00 862.13

FY13E 40.00 3.20 959.27 0.00 0.00 1002.47 0.00 0.00 0.00 0.00 1006.78

Gross Block Less: Accumulated Depreciation Net Block Add: Capital WIP Total Fixed Assets Marketable Investments Non – Marketable Investments Total Investments Inventories Sundry Debtors Cash & Bank Balance Other Current Assets Loans & Advances Total Current Assets, Loans & Advances Less: Current Liabilities Net Current Assets Total Assets

337.24 157.26 179.98 37.74 217.73 88.01 0.00 88.01 0.00 103.42 16.54 13.03 45.40 182.21 89.33 92.89 398.62

371.48 188.12 183.36 48.48 231.84 156.17 1.00 157.17 0.00 136.33 191.77 33.99 63.75 422.86 174.86 248.00 637.01

454.28 228.15 226.13 60.45 286.58 250.04 2.00 252.04 0.00 158.21 99.99 22.62 86.92 367.74 157.22 210.52 749.14

514.28 271.73 242.54 50.45 292.99 300.04 3.00 303.04 0.00 192.83 121.53 32.62 106.92 453.90 187.80 266.10 862.14

574.28 320.72 253.56 50.45 304.01 350.04 4.00 354.04 0.00 230.19 163.11 42.62 126.92 562.83 214.11 348.72 1006.78

Persistent Systems Ltd.

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Team Analyst

Designation

Sector

Telephone

Nilesh Doshi

President (Research)

-

+9122-66338950

Abhilasha Satale

Senior Manager

Metals & Mining, Textiles

+9122-6663 8953

Debashish Mazumdar

Sr. Research Analyst

Information Technology, Media

+9122-6663 8952

Shivani Mehra

Research Analyst

FMCG, Consumer Durables

+9122-6663 8956

Sejal Jhunjhunwala

Research Analyst

Auto, Auto Ancillary

+9122-6146 2956

Jigisha Jaini

Research Analyst

Capital Goods, Engineering

+9122-6146 2957

Kunal Rambhia

Research Associate

Sugar

+9122-6663 8951

Ashwini Manwatkar

Research Associate

Auto, Auto Ancillary

+9122-6146 2949

Institutional Sales

Designation

Sector

Telephone

Shilpa Venugopal

Senior Manager

+9122-6164 2969

Anjali Dave

Sales Associate

+9122-6663 8954

Institutional Dealing

Designation

Ajay Prabhudesai

Assistant Vice President

+9122-4027 8930

Vipul Mehta

Manager

+9122-4027 8931

Gaurav Shah

Manager

+9122-4027 8933

Mitul Doshi

Senior Executive

+9122-4027 8932

Sector

Telephone

Corporate Office: 3rd Floor, Hincon House, Tower - B, 247 Park, L.B.S. Marg,Vikhroli (W), Mumbai, Maharashtra – 400083, India. Tel No. 91-22 – 6663 8900

Email: [email protected]

website: www.technoworld.in, www.way2wealth.com

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