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10 November 2010
3i Infotech – 2QFY2011 Result Update- Angel Broking
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3i Infotech – 2QFY2011 Result Update
Angel Broking maintains a
with a Target Price of Rs78.
For 2QFY2011, 3i Infotech reported dismal set of numbers with meager
1.0% qoq top-line growth. Due to improvement in operating margin, net profit
grew by 4.6% qoq in 2QFY2011 to `64cr as against `61.2cr in 1QFY2011.
Muted revenue growth due to ramp down in transaction services: For 2QFY2011,
3i Infotech posted mere 1.0% qoq top-line growth to `643.4cr (v/s our estimate of
`666.3cr), primarily on the back of steep ramp down in volumes in the
transaction services segment (largely in the US), which declined by 10.9% qoq.
Growth was, however, led by the IT solutions segment, which posted 8.4% qoq
revenue growth to `426.4cr.
Margin up 92bp: EBITDA margin grew by 92bp qoq to 20.4% mainly due to
improved business mix, with the higher-margin IT solutions segment (IT products
and IT services) posting a 200bp qoq increase in gross margin to 66.2%.
Outlook and valuation: Management has revised down its guidance for FY2011
from 10–14% yoy revenue growth to 5% due to unanticipated drop in cheque
processing volumes. At the CMP of `66, the stock is trading at attractive
valuations in the mid-cap space at 4.8x only due to overhang related to high
current debt-to-equity of 1.8x. Overall, we expect this to come down to 1.48x in
FY2012 on the back of sizeable quarterly operating profits of ~`130cr and
maintenance capex need of `15cr–16cr only, even after factoring in all the earnouts,
debt and repayment of various tranche of FCCB. We expect revenue growth
to remain subdued at 4% yoy in FY2011 and pick up only in FY2012 with 9% yoy
growth. Thus, we value 3i Infotech at 75% discount to Infosys’ FY2012 target P/E
of 23x, i.e. 5.8x. We maintain Buy on the stock with a revised Target Price of `78.
Muted revenue growth
For 2QFY2011, 3i Infotech posted disappointing performance. The top line grew
by merely 1.0% qoq, led by 8.4% qoq revenue growth (decline of 1.2% yoy) in the
IT solutions segment (the erstwhile products segment and the IT services segment
are clubbed under the IT solutions business segment from 1QFY2011). Growth in
the IT solutions segment was overshadowed by a 10.9% qoq decline in the
transaction services segment (majorly in the US), which is witnessing significant
ramp down since the latter part of 1QFY2011. The decline in the transaction
services segment was, however, compensated by growth in emerging markets,
which now contribute nearly 43% to revenue. The company did not witness any
ramp downs in the standalone IT products segment (part of the IT solutions
segment) during 2QFY2011.
The IT solutions segment is currently witnessing good traction. During 2QFY2011,
the segment reported 8.4% qoq growth in revenue to `426.4cr as against
`393.5cr in 1QFY2011 and it now contributes 66% (62% in 1QFY2011) to the
company’s overall revenue. Further, the company has signed few major deals in
this segment with Indian clients, including a healthcare agency for providing endto-
end IT infrastructure solutions and a leading scientific research organisation for
providing storage and datacenter solutions.
The transaction services segment is currently witnessing a huge decline in volumes.
During the quarter, the segment posted a 10.9% qoq decline in revenue to `217cr
as against `243.5cr in 1QFY2011, mainly due to volume loss (rather than client
loss) witnessed in the US. The segment now contributes 34% to the company’s
overall revenue as against 38% in 1QFY2011.
During the quarter, the revenue break-up in terms of geographies shifted slightly
towards emerging markets, contributing 43% to revenue as against 37% in
1QFY2011, due to significant ramp down in the US-based transaction services
segment. However, the company has signed a three-year deal with an electricity
and gas company of North America for offering remittance processing services.
During the quarter, 3i Infotech’s gross as well as EBITDA margins improved by
50bp qoq and 90bp qoq, respectively, on the back of change in the business mix.
Contribution from the IT solutions segment, which has high gross and EBITDA
margins of 41.1% and 21%, respectively, improved by 200bp qoq to 66%.
On the other hand, the transaction services segment, which has low gross and
EBITDA margins of 25.5% and 17%, respectively, faced business loss due to a
steep drop in volumes related to cheque processing witnessed by large banks such
as JP Morgan, Wachovia and Wells Fargo.
During the quarter, revenue contribution from ICICI Group, 3i Infotech’s top client,
improved significantly. However, revenue from the top 10 clients significantly
declined to 15% in 2QFY2011 as compared to 22% in 2QFY2010 on account of
ramp down in revenue from the transaction services segment.
Dynamic debt management feasible: The stock has underperformed the broader
markets as well as the Indian IT service pack because of the overhang related to
stretched balance sheet with current debt-to-equity of 1.8x. 3i Infotech has grown
inorganically over 2006–2008 by acquiring boutique businesses. These businesses
have scaled up to their target levels, resulting in need for earn-out payments. This
has primarily led to increased leverage despite sizeable equity dilution of `500cr.
Going forward, the left-out earn-out liability is only `47.5cr and `25cr for
2HFY2011 and FY2012 vis-à-vis `253cr and `74cr for FY2010 and 1HFY2011,
respectively. We expect this to be easily financed by internal accruals as the
company is generating quarterly operating cash of ~`130cr and does not have
any incremental capex needs. Also, we expect the tranche-I of FCCB repayment,
which is due to be matured in March 2011, to be refinanced. Overall, we expect
the debt-to-equity ratio to ease at 1.48x in FY2012, even after factoring in all the
earn-outs, debt repayment related to US $105mn loan form Axis Bank as well as
repayment of various tranche of FCCB.
Outlook and valuation
Management has revised down its guidance for FY2011 from 10–14% yoy revenue
growth to 5% yoy growth on the back of unanticipated drop in cheque processing
volumes. We expect revenue growth to remain subdued at 4% yoy in FY2011 and
pick up only in FY2012 with 9% yoy growth. On the profitability front, we expect
operating margin to be stable as the company’s improving business mix will
cushion any headwinds such as wage inflation and rupee appreciation. At the CMP
of `66, the stock is trading at attractive valuations in the mid-cap space at 4.8x
only. Hence, we value the company at 75% discount to Infosys’ FY2012 target P/E
of 23x, i.e. 5.8x. We maintain Buy with a revised Target Price of `78.
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