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Persistent Systems -Supply side issues to erode margins
Persistent’s revenue grew by 6.7% sequentially in dollar
terms backed by a muted volume growth of 3.4% and
unexpected pricing increase. Company however continues to
struggle with high attrition levels which rose to 21.5% forcing
the company to declare an interim wage hike of 10%. As we
had elaborated in our initiation report (‘Positioning Trap’
dated 25th October), Persistent would continue to face supply
side issues resulting in further margin erosion. We maintain
our negative stance on niche players’ ability to create value in
the long term as concerns raised by us are now panning out.
�� Muted Volume growth; Falling behind diversified players:
Persistent systems reported a muted volume growth of 3.4%.
Revenue was however helped by an unexpected increase in
onsite pricing (4.7%) and offshore pricing (2.1%). The growth is
much lower than Product engineering revenue growth of
Infosys which has grown at a CQGR of 21% in FY11.
�� Interim wage hike to impact margins by 250 bps: Company
announced a 10% increase in salaries effective 1st Jan 2011,
third hike in last 18 months. This will have a -250bps impact on
Q4FY11 margins. This will be followed by another round of
salary hike in Q1FY12 or Q2FY12. High offshore leverage and
dependence on T&M projects for ~80% of total revenue leaves
the company with little margin levers to counter absorb wage
pressures.
�� Supply side issues to persist; we remain sceptical of niche
positioning: Smaller addresable universe, lack of pricing
power, competition with captive ISV units and diversified IT
services players and worsening supply side issues continue to
plague Persistent. We remain skeptical of Persistent’s ability to
create value in the long term. We have revised our numbers
downwards to reflect higher wages and lower margins. We
maintain Sell with TP of Rs366.
Low volume growth; Are larger players eating market share?
Persistent systems reported a muted volume growth of 3.4% on the back of a 2.2% volume growth in
previous quarter. Revenue was however helped by an unexpected increase in onsite pricing (4.7%)
and offshore pricing (2.1%). Increase in onsite pricing was largely due to higher amount of work done
towards the end of calender year 2010 and is expected to come off in the next quarter.
Persistent has not been able to capitalize on the demand pickup that helped other more diversified IT
services players in the industry due to its niche focus. This we believe is partly due to the lower growth
rate of Outsource product Development (OPD) market and possinbly due to loss of market share to
larger diversified players like Infosys. Infosys’ Product Engineering (PE) services revenue is growing at
a much faster rate than that of Persistent. This is despite Persistent’s positioning as a niche player in
this space.
Supply side issues to impact margins
As we had alluded in our initiation report (‘Positioning Trap’ dated 25th October), Persistent is facing stiff
supply side issues. Attrition levels continue to rise forcing the company to offer the third salary hike in
last 18 months. Company announced a 10% increase in salaries effective 1st Jan 2011. This will be
followed by another round of salary hike in Q1FY12 or Q2FY12. Rise in salaries will have an impact of
negative 250bps on the gross margin in Q4FY11.
Also with company’s policy of hiring only computer science graduates with salary levels at par with
other companies who hire any engineering graduates, it would be difficult for Persistent to attract and
retain good quality talent. Captive units on the other hand pay much higher salaries to these
professionals. In order to retain such talent, we believe the company will continue to face wage
pressures and would likely see its margins declining going forward.
Already high offshore leverage and high proportion of Time and Material projects would impair
Persistent’s ability to absorb the wage increase going ahead. IP-led revenue could potentially help the
company to negate some of the margin pressures though it has not been growing at a pace guided
by management.
Skpetical about Niche players
Smaller addresable universe, lack of pricing power, competition with captive ISV units and diversified IT
services players and worsening supply side issues continue to plague Persistent. We maintain our view
that it is the diversified players and not the niche ones who have been able to create value (refer our IPO
note “’Niche’ no guarantee for value creation” dated 18 March 2010) in the long run.
Revise margin and EPS downwards; TP Rs366; Maitain Sell
Owing to increase in wages, we revise our EBITDA and EPS numbers downwards. Valuing the company
at 11x FY13 FDEPS, we get a target price of Rs366. We maintain Sell.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Persistent Systems -Supply side issues to erode margins
Persistent’s revenue grew by 6.7% sequentially in dollar
terms backed by a muted volume growth of 3.4% and
unexpected pricing increase. Company however continues to
struggle with high attrition levels which rose to 21.5% forcing
the company to declare an interim wage hike of 10%. As we
had elaborated in our initiation report (‘Positioning Trap’
dated 25th October), Persistent would continue to face supply
side issues resulting in further margin erosion. We maintain
our negative stance on niche players’ ability to create value in
the long term as concerns raised by us are now panning out.
�� Muted Volume growth; Falling behind diversified players:
Persistent systems reported a muted volume growth of 3.4%.
Revenue was however helped by an unexpected increase in
onsite pricing (4.7%) and offshore pricing (2.1%). The growth is
much lower than Product engineering revenue growth of
Infosys which has grown at a CQGR of 21% in FY11.
�� Interim wage hike to impact margins by 250 bps: Company
announced a 10% increase in salaries effective 1st Jan 2011,
third hike in last 18 months. This will have a -250bps impact on
Q4FY11 margins. This will be followed by another round of
salary hike in Q1FY12 or Q2FY12. High offshore leverage and
dependence on T&M projects for ~80% of total revenue leaves
the company with little margin levers to counter absorb wage
pressures.
�� Supply side issues to persist; we remain sceptical of niche
positioning: Smaller addresable universe, lack of pricing
power, competition with captive ISV units and diversified IT
services players and worsening supply side issues continue to
plague Persistent. We remain skeptical of Persistent’s ability to
create value in the long term. We have revised our numbers
downwards to reflect higher wages and lower margins. We
maintain Sell with TP of Rs366.
Low volume growth; Are larger players eating market share?
Persistent systems reported a muted volume growth of 3.4% on the back of a 2.2% volume growth in
previous quarter. Revenue was however helped by an unexpected increase in onsite pricing (4.7%)
and offshore pricing (2.1%). Increase in onsite pricing was largely due to higher amount of work done
towards the end of calender year 2010 and is expected to come off in the next quarter.
Persistent has not been able to capitalize on the demand pickup that helped other more diversified IT
services players in the industry due to its niche focus. This we believe is partly due to the lower growth
rate of Outsource product Development (OPD) market and possinbly due to loss of market share to
larger diversified players like Infosys. Infosys’ Product Engineering (PE) services revenue is growing at
a much faster rate than that of Persistent. This is despite Persistent’s positioning as a niche player in
this space.
Supply side issues to impact margins
As we had alluded in our initiation report (‘Positioning Trap’ dated 25th October), Persistent is facing stiff
supply side issues. Attrition levels continue to rise forcing the company to offer the third salary hike in
last 18 months. Company announced a 10% increase in salaries effective 1st Jan 2011. This will be
followed by another round of salary hike in Q1FY12 or Q2FY12. Rise in salaries will have an impact of
negative 250bps on the gross margin in Q4FY11.
Also with company’s policy of hiring only computer science graduates with salary levels at par with
other companies who hire any engineering graduates, it would be difficult for Persistent to attract and
retain good quality talent. Captive units on the other hand pay much higher salaries to these
professionals. In order to retain such talent, we believe the company will continue to face wage
pressures and would likely see its margins declining going forward.
Already high offshore leverage and high proportion of Time and Material projects would impair
Persistent’s ability to absorb the wage increase going ahead. IP-led revenue could potentially help the
company to negate some of the margin pressures though it has not been growing at a pace guided
by management.
Skpetical about Niche players
Smaller addresable universe, lack of pricing power, competition with captive ISV units and diversified IT
services players and worsening supply side issues continue to plague Persistent. We maintain our view
that it is the diversified players and not the niche ones who have been able to create value (refer our IPO
note “’Niche’ no guarantee for value creation” dated 18 March 2010) in the long run.
Revise margin and EPS downwards; TP Rs366; Maitain Sell
Owing to increase in wages, we revise our EBITDA and EPS numbers downwards. Valuing the company
at 11x FY13 FDEPS, we get a target price of Rs366. We maintain Sell.
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