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ZENSAR TECHNOLOGIES LTD
PRICE: RS.170
RECOMMENDATION: BUY
TARGET PRICE: RS.211
FY12E PE: 4.9X
q Zensar's operating results were marginally lower than our estimates for
this seasonally weak quarter.
q Volumes remained flat due to lower billing hours but the company was
able to maintain margins despite the rupee appreciation. Billing rates
remained stable and the management expects rates to rise some time
early next fiscal, in case demand persists.
q Higher other income compensated for the one time tax provision and led
to higher-than-estimated PAT.
q The demand environment has become favourable with clients looking at
growth as well as efficiencies.
q Post the acquisition of Akibia, Zensar is in a position to cross sell services
to the mutually exclusive set of clients and this is expected to help
growth rates.
q Post the acquisition, contribution of the top client has reduced and we
understand that, this paves the way for further business from this client.
q Zensar is optimistic about increase in business from existing accounts in
key geographies reflecting higher spending by clients / increased market
share.
q We have marginally revised our FY11E and FY12E EPS to Rs.30.2 (Rs.29.1)
and Rs.34.8 (Rs.35.1), respectively.
q The stock is available at 5x FY12E earnings. We maintain BUY with a DCFbased price target of Rs.211. We note that, over the recent past, Zensar
has been able to bring in higher predictability to the business model.
q A prolonged recession in major user economies and a sharper-than-expected appreciation in rupee v/s major currencies are pronounced risks
for a smaller player like Zensar.
Revenues down by 1.6%, volumes flat
n Revenues during the quarter fell by 1.6% largely due to the currency fluctuations. Volumes were flat on a sequential basis as they were impacted by the
lower number of billing hours in this seasonally weak quarter.
n In the previous quarter, exchange gains had contributed 3% to the growth.
n Within geographies, APAC reported significant growth whereas Europe revenues
rose marginally in USD terms, we understand.
n In terms of verticals, BFSI and retail saw strong traction whereas manufacturing
and telecom saw tepid performance QoQ.
n We understand that, this was largely due to the lack of scale up in the top client.
This account is expected to start scaling up as its contribution to Zensar's revenues has reduced to 25% post the Akibia acquisition (4Q).
n The management indicated that, the spending outlook from clients remains encouraging.
n Zensar has been able to penetrate deeper into clients by providing diverse services as well as make strong additions to its clientele. The company added 27
new accounts during the quarter.
n Despite the recent problems in Europe, the company has not experienced and
slowdown or elongation of sales cycle.
n Even the existing projects from the developed markets have not faced any slowdown.
n However, we believe that, if the situation in Europe continues to remain weak,
then the business flows will be impacted.
New business flowing in as macro scene improves
n Business flows have picked up, according to the management with existing clients scaling up business with Zensar.
n Zensar has deepened its relationship with Danahur and has also moved in to
provide BPO services to that client.
n The company is also now working with 4 group companies of Assurant and this
account had scaled up / may scale up be a $10mn account for Zensar.
n As far as Cisco is concerned, it has rationalized a couple of vendors and according to the management, additional business can come to Zensar.
n The only irritant was the large exposure which Zensar already has (about 36% of
revenues come from Cisco). However, the acquisition of Akibia has reduced the
exposure and this can lead to additional business from Cisco, we opine.
n The EAS business has scaled up nicely on the back of increased discretionary
spends by clients. Oracle continues to grow at a rapid pace and that, in turn, is
helping this practice at Zensar.
n About 40% of Zensar's revenues come from projects business, prime among
which are the enterprise applications revenues.
n The management has indicated that, the demand scenario has improved with
faster decision making and allocation of budgets.
Average realizations were almost unchanged
n Average realizations for the company were almost stable over the previous quarter.
n New contracts are coming in at higher-than-average rates. However, billing rate
increases are expected to happen only early in next fiscal, given consistent demand.
Net addition of 296 employees
n Zensar added 296 (243) employees during the quarter. These were both in the IT
services business as well as BPO.
n The company is focusing more on platform based BPO and has started pitching
for business. It has won one account which is expected to start scaling up in
FY11.
n The management has indicated net additions of about 800 employees in FY11.
EBIDTA margins maintained
n EBDITA margins during the quarter were almost unchanged as the company improved efficiencies and controlled costs to mitigate the impact of the appreciating rupee.
n 2Q margins were impacted by the increments given to off-shore employees and
an increase in license costs (bought outs).
Akibia integration initiated - Consolidates Zensar's presence in
IMS
n Zensar has initiated a 100-day integration program with Akibia. The same is expected to be completed by April 10th.
n As of now, Akibia will remain a separate entity and the current management
will continue to run that business.
n We understand that, the acquisition will consolidate Zensar's presence in the rapidly growing infrastructure management business. According to industry sources,
Infrastructure Management Solutions (IMS) is a $370bn market, split into Data
Centre services ($231bn), Remote Infrastructure Management ($108bn) and
Managed Services ($31bn).
n While Akibia has presence in the data centre, network and security services solutions, Zensar has operations in the RIM business. In our opinion, these are two
complimentary services whereby, Zensar will be able to offer its offshore RIM services to Akibia's clients.
n In turn, Akibia's on-site data centre and security services are expected to attract
and provide more comfort to several US - based clients as the same will act as
near-shore centres for those clients.
n Adding the capabilities of Akibia will further enhance Zensar's customer base for
Datacenter services while there is an equal opportunity to scale the Remote Infrastructure Management Services business using Akibia's large datacenter customer base.
n We understand that, both entities have a largely exclusive set of clients with
minimum overlap. Akibia has 53 active clients and serves large accounts like
Goldman Sachs, IBM and Fujitsu US.
Financial prospects
n We have made changes to our FY11E and FY12E earnings
n We assume the rupee to average Rs.45 per USD till FY12 end.
n EPS in FY11E and FY12E is expected to be Rs.30.2 and Rs.34.8, respectively.
n We have assumed tax rate to increase to 23% v/s 17% in FY12.
Valuations
n We have done our DCF analysis wherein we have also incorporated a WACC of
about 13.5% to compensate for the higher risks.
n We maintain our price target of Rs.211 for the stock, based on FY12E earnings.
n Sustained rise in margins and reduced attrition rates may lead us to accord
higher valuations to the stock.
Concerns
n A sharp acceleration from the current levels may impact our earnings estimates
for the company.
n A delayed recovery in major global economies could impact revenue growth of
Zensar.
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