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R SYSTEMS INTERNATIONAL LTD (RS)
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.150
CY11E P/E: 8.5X
R Systems' 4QCY10 results were lower than expectations. While volumes
grew by about 3%, margins surprisingly fell by 350bps QoQ. Margins fell
largely due to higher S&M expenses. The company added 5 new accounts
which can scale up significantly in future. However, lack of scale up in
existing large accounts has kept revenues range-bound over the past 5
quarters. The revenue profile reflects the challenges associated with a
project - based business. The macro scene has likely improved with more
discretionary spends being seen by the management. This is likely to
support revenue growth going ahead, in our view. The company has also
invested in its client acquisition initiatives. However, only higher
consistency in revenue will lead to better margins and attract higher
valuations for the stock, we maintain. Tax rates are expected to rise to
about 30% due to no SEZ cover. The acquisition of Computaris is expected
to be EPS accretive for R Systems, we believe. The price target stands revised
to Rs.150 (Rs.121) based on CY11E earnings. Earnings per share stand at
Rs.16.2 (Rs.11.2) for CY11, post Computaris acquisition. On an organic basis,
earnings are expected to de-grow. We maintain ACCUMULATE in view of the
limited upside from current levels. The high amount of (net) cash in the
balance - sheet of about Rs.65 per share by CY11 end may act as cushion. A
delayed recovery in major user economies and a sharper-than-expected
appreciation in rupee v/s major currencies are the primary risks to our call.
4QCY10 results
Results for 4QCY10 were below estimates.
Volumes grew by 3% QoQ
n Revenues fell by 2.6% on a sequential basis in INR terms. However, they were
flat in ISD terms.
n Moreover, the growth was impacted by a one-off license sale in 3Q totaling
about Rs.24 mn.
n Excluding this, revenues grew by about 3% QoQ, largely on the back of higher
volumes.
n Average realizations remained flat sequentially. The company has been renewing
existing contracts and entering into new accounts.
n However, there have been no rate re-negotiations till date, according to the
management.
n This the second consecutive quarter of volume growth after 6 consecutive quarters
of de-growth. Volumes had grown by 5% in the previous quarter.
n The reduction in volumes in the past largely reflects the volatility and risks associated
with a project-based business.
n The Company won new assignments from customers who are industry leaders.
n The company added 5 new accounts during the quarter, which have the potential
to become large accounts for the company.
n The management has also indicated that, for GE, the company was doing work
only for the consumer finance division but it has now entered into commercial
finance division and has started the first project for this division.
n In 1QCY10, two of AIG's separated businesses had already become clients of R
Systems and should scale up in due course.
n During the quarter, the company initiated two contracts with a Automotive major
having operations in India and Europe.
n Moreover, the management has indicated that, clients are diverting some of
their 'run-the-business' budgets to discretionary spends, which is benefiting companies
like R Systems.
n Clients continue to focus more on cutting costs and reducing flab.
n While sales cycles remain long, there are more prospects and leads, which now
need to be converted into business.
n We believe that, these factors should support the revenue stream going ahead
Business restructuring
n The corporate and business restructuring of two subsidiaries of R Systems based
in Singapore is underway.
n R Systems will convert loan given to ECnet into equity into equity investment and
thereafter the two subsidiaries will be amalgamated.
Employee count reduced
n After coming back in the hiring mode last quarter, the company has once again
failed to add employees on a net basis during the quarter. The number of employees
(net) reduced during the quarter, though marginally.
n This, once again, reflects the uncertainty and volatility associated with a projectbased
business.
n The blended utilization level including trainees fell marginally to 65.6% during
the quarter.
Margins lower
n EBIDTA margins fell by about 350bps, which came as a negative surprise.
n In 3Q, margins had risen by about 500bps.
n Margins fell likely on the back of reduced utilization levels and increased spend
on S&M.
n The 'Other income' component was marginally lower QoQ.
n The company had a tax credit during the quarter, which helped in pushing up
the net profit.
n The company availed of tax credit ahead of expiration of tax benefits under the
STPI scheme.
n Going forward, we expect tax rate to be about 26% of PBT in CY11.
Acquisition of Computaris
n R Systems has acquired Computaris in an all-cash transaction valued at about
GBP 9mn. Of these about GBP4.25mn will be paid upfront and the balance as
earn-outs over a two year period.
n Computaris is provides solutions and services to telecom industry and specializes
in real-time ratings and billing solutions. It has operations spread across five
countries and has about 240 employees.
n Computaris had revenues of about GBP9mn in CY10 with PAT of about GBP 1 -
1.1mn.
n We believe that, the acquisition will be EPS accretive in CY11, though we are
surprised by the valuations at which R Systems has been able to acquire
Computaris.
Cash balance
n R Systems had a net cash balance of about Rs.957mn as at December 2010.
However, the company will be paying Rs.308mn to acquire Computaris and we
expect the cash balance to be Rs.790mn. This works out to about Rs.65 per
share.
n We see the cash in the balance sheet as a cushion against any significant fall in
the price from the current levels.
Future prospects
n We have incorporated the 4QCY10 results and have made changes to our CY11
estimates.
n We expect revenues to rise by about 32% on the partly back of consolidation of
Computaris.
n Margins are expected to improve marginally in CY11 as currency appreciation
and salary increases set off productivity and revenue related gains.
n We expect tax rate at 26% of PBT in the absence of the STPI tax cover.
n Consequently, PAT is expected to rise by 15% to Rs.198mn, resulting into an
EPS of Rs.16.
Valuations and recommendation
n The stock is currently quoting at valuations, which are not demanding, based on
CY11E earnings.
n The valuations have remained undemanding because of the consistent macro
concerns over the sector and also the consistent decline in volumes over the past
six quarters.
n The macro scene indicates that, the revenues should grow at a decent pace over
the next few quarters.
n However, margins are expected to remain under pressure because of the currency
movement and salary pressures.
n The revenue growth has remained erratic because of the project-based nature of
the business.
n We will become more positive on the stock post seeing increased hiring and
consistent revenue growth on a sequential basis along with improved margins.
n We continue to maintain ACCUMULATE.
Concerns
n Rupee appreciation beyond our assumed levels could provide a downward bias
to our earnings estimates.
n A delayed recovery in major global economies could impact revenue growth of
Indian vendors, including R Systems.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
R SYSTEMS INTERNATIONAL LTD (RS)
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.150
CY11E P/E: 8.5X
R Systems' 4QCY10 results were lower than expectations. While volumes
grew by about 3%, margins surprisingly fell by 350bps QoQ. Margins fell
largely due to higher S&M expenses. The company added 5 new accounts
which can scale up significantly in future. However, lack of scale up in
existing large accounts has kept revenues range-bound over the past 5
quarters. The revenue profile reflects the challenges associated with a
project - based business. The macro scene has likely improved with more
discretionary spends being seen by the management. This is likely to
support revenue growth going ahead, in our view. The company has also
invested in its client acquisition initiatives. However, only higher
consistency in revenue will lead to better margins and attract higher
valuations for the stock, we maintain. Tax rates are expected to rise to
about 30% due to no SEZ cover. The acquisition of Computaris is expected
to be EPS accretive for R Systems, we believe. The price target stands revised
to Rs.150 (Rs.121) based on CY11E earnings. Earnings per share stand at
Rs.16.2 (Rs.11.2) for CY11, post Computaris acquisition. On an organic basis,
earnings are expected to de-grow. We maintain ACCUMULATE in view of the
limited upside from current levels. The high amount of (net) cash in the
balance - sheet of about Rs.65 per share by CY11 end may act as cushion. A
delayed recovery in major user economies and a sharper-than-expected
appreciation in rupee v/s major currencies are the primary risks to our call.
4QCY10 results
Results for 4QCY10 were below estimates.
Volumes grew by 3% QoQ
n Revenues fell by 2.6% on a sequential basis in INR terms. However, they were
flat in ISD terms.
n Moreover, the growth was impacted by a one-off license sale in 3Q totaling
about Rs.24 mn.
n Excluding this, revenues grew by about 3% QoQ, largely on the back of higher
volumes.
n Average realizations remained flat sequentially. The company has been renewing
existing contracts and entering into new accounts.
n However, there have been no rate re-negotiations till date, according to the
management.
n This the second consecutive quarter of volume growth after 6 consecutive quarters
of de-growth. Volumes had grown by 5% in the previous quarter.
n The reduction in volumes in the past largely reflects the volatility and risks associated
with a project-based business.
n The Company won new assignments from customers who are industry leaders.
n The company added 5 new accounts during the quarter, which have the potential
to become large accounts for the company.
n The management has also indicated that, for GE, the company was doing work
only for the consumer finance division but it has now entered into commercial
finance division and has started the first project for this division.
n In 1QCY10, two of AIG's separated businesses had already become clients of R
Systems and should scale up in due course.
n During the quarter, the company initiated two contracts with a Automotive major
having operations in India and Europe.
n Moreover, the management has indicated that, clients are diverting some of
their 'run-the-business' budgets to discretionary spends, which is benefiting companies
like R Systems.
n Clients continue to focus more on cutting costs and reducing flab.
n While sales cycles remain long, there are more prospects and leads, which now
need to be converted into business.
n We believe that, these factors should support the revenue stream going ahead
Business restructuring
n The corporate and business restructuring of two subsidiaries of R Systems based
in Singapore is underway.
n R Systems will convert loan given to ECnet into equity into equity investment and
thereafter the two subsidiaries will be amalgamated.
Employee count reduced
n After coming back in the hiring mode last quarter, the company has once again
failed to add employees on a net basis during the quarter. The number of employees
(net) reduced during the quarter, though marginally.
n This, once again, reflects the uncertainty and volatility associated with a projectbased
business.
n The blended utilization level including trainees fell marginally to 65.6% during
the quarter.
Margins lower
n EBIDTA margins fell by about 350bps, which came as a negative surprise.
n In 3Q, margins had risen by about 500bps.
n Margins fell likely on the back of reduced utilization levels and increased spend
on S&M.
n The 'Other income' component was marginally lower QoQ.
n The company had a tax credit during the quarter, which helped in pushing up
the net profit.
n The company availed of tax credit ahead of expiration of tax benefits under the
STPI scheme.
n Going forward, we expect tax rate to be about 26% of PBT in CY11.
Acquisition of Computaris
n R Systems has acquired Computaris in an all-cash transaction valued at about
GBP 9mn. Of these about GBP4.25mn will be paid upfront and the balance as
earn-outs over a two year period.
n Computaris is provides solutions and services to telecom industry and specializes
in real-time ratings and billing solutions. It has operations spread across five
countries and has about 240 employees.
n Computaris had revenues of about GBP9mn in CY10 with PAT of about GBP 1 -
1.1mn.
n We believe that, the acquisition will be EPS accretive in CY11, though we are
surprised by the valuations at which R Systems has been able to acquire
Computaris.
Cash balance
n R Systems had a net cash balance of about Rs.957mn as at December 2010.
However, the company will be paying Rs.308mn to acquire Computaris and we
expect the cash balance to be Rs.790mn. This works out to about Rs.65 per
share.
n We see the cash in the balance sheet as a cushion against any significant fall in
the price from the current levels.
Future prospects
n We have incorporated the 4QCY10 results and have made changes to our CY11
estimates.
n We expect revenues to rise by about 32% on the partly back of consolidation of
Computaris.
n Margins are expected to improve marginally in CY11 as currency appreciation
and salary increases set off productivity and revenue related gains.
n We expect tax rate at 26% of PBT in the absence of the STPI tax cover.
n Consequently, PAT is expected to rise by 15% to Rs.198mn, resulting into an
EPS of Rs.16.
Valuations and recommendation
n The stock is currently quoting at valuations, which are not demanding, based on
CY11E earnings.
n The valuations have remained undemanding because of the consistent macro
concerns over the sector and also the consistent decline in volumes over the past
six quarters.
n The macro scene indicates that, the revenues should grow at a decent pace over
the next few quarters.
n However, margins are expected to remain under pressure because of the currency
movement and salary pressures.
n The revenue growth has remained erratic because of the project-based nature of
the business.
n We will become more positive on the stock post seeing increased hiring and
consistent revenue growth on a sequential basis along with improved margins.
n We continue to maintain ACCUMULATE.
Concerns
n Rupee appreciation beyond our assumed levels could provide a downward bias
to our earnings estimates.
n A delayed recovery in major global economies could impact revenue growth of
Indian vendors, including R Systems.
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