RBS:: Buy Polaris Software Lab – High earnings visibility; target Rs 231

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Polaris should see a 21% revenue CAGR over FY11-13, anchored by a strong product suite
and financial services IT spend. It offers high earnings visibility on evolving business mix and
hedge positions. In our view, its growth prospects and impressive cash generation are not
reflected in valuations. Initiate at Buy.

21% revenue CAGR over FY11-13F, driven by products growth and demand tailwinds

Polaris is a direct play on the banking, financial services and insurance (BFSI) vertical, which

has emerged early from the downturn. We expect growth to be driven by: 1) volumes in IT

services (77% of revenues in 3Q11) given traction in IT spending by large financial services

clients; and 2) an unfolding products story, which should grow faster (33% CAGR over FY11-

13F) as Polaris spreads its footprint and scales up deal sizes. High client concentration

should be less of a concern going forward as pricing power returns and given sticky

relationships with key clients.

Polaris offers better-than-average visibility on profitability, in our view

Intellect, a suite of products offered by Polaris (23% of 3Q11 revenues vs 17% in 3Q09), is

steadily gaining traction. A credible reference base (installations in 60 countries) and positive

reviews from industry advisory groups should help it continue on a high growth path. We see

Intellect’s non-linear growth potential as a significant hedge against wage-related margin

pressures in the services business. Consequently, we project a fairly healthy c20% EBITDA

CAGR over FY11-13. Hedges of US$188m over FY11-FY13 at Rs48.3-49.4 provide a

substantial defence against rising tax rates (from 16% in FY11F to 26% in FY13F).

Growth prospects and cash generation track justify better valuations, in our view

We believe Polaris is cheap at 8.7x FY12F EPS, a 14% discount to mid-cap peers, while offering

relatively high visibility on earnings. Its cash generation record is impressive – about 100% of

generated retained earnings (post dividends) has been converted into cash over the past three

years, due to tight receivables management (receivables less than 50 days sales). Net cash of

(over US$100m) accounts for 27% of market cap and offers valuation support. We estimate cash

over the next three years could be 47% of the current market cap. Our DCF check also yields a

value of Rs231, significantly above the current price. We believe a key risk to the stock’s

performance is the open market sale of shares by CitiGroup.