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Persistent Systems Ltd. (PSL) is a leading player in the niche Outsourced Product Development
(OPD) market. OPD is a high growth sector which is also highly underpenetrated at the same
time. The company's strong technical expertise and the ability to provide services across the
product life cycle differentiates it from the peers. The contribution of non-linear revenue (IP
sales) stream at ~9% offsets some volatility while cushioning PSL from margin pressures.
Strong focus on the fast growing niche OPD space provides good growth potential
International Data Corporation (IDC) expects R&D / Product Engineering (PE) services to grow
at a CAGR of 14% during CY09-13E to reach $65.7bn. Over the same period, outsourced R&D
spending (off-shore revenue) is expected to grow at a CAGR of 19.1% and touch $16.1 bn. PSL
being a pure OPD player and an early entrant in the space is expected to notch up much higher
growth compared to the industry. PSL has expertise across the value chain in product
development and thus enjoys a competitive advantage enabling it to garner more orders.
Only 5% of the total R&D spend is outsourced to third party OPD players. With fuelling costs
and uncertainty more and more ISVs are expected to outsource at least noncore part of their
business resulting in a huge potential in several untapped areas for OPD companies. The offshore
segment of the OPD market stood at ~US$ 10.7 bn in FY11 with Indian companies commanding
just 10%of the total offshore market. PSL with a market share of ~13-14% is well positioned to
derive growth from the huge opportunities present in this space.
Underpenetration and higher growth relative to IT services provide huge upside for OPD
players
OPD market is also highly under penetrated in comparison to IT services, where 70% of the
market is outsourced while its just 4% in case of R&D, thus providing a huge upside for OPD
players. We believe that with increased competition and lesser time to market, more and more
R&D related work will be outsourced.
The rate of growth in the R&D/PE outsourcing business is greater than the 4-5% growth seen
in the traditional IT services business and being relatively untapped presents a huge opportunity
for the niche players like PSL.
Growth in IP led revenues to boost non-linear revenue
PSL engages ~5% of its technical manpower in R&D. The higher investment has led to a growth
in IP generated revenue for PSL which is expected to contribute 17% of the total revenue in
FY13E, up from 8.8% in FY11. PSL currently owns 14 IP's (Intellectual Property) with many in
the pipeline. The increasing IP revenue would have a positive impact on the EBIDTA margins
as well which could boost it by as much as 60bps in FY13E.
Investments in new technologies key for competitive advantage
PSL is one of the pioneers in offering services in new technology areas like Cloud, Analytics,
Collaboration and Enterprise Mobility. PSL derives almost 40% of its revenues from these
emerging areas. PSL is investing heavily in these areas to generate more IP and cash in on the
growth in these domains.
Higher offshoring leads to one of the best EBIDTA margins among Indian mid-caps
PSL has a high offshore-centric business model contributing 79% of the total revenue. The
company books a substantial portion of revenues in USD, while a significant part of costs
(primarily employee cost) is INR denominated resulting in one of the best EBIDTA margins
among the Indian midcaps IT companies. We believe the possibility of INR depreciating against
the USD is high considering higher twin deficits (current/fiscal) and slower GDP growth of
India which could further aid in margin expansion.
Guidance maintained while strong client additions remains a positive
The Company maintained the revised guidance of $205-210mn for FY12E and should be able to
achieve a flat USD revenue growth sequentially in Q4FY12. We also get some comfort on FY13
outlook given the recent additions of 40 new clients of which 7 are large multi-billion dollar companies.
On the back of its good track record, PSL should be able to increase the revenue contribution from
these clients going ahead.
Valuation & Recommendation
PSL, over the years has built a differentiated model focusing only on the OPD business and is investing
heavily in new technology areas. The next leg of growth for the company is expected to come from IP
sales where it would have a shared risks and revenue model on the pay per use concept. Even though
the top line growth in the recent quarters has been tepid on the back of a weak U.S outsourcing
market we believe the long term growth story of the company remains intact. At CMP, PSL is trading
at 8.0x and 7.0x its FY13E and FY14E EPS of Rs 38 & Rs 44 respectively. Factoring the better EBIDTA
margins compared to its midcap peers and superior earnings quality derived from premium service
offerings we value the company at a P/E of 10.0x FY13E earnings to arrive at a target price of Rs 388,
in line with other mid-cap players. This provides an upside of 26% from the current price of Rs 309.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Persistent Systems Ltd. (PSL) is a leading player in the niche Outsourced Product Development
(OPD) market. OPD is a high growth sector which is also highly underpenetrated at the same
time. The company's strong technical expertise and the ability to provide services across the
product life cycle differentiates it from the peers. The contribution of non-linear revenue (IP
sales) stream at ~9% offsets some volatility while cushioning PSL from margin pressures.
Strong focus on the fast growing niche OPD space provides good growth potential
International Data Corporation (IDC) expects R&D / Product Engineering (PE) services to grow
at a CAGR of 14% during CY09-13E to reach $65.7bn. Over the same period, outsourced R&D
spending (off-shore revenue) is expected to grow at a CAGR of 19.1% and touch $16.1 bn. PSL
being a pure OPD player and an early entrant in the space is expected to notch up much higher
growth compared to the industry. PSL has expertise across the value chain in product
development and thus enjoys a competitive advantage enabling it to garner more orders.
Only 5% of the total R&D spend is outsourced to third party OPD players. With fuelling costs
and uncertainty more and more ISVs are expected to outsource at least noncore part of their
business resulting in a huge potential in several untapped areas for OPD companies. The offshore
segment of the OPD market stood at ~US$ 10.7 bn in FY11 with Indian companies commanding
just 10%of the total offshore market. PSL with a market share of ~13-14% is well positioned to
derive growth from the huge opportunities present in this space.
Underpenetration and higher growth relative to IT services provide huge upside for OPD
players
OPD market is also highly under penetrated in comparison to IT services, where 70% of the
market is outsourced while its just 4% in case of R&D, thus providing a huge upside for OPD
players. We believe that with increased competition and lesser time to market, more and more
R&D related work will be outsourced.
The rate of growth in the R&D/PE outsourcing business is greater than the 4-5% growth seen
in the traditional IT services business and being relatively untapped presents a huge opportunity
for the niche players like PSL.
Growth in IP led revenues to boost non-linear revenue
PSL engages ~5% of its technical manpower in R&D. The higher investment has led to a growth
in IP generated revenue for PSL which is expected to contribute 17% of the total revenue in
FY13E, up from 8.8% in FY11. PSL currently owns 14 IP's (Intellectual Property) with many in
the pipeline. The increasing IP revenue would have a positive impact on the EBIDTA margins
as well which could boost it by as much as 60bps in FY13E.
Investments in new technologies key for competitive advantage
PSL is one of the pioneers in offering services in new technology areas like Cloud, Analytics,
Collaboration and Enterprise Mobility. PSL derives almost 40% of its revenues from these
emerging areas. PSL is investing heavily in these areas to generate more IP and cash in on the
growth in these domains.
Higher offshoring leads to one of the best EBIDTA margins among Indian mid-caps
PSL has a high offshore-centric business model contributing 79% of the total revenue. The
company books a substantial portion of revenues in USD, while a significant part of costs
(primarily employee cost) is INR denominated resulting in one of the best EBIDTA margins
among the Indian midcaps IT companies. We believe the possibility of INR depreciating against
the USD is high considering higher twin deficits (current/fiscal) and slower GDP growth of
India which could further aid in margin expansion.
Guidance maintained while strong client additions remains a positive
The Company maintained the revised guidance of $205-210mn for FY12E and should be able to
achieve a flat USD revenue growth sequentially in Q4FY12. We also get some comfort on FY13
outlook given the recent additions of 40 new clients of which 7 are large multi-billion dollar companies.
On the back of its good track record, PSL should be able to increase the revenue contribution from
these clients going ahead.
Valuation & Recommendation
PSL, over the years has built a differentiated model focusing only on the OPD business and is investing
heavily in new technology areas. The next leg of growth for the company is expected to come from IP
sales where it would have a shared risks and revenue model on the pay per use concept. Even though
the top line growth in the recent quarters has been tepid on the back of a weak U.S outsourcing
market we believe the long term growth story of the company remains intact. At CMP, PSL is trading
at 8.0x and 7.0x its FY13E and FY14E EPS of Rs 38 & Rs 44 respectively. Factoring the better EBIDTA
margins compared to its midcap peers and superior earnings quality derived from premium service
offerings we value the company at a P/E of 10.0x FY13E earnings to arrive at a target price of Rs 388,
in line with other mid-cap players. This provides an upside of 26% from the current price of Rs 309.
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