Polaris Financial Technology --Investment in product = weaker margin outlook :Prabhudas Lilladher,

Polaris Software Lab (Polaris) reported revenues ahead of expectation; however,
investment in R&D resulted in weaker margin. The management has guided for an
EPS of Rs25.5 (~15% YoY growth). We expect stress in the BFSI sector globally to
have a bearing on the financial performance of the company. Moreover, continued
investment in the product would put further pressure on the margin outlook. We cut
our rating to “Accumulate” (from BUY), with a revised target price of Rs150.

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􀂄 Revenue ahead, margin weaker due to investment in R&D: Polaris reported
revenue ahead but margin below expectation. The company reported revenue
growth of 9.4% to Rs5.59bn (PLe: Rs5.67bn, Cons: Rs5.85bn) and growth of 3.9%
QoQ (@cc 5.6%) in USD terms to $107.6m (PLe: $105m). Operating margins
eroded by 33bps to 12.2% (PLe: 14%, Cons: 14%), despite 5.5% currency
depreciation due to investment in R&D. Polaris has delivered EPS growth of
0.1% QoQ to Rs6.11 (PLe: Rs5.58, Cons: Rs5.38), largely driven by other income.
􀂄 Investment in business to put pressure on margins: The management is looking
forward to invest further in product development. Q1FY13 witnessed a jump of
~13% QoQ in R&D investment. The company is looking to improve the
competitiveness by investing in the product enhancement for Insurance,
Treasury & Capital Market and Core Banking software. We see investment in
R&D to push any scope of margin improvement to FY14. Moreover, investment
in S&M is likely to put further pressure on margin.
􀂄 Conference Call Highlights: 1) Sales Team: Europe-10, US-14 2) IdenTrust: Loss
Rs42.3m; Likely to be profitable in Q4FY13 3) DSO: 118 (Q4FY12: 112, Q1FY12:
92) 4) Hedging: $25m/qtr; Total: $93m (@~Rs50/$) 5) FY13 Tax Rate: 20-25%.
􀂄 Valuation and Recommendation: We continue to see increased
competitiveness of Intellect. However, investment in R&D would push the
margin recovery to FY14. Moreover, due to growing uncertainty around BFSI
domain, we cut our multiple to 6x (from 8x); hence, cut target price to Rs150
(from Rs200) and downgrade rating to “Accumulate” (from BUY). We see
weaker cash flow generation and margin outlook in FY13.