Accumulate NIIT TECHNOLOGIES :: Kotak Sec,report

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NIITT's operational results were lackluster and came in marginally better
than our expectations. Apart from seasonality, continuing delays in a couple
of Insurance accounts and a T&T account impacted the revenue growth,
which came in at 1% QoQ in CC terms (2.1% in 2Q). This is the fourth
quarter of flattish-to-low services revenues. NIITT needs to tighten its
delivery organization further. The order bookings were encouraging at $109
($103mn in 2Q) and these should translate into better revenue growth,
going ahead. We tweak our earnings to Rs.37 per share for FY16 (Rs.36,
earlier) and TP to Rs.405 (Rs.396 earlier). We recommend buying the stock at
declines - ACCUMULATE (REDUCE earlier). NIITT needs to ensure better
consistency in revenue growth to attract higher valuations. The company
will have net cash of about Rs.80 per share by FY16 end, as per our
estimates

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Services revenue growth lack-lustre
 NIITT reported a 1% CC growth in services revenues, according to the management.
This follows a 2.1% growth in 2Q and flat growth in 1QFY15/4QFY14. This
is after excluding the hedging gain / loss. Revenues from bought-outs were at
Rs.57mn v/s Rs.57mn in 1Q.
 As in the past two quarters, 3Q revenues were also impacted by delays in two
projects in BFSI vertical (largely Insurance). These were delayed due to issues
specific to the clients and were expected to ramp up in 2H (both accounts). In
fact, one of the accounts was earlier expected to ramp up in 2Q itself.
 T&T revenues were down by 4% QoQ in INR terms because of delays in recognition
of revenues for two airports (implementation at 2 airports instead of 4) as
well as weakness in one large account due to the management changes at the
client's end.

 GIS revenues, at Rs.344mn, were up by 8% QoQ on a low base (Rs.318mn in a
seasonally weak 2Q).
 Revenue growth came in largely on the back of the Government revenues in
ROW geography (mostly India).
 While US and BFSI reported almost flat growth QoQ in INR terms, EU and T&T
saw revenues fall by 4% each over the period.
 We are concerned by the delays in projects and feel that, NIITT needs to tighten
its delivery organization to avoid such disappointments in the future.
Prospects of T&T good; Insurance remains impacted
 Within T&T, the airlines vertical has seen stable spending trends, we understand
(except client specific issues). According to the management, IATA has indicated
that, growth in 2015 / 2014 would also be better v/s 2014 / 2013 and it will be
the third / second successive year of improving profitability for the industry.
 NIIT has been able to win market share from larger incumbents, both local and
global, which should help improve revenue growth in future quarters. In 3Q, it
added two new accounts in this vertical.
 On the other hand, within BFSI, growth in Insurance continues to remain subdued.
The insurance vertical in US / Europe remains impacted.
 Two clients have continued to delay projects because of which, the vertical witnessed
a flattish growth QoQ in INR terms.
 ROOM (NIITIT), which had seen flat revenues for five successive quarters, actually
saw de-growth of 0.4% QoQ in 3Q at Rs.393 (Rs.409mn in 2Q). Revenues
were Rs.410mn in 1Q. Consolidated margins were at about 18% as against 16%
in 2QFY15, largely due to rupee depreciation and improved efficiencies.
 The vertical remains challenged for NIITT as well as for the whole industry.
 While revenues had stabilized in past five quarters, we are concerned by the lack
of growth in revenues and the consistent underperformance of this vertical.
 NIITT is now taking this business global with new contracts already gained in US
and ME. The company has gained one large order in US during the quarter.
 It has also added mobility and analytics features to the products and has developed
a healthy pipeline for the same.
 We expect revenues from the vertical to recover in FY16.
 While NIITT has been witnessing some challenges in the large BFS accounts, the
smaller accounts have continued to scale up. If spending from BFS improves,
NIITT may also see demand rising from this vertical.
 Mr. Sudhir Chaturvedi has come on board now expectations are that he would
rev up growth in this vertical. He is a senior hand in the Financial Services vertical.
He last served in Infosys as Senior VP and Head of Financial Services Americas
Business Unit.
 However, revenues from BFSI in the last 5-6 quarters have stagnated. We will
watch out for better execution in this vertical.
Sharper focus on growth markets and higher margin businesses
 Under Sudhir Chaturvedi, NIITT is sharpening its focus on growth markets as well
as on relatively higher margin businesses.
 We understand that, NIITT has increased its focus on the US markets, which
currently contributes about 44% to the revenues as against about 60% for the
industry. The company plans to increase contribution from US.

 Thus, the platforms / solutions of NIITIT will now be targeted at customers in US
as compared to the earlier focus on European markets only.
 On the other hand, it will go slow on the domestic business, which has higher
hardware content and hence, lower margins. Thus, we may see the order wins
in the domestic market dwindling.
 In addition to this, NIITT will be deepening its presence as well as expertise in
the T&T vertical, where it is one of the leading players from India. We understand
that, it is the largest in this vertical after TCS.
 Apart from the above, NIITT plans to lay more stress on the IMS business, where
it does not have any major presence.
 This is more with a view of filling up the service gaps which are present in the
company's portfolio and offer an integrated solutions approach to the client.
 We believe that, in a rising demand scenario, focusing on growth markets will
yield results and should also lead to better margins.
 However, the company should guard against over-dependence on one segment
or geography. Based on the current revenue profile, we believe that, the company
does not run this risk in the immediate future.
Order booking - high levels sustained
 One of the positive aspects of the results was the order flow. The order booking
for the quarter was at $109mn as against $103mn in 2Q and $124mn in 1Q.
 The order-book executable over the next 12 months is at $296mn as compared
to $298mn in 2Q.
 We note that, the company has now moved on to a higher trajectory of order
bookings over the past few quarters and the same will help future revenue
growth.
 The company has been consistently adding orders worth $70mn - $90mn over
the past few quarters and now expects this number to stabilize at more than
$100mn per quarter, going ahead.
Non-linear initiatives - pressured due to NIIT Insurance Technologies
 Non-linear initiatives have remained at about 28% of overall revenues in
3QFY15, we believe. This includes 3% from Non-linear BPO, 16% from Managed
Services and 9% from IP assets.
 Managed Services (MS) revenues have grown from 12% of revenues to 16% of
revenues as some of the domestic projects entered the operations & maintenance
space (which is MS). AAI project was also completed and entered the MS
space in 1Q.
 Revenues from NIIT Insurance Technologies (Room) remain impacted and are
expected to improve only in FY16.
 With revenues from new deals like Morris and Eurostar scaling up, we expect
non-linear revenues to grow as a proportion of revenues over the next few quarters.
 Morris had revenues of Rs.428mn in 3Q (Rs.406mn in 2Q) with margins of 14%
(10% in 2Q). However, Proyecta's revenues fell to Rs.173mn (Rs.184mn in 2Q)
and margins to 6% (11%).
 The company has various platforms for the insurance vertical - Subscribe
(ROOM), airlines vertical (revenue accounting) and cargo business (through partners).

 The platform based services should gather steam in the future quarters (with
ROOM's platform gaining traction) while the IMS business is also expected to
contribute more.
 The company has also launched the SaaS initiative and the Cloud initiative.
 The company has already won customers in Asia Pac and the practice should
scale up over the next few quarters.
 These non-linear initiatives are expected to help the company restrict impact on
margins due to salary hikes and potential rupee appreciation, if any.
Morris margins improve / GIS flattish
 GIS revenues were at 344Rs.mn (Rs.318mn in 2Q). The profitability for this business
has jumped significantly over the past 2-3 quarters. Margins were sustained
QoQ at 28% in 3Q (24% in 1Q).
 We do expect the revenue growth to improve and margins to sustain in the future.
 Revenues from Morris (NIIT Media Technologies) were higher at Rs.428mn
(Rs.406mn in 2Q). Margins were at 14% v/s 10% QoQ and 16% in 1Q.
 Margins were higher in 1Q because of the relatively higher off-shore component
during the quarter.
Employee count - lower QoQ
 The number of billable employees fell by 229 QoQ, the third successive quarter
of reduction. Utilisation rate excluding BPO rose marginally by about 20bps QoQ
to 78.8%.
 The reduction in employees is a negative surprise for us. We believe that, the
company can increase the utilization rates only marginally from the current levels.
 The management has guided for 150 - 200 employee addition in 4Q and also
consistent additions in FY16.
Services margins slightly higher QoQ;
 EBIDTA margins in the services business were up by about 51bps QoQ and came
in slightly higher than estimates.
 The hedging gain was at Rs.98mn v/s a gain of Rs.96mn in 2Q. The hardware
revenues were also at a level of Rs.57mn v/s 2Q levels of Rs.57mn.
 On the services front, margins were helped by the rupee depreciation, higher
utilization rates and better efficiencies.
 About 40% of NIITT's on-site employees are either US citizens (35%) or have
Green Cards.
 Margins are expected to improve going ahead, as profitability of NIITIT and
Morris improves QoQ.
 Depreciation charge was at Rs.231mn as compared to Rs.254 in 2Q.
 In 2Q, the depreciation charge had increased to Rs.254mn v/s Rs.189mn in 1Q.
This was due to the increased depreciation in the AAI projects, where the company
had capitalized hardware as well as software assets.
 The company is writing off these assets over a three year period and hence, this
charge is expected to sustain and improve marginally over the next three years.
 However, in 3Q, there was a re-assessment of useful life of AAI assets and that
led to a lower number. 3Q consisted of a write back of Rs.10mn for prior period
depreciatio

 NIITT's yields on investments are relatively lower (cash / equivalents of
Rs.3.36bn) likely due to higher amounts in current accounts / foreign accounts /
liquid funds. Better allocation may lead to higher yields for the company.
 The receivables days rose from 90 days to 94 days in 3Q.
Future prospects
 We expect revenues to grow by 2% YoY in FY15 and by 8% YoY in FY16. Rupee
is assumed to average 61/USD in FY15 and 60.5 / USD in FY16.
 Margins are expected to be sustained over FY14 - FY16. The expected rupee
appreciation and salary hikes would likely impact margins.
 However, higher utilization levels and improved margins in Morris/NIITIT will
likely set off the impact.
 With the rupee volatility expected to reduce, the company is expected to have
hedging gains v/s losses in FY14.
 However, the sharp rise in depreciation charge is expected to impact profits.
 PAT is, thus, expected to amount to Rs.2.25bn in FY16, leading to EPS of Rs.37.
Valuations and recommendation
 In our DCF model, we have incorporated a benign operating environment in our
near term assumptions for the company.
 A WACC of 14% and terminal growth of 1% leads us to a fair value of Rs.405
for the stock, on a one-year FW basis (Rs.396 earlier). At those levels the stock
will quote at about 11x FY16 earnings, which is reasonable, in our view.
 The stock has under-performed post the 2Q results. Looking at the 7% upside,
we now recommend buying the stock at declines - ACCMULATE. We are slightly
concerned about the revenue growth over the past three quarters.
 The company will have net cash of about Rs.80 per share by FY16 end, as per
our estimates.
Concerns
 Rupee appreciation beyond our assumed levels could provide a downward bias
to our earnings estimates.
 A delayed recovery in major global economies could impact growth prospects of
NIITT.

LINK
http://www.kotaksecurities.com/pdf/dmb/MorningInsight15012015bc.pdf