Persistent Systems -Where’s the margin of safety? :: ICICI Securities, report

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Where’s the margin of safety? • US$ revenues grew 4.2% QoQ to $79.5 million, modestly below our 4.8% QoQ growth and $80 million estimate • Rupee revenues grew 6.6% QoQ to | 494.6 crore, in line with our 6.8% QoQ growth and | 495.6 crore estimate led by higher rupee realisation (average rupee assumed: 61.9 vs. 62.2 realised) • PAT of | 74.4 crore was in line with our | 75.1 crore estimate led by lower taxes rates relative to our assumption • The Board announced bonus shares in the ratio of 1:1 Q4 asking rate too steep; adjusting FY15E estimates lower… Persistent’s Q3 earnings were marginally below our estimates but could have been better if not for the IP-led business, which continues to be sluggish (1.8%, 2.8%, 1.2% QoQ growth in Q1, Q2, Q3, respectively). Services business (81% of revenues) growth continues to be robust (4.9%) despite 1) base effect (5.6% in Q2), 2) seasonality, and continues to be driven by strategies around platform and digital enterprise. Persistent reiterated its FY15E better than FY14E growth guidance but the Q4 asking rate to achieve FY14E similar dollar growth (15.2%) is 9.7%. Though achievable (11.1% QoQ growth reported in Q4FY10), it appears too steep. Consequently, we lower our FY15E revenue estimate to 15.1% YoY growth vs. 15.5% earlier. That said, we maintain our FY16E estimates given healthy pipeline, acceleration in recently acquired IPs and mining of enterprise accounts acquired through platform business. Reinvestments impact Q3 EBITDA margins… Persistent’s Q3 EBITDA margins declined 49 bps QoQ to 20.1% vs. 20.6% in Q2 primarily led by 40 bps QoQ increase in S&M spends to 9.4% and higher onsite effort partially offset by rupee tailwinds and utilisation. Though 9MFY15 EBITDA margins were soft (20.9% average vs. 25.1% during 9MFY14), commentary continues to suggest that FY15E PBT margins could be flat YoY – implies higher other income given Persistent continues to reinvest in the business – led by revenue acceleration and increasing contribution of non-linear IP revenues (19% in Q3FY15 vs. 5% in FY09) and operational efficiencies. That said, we adjust our estimates lower and expect FY15E EBITDA margins to decline 428 bps YoY to 21.5% (23% earlier) and significantly below its FY09-14 average of 24.9%. Utilisation recovers but rising attrition may be a concern… At 74.3%, Q3 utilisation jumped 400 bps QoQ led by a healthy uptick in onsite (6.7%) and offshore (5.8%) volumes. LTM attrition increased 60 bps QoQ to 14.7% vs. 14.1%,14% in Q2, Q1, respectively, and is up 130 bps relative to FY14 average of 13.4% likely due to just-in-time hiring in newer technologies. Downgrading to SELL given minimum margin of safety We estimate Persistent will report rupee revenue, earnings CAGR of 16%, 22% over FY14-16E (average 22.8% EBITDA margins in FY15-16E), vs. 23%, 30% reported during FY09-14 (average 24.9%), driven by acceleration in recently acquired IPs and mining of enterprise accounts acquired through platform business. Though Persistent is among the few companies that predominantly focuses on newer technologies, valuations are excessive. We value PSL at | 1,500 i.e. at 16x its FY16E EPS of | 93. A 50% PE multiple premium relative to historical average (10.7x) captures significant positives leaving limited margins of safety. Consequently, we downgrade the stock to SELL.

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http://content.icicidirect.com/mailimages/IDirect_Persistent_Q3FY15.pdf