Persistent Systems -Positioning trap :: Centrum

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Persistent Systems -Positioning trap

Persistent Systems has positioned itself differently in its
service offering, but has failed to differentiate its
revenue model or pricing accordingly. This leaves the
company addressing a smaller universe, while
maintaining all the characteristics of an IT service player
along with some of the risks associated with the product
development life cycle. We continue to be skeptical
about the business model (refer our IPO note “’Niche’ no
guarantee for value creation” dated 18 March 2010) and
initiate coverage on the stock with a Sell rating and a
one-year target price of Rs352.
􀂁 Addressable universe is small: Persistent has
positioned itself in the niche segment of outsource
product development (OPD)/product engineering (PE),
which is only 5% of the entire IT-services space.
Worldwide PE spend is $40bn, versus total IT-services
spend of $800bn.
􀂁 Slow growth and ISVs’ captive presence to cap
future growth: India’s OPD export has grown at 16.1%
CAGR over the last three years, against the IT-BPO
export growth of 16.5%. Most of the IT-services players
are focusing on areas such as Infrastructure
Management Services (IMS) which is growing at a much
higher rate of 39%. With captive units of product
companies garnering a meaty 90% of the offshore PE
pie, Persistent is likely to be left with little headroom to
grow.
􀂁 Revenue model similar to IT-services players:
Although Persistent is addressing a high-end, niche and
much smaller segment; it is unable to differentiate itself
with regards to its revenue model. Unlike a product’s
revenue model, the company has a linear IT-service
model. With 81% revenue from T&M projects, it is
unable to reap the benefits of a product’s revenue
stream, while it faces some of the inherent risks
associated with the product development life cycle.
􀂁 Manpower supply and wage pressure to erode
margins: Persistent’s high skill requirements indicates
that it will have to face higher than industry attrition
levels and wage pressure. With offshore leverage and
utilization already at very high levels, the company is
left with few levers to mitigate margin pressures.
􀂁 Target price of Rs352; Sell: DCF valuation gives a
target price of Rs352, implying a PE of 11x September
2012 earnings. We believe this is a fair value for the
stock. As this indicates a potential downside of 15%
from current levels, we recommend a SELL.