Persistent Systems: Play on OPD - Outperform rating and Rs450 TP ::Macquarie Research,

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Persistent Systems
Play on OPD
Initiating coverage with Outperform rating and Rs450 TP
 We initiate coverage of Persistent Systems with an Outperform rating and a
target price of Rs450, implying 33% upside. We like Persistent for its focus on
the under-penetrated OPD market and strong client relations that could
translate into large deal wins. For our detailed thesis please see our sector
report, India IT Services - Mid Cap Mantra for growth.
Pure play on Outsourced Product Development (OPD)
 OPD is an emerging niche category in the Indian software industry. The
industry body NASSCOM estimates Outsourced Product Development
revenues grew at a CAGR of 16% for 2007-10. Persistent, with its track
record of 20 years in this field, enjoys a formidable reputation with its clients.
 Persistent’s business model is to provide services to large software product
companies for reducing costs and time to market of their new products. For
the smaller software product companies, Persistent provides end-to-end
solutions in niche domains and technologies.
Focus on Non-Linear Revenues: Cloud and IP Strategy
 Management focused on four growth drivers. Persistent has identified four
growth areas: Cloud Computing & IP led Initiatives, Business Intelligence
/Analytics, Mobility and Enterprise Solutions. Of the four, we believe Cloud and
IP initiatives provide an excellent opportunity to drive non-linear revenue growth.
 Engagements with leading tech names on Cloud in place. Persistent has
400+ employees working on the IBM, Amazon, and Salesforce.com platform
to help develop their Cloud offerings. We are positive on the demand scenario
for OPD players following rapid deployment of “Cloud Computing”.
Sound Operating Metrics
 IP-driven work already contributing to revenues in FY11: Persistent has
invested ~4% of its total technical time in IP development, leading to a ~9%
share in revenues from non-linear revenues. This investment should lead to a
larger share of revenues with no incremental effort in the coming quarters.
 Strength of client relationship. Persistent’s client list includes long-term
relationships with 37 companies having more than US$1bn in revenues. This
gives us confidence in their ability to attract and retain clients.
 Geo mix and client concentration. North America accounts for 86% of
revenues. Contribution from Europe is minimal at 6%. Top 10 clients
contribute 50% of total revenues. Though, this poses client concentration risk,
this compares favourably when compared to other Tier 2 Indian IT vendors.
Valuation
 Lapse of STPI tax benefits hurting earnings in FY12. The extinction of tax
breaks for Indian IT vendors could see a big jump (30% from 7%) in
Persistent’s tax rate in FY12. This could be a key reason for potentially
depressed earnings in FY12, but an expected ~20% earnings growth in the
next two years makes us positive. Our target price of Rs450 is based on 13x
FY12E PER and 11x FY13E PER.