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Should be available cheaper
Downgrade to REDUCE, significant risk to Street FY12-13 EPS
Weak macro puts revenue at risk just as it did in 2008-09
Price losses could put margins under further pressure
Heightened risk aversion likely for mid and small caps
Downgrade to REDUCE
We downgrade Persistent Systems to
REDUCE (from Buy) and the Indian IT
services sector outlook to
DETERIORATING. In a series of recent
investor meetings that we hosted with the
company, the CEO did not seem
concerned about the weakening macro
environment and insisted the work
Persistent does is not discretionary, but is
“bread-and-butter” for its clients.
Management cited the examples of strong
results from top client IBM (IBM US, Not
rated), and key clients such as Cisco
(CSCO US, Not rated), which are unlikely to cut spending on focus areas
such as collaboration (Persistent is a key partner for Cisco in the area).
Persistent has about 90% revenue visibility for the immediate quarter and
a reasonable idea of customer plans for the year which is factored into its
guidance. However, during the previous downturn, Persistent saw three
successive quarters of 5-7% USD revenue growth declines, which we
worry could repeat.
Revising estimates significantly downward
Other points of concern are: 1) About 30% of Persistent’s revenue comes
from smaller clients and start-ups that contribute less than USD1m in
revenue each annually. In the eventuality of a recession, we believe this
revenue base could be at particular risk. 2) During the previous downturn,
price cuts accompanied volume declines, which could hurt the company’s
margins that are already under pressure from an increasing wage base.
Our FY13-14 revenue estimates are now lower by 16-21%, while we cut
our EPS estimates by 30-32%.
Valuation and target price derivation
We have so far liked Persistent as a play on the structural shifts (cloud
computing, collaboration, data analytics and mobility, which contribute
over 40% of its revenue) that the software industry is undergoing.
However, given heightened macro uncertainty, we believe investors
would be able to buy the stock cheaper over the next few months. We
also note that in 2008-09, FY10 P/E multiples went down 30-50% for
large-cap stocks, while those of some mid-cap companies fell more to
fundamentally unjustifiable levels. Given the likely investor risk aversion
ahead, we believe this is another reason to avoid smaller Indian IT
names. To capture this extra risk, we increase the beta in our DCF
assumptions to 1.3, from 1.1. As a result of this and our estimate cuts,
our TP for Persistent falls to INR250.00 (from INR470), which implies an
FY13E P/E of 9.1x. Risks: unexpected USD/INR weakness and lessthan-
expected deterioration of the macro environment.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Should be available cheaper
Downgrade to REDUCE, significant risk to Street FY12-13 EPS
Weak macro puts revenue at risk just as it did in 2008-09
Price losses could put margins under further pressure
Heightened risk aversion likely for mid and small caps
Downgrade to REDUCE
We downgrade Persistent Systems to
REDUCE (from Buy) and the Indian IT
services sector outlook to
DETERIORATING. In a series of recent
investor meetings that we hosted with the
company, the CEO did not seem
concerned about the weakening macro
environment and insisted the work
Persistent does is not discretionary, but is
“bread-and-butter” for its clients.
Management cited the examples of strong
results from top client IBM (IBM US, Not
rated), and key clients such as Cisco
(CSCO US, Not rated), which are unlikely to cut spending on focus areas
such as collaboration (Persistent is a key partner for Cisco in the area).
Persistent has about 90% revenue visibility for the immediate quarter and
a reasonable idea of customer plans for the year which is factored into its
guidance. However, during the previous downturn, Persistent saw three
successive quarters of 5-7% USD revenue growth declines, which we
worry could repeat.
Revising estimates significantly downward
Other points of concern are: 1) About 30% of Persistent’s revenue comes
from smaller clients and start-ups that contribute less than USD1m in
revenue each annually. In the eventuality of a recession, we believe this
revenue base could be at particular risk. 2) During the previous downturn,
price cuts accompanied volume declines, which could hurt the company’s
margins that are already under pressure from an increasing wage base.
Our FY13-14 revenue estimates are now lower by 16-21%, while we cut
our EPS estimates by 30-32%.
Valuation and target price derivation
We have so far liked Persistent as a play on the structural shifts (cloud
computing, collaboration, data analytics and mobility, which contribute
over 40% of its revenue) that the software industry is undergoing.
However, given heightened macro uncertainty, we believe investors
would be able to buy the stock cheaper over the next few months. We
also note that in 2008-09, FY10 P/E multiples went down 30-50% for
large-cap stocks, while those of some mid-cap companies fell more to
fundamentally unjustifiable levels. Given the likely investor risk aversion
ahead, we believe this is another reason to avoid smaller Indian IT
names. To capture this extra risk, we increase the beta in our DCF
assumptions to 1.3, from 1.1. As a result of this and our estimate cuts,
our TP for Persistent falls to INR250.00 (from INR470), which implies an
FY13E P/E of 9.1x. Risks: unexpected USD/INR weakness and lessthan-
expected deterioration of the macro environment.
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