Focus on new technology to help Persistent Systems

With increasingly large software product development companies looking to outsource the product design and development to third party vendors, IT companies undertaking the outsourcing job would continue to see decent growth in coming years. Persistent Systems, a midsize IT company  operating in niche segment would benefit from its vast experience and its focus towards new technology areas.

BusinessPersistent is one of the leading players in the fragmented outsourced software product development (OPD) space in India. The company designs, develops and maintains software systems and solutions, creates new applications and enhances the functionality of its customers’ existing software products.

The Pune-based company offers offshore delivery services across software product life-cycle stages that include research and prototyping, development and testing, consulting services and deployment, and support and maintenance.

The company has helped its customers in developing over 3000 product releases in last five years. The company has developed domain expertise in the areas of telecommunications, life sciences, and infrastructure and systems. These verticals contribute to around 20%, 10% and 70% of the overall revenues.

Persistent caters to software product companies globally, with almost 85% of its annual revenues coming from US market, while Europe and Asia Pacific contribute remaining 8% and 7% to revenues respectively.

The company has been successful in retaining its high profile customers over the years and derives almost 90% of consolidated revenues from repeat business.  Investment Rationale Large software product companies which spend part of their revenues from sales on research and development (R&D) are increasingly getting dependent on third party developers as it helps them to not only reduce costs, but also reduce the time to market while reducing management bandwidth and engineering failure risks.

As per International Data company (IDC) forecasts, the product engineering services is expected to grow at around 18% per annum in next three years. Also the Indian OPD market, which is currently under-penetrated and fragmented, offers huge growth potential in coming years.

The company with vast experience and strong customer relationships is well placed to  benefit from this growth. The company has close to 200 customers with 31 of them giving over $1  million annual revenues. Further, its top 10 clients contribute to around 49% of the revenues and top client contributing to over 13% revenues.

This broad-based customer portfolio reduces major dependence on any one client and offers opportunity to grow deal sizes from smaller accounts in coming years.

The company has, over the years, migrated itself upwards to design stage thereby generating more of non-linear revenues in form of royalties, fixed price and product licenses. The share of IP-driven revenues has gone from around 5% in FY09 to around 8-9% since last few quarters.

The company operates in niche spaces, where the impact of an economic slowdown is less as spends on R&D by product companies does not decline as rapidly as discretionary spend on general and administrative related software spends.

In recent times, the company has expanded its focus to emerging technologies such as cloud computing, analytics, enterprise mobility and enterprise collaboration, which help customers to reduce cost of ownership of IT systems, easy access to applications and reduce processing time.

These new initiatives have seen strong traction and contributed 40% to overall revenues last quarter. Persistent’s experience in these technologies would help the company to improve its margins and also make its presence felt in BFSI segment.

The company, which has zero debt and has strong cash flows, has made three acquisitions in the past and may look at inorganic route to increase its product portfolio and expertise further.

ConcernsThe company derives a considerably high portion of its revenues from North America and European markets, exposing it to risks associated with any slowdown in engineering design spend by companies there and also to currency fluctuations. The company also faces competitive pressures from large service IT companies, who have also ventured into OPD and from its large clients’ captive OPD centres.

ValuationsHigher growth rates in the under-penetrated OPD space and increased focus by the company on newer technologies would help the company’s revenues to grow at CAGR of 25% over FY10-FY12E. Also due to increasing focus on higher margin IP related and emerging solutions, the net profits are expected to rise at CAGR of 15% over the same period.

At current market price of Rs446.05, the stock trades at 12.22 its FY11E expected earnings and 11.22 times its FY12E earnings per share. In view of its presence in niche business segment, its diversified and long-term client relationships and better margins than its peers, one can look to enter the stock on dips from medium-term perspective.

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