With its infrastructure in place and focus on high-growth segments, Allied Digital Services is poised to gain from the opportunities in IT infrastructure management space.

As businesses around the world grow, so do their IT spend and the complexity in managing IT infrastructures. With companies having their offices at multiple locations, it has become very important that their IT infrastructure is secure and running all the time.

On the other hand, corporate governance is gaining momentum and regulators around the world are increasing the level of mandatory compliance to be made by companies.

This trend favours IT infrastructure management company - Allied Digital Services (ADSL), which has to its credit, the first Security Operation Center (SOC) that provides proactive protection and risk management for enterprise security round the clock.

Focus on margin expansion
System integration, which involves designing and setting up of IT infrastructure for enterprises, accounts for 70 per cent of ADSL’s revenue and enjoys EBIDTA margins of about 18 per cent. The balance 30 per cent of the revenue is generated from ‘services’ comprising of Infrastructure Management Services (IMS), annual maintenance contracts and technical support.

The company is working towards increasing the contribution from services to about 50 per cent by FY10 as it enjoys a much higher EBIDTA margin of 50-60 per cent. The company enjoys 13 per cent market share in the domestic IMS segment and caters to a diverse customer base across the banking, manufacturing, retail, telecom and BPO industries.

As per McKinsey, the global IMS industry size is estimated at $524 billion in 2008. Out of this, the addressable market for remote IT infrastructure management services (RMS) is estimated at $104 billion.

In this regard, the company raised Rs 85 crore from the IPO market in June last year (issue price of Rs 190) and set up a Global Service Delivery Centre at Mahape, which houses a Network Operation Centre (NOC) and Security Operation Centre (SOC) with a capacity of 50 seats each.

Each seat is capable of monitoring up to 1,200 devices and the company charges its clients about $800 per devise per month. The Mahape centre’s capacity is planned to be scaled up to 150 and 275 seats during FY09 and FY10, respectively.

First mover advantage
While IMS includes NOC and SOC, the former (NOC) remotely manages clients IT infrastructure and is a service provided by few other Indian companies like Glodyne, HCL and Wipro. But, it is the SOC service that sets the company aside from the crowd.

The company has tied up with Singapore based E-cop (a Temasek subsidiary), a pioneer in SOC technology with 90 per cent market share in far-east. ADSL currently pays 8 per cent of the revenue from the SOC segment to E-cop and is in advanced stages of forming a joint venture (JV) with the company.

The JV agreement would restrict E-cop from further sharing its technology with other contenders. ADSL and E-cop had to work together for 1.5 years to build ADSL’s SOC framework developed on E-cops technology (which E-cop took 4.5 years to compile).

This will act as a strong entry barrier for new entrants and give ADSL the first mover advantage. And while the company currently faces competition from global giants like British Telecom (through Counterpane), EDS and Secure Source in the SOC field, the market is way too large to give each player considerable room to grow at least for the next few years.

Strategic acquisition
The demand for SOC services is expected to be generated mostly from the west as it has been made mandatory for listed companies to include IT security status reporting, as a part of Securities and Exchange Commission (SEC) fillings under the Sarbanes Oxley Compliance Act.

To cash in on this opportunity and increase its geographical reach, the company acquired 80.5 per cent stake in US based IMS company, EnPointe Global Services (EGS), for an equity valuation of $30 million last month. EGS is a carved out subsidiary of EnPointe Technologies Inc (ENPT), a NASDAQ listed technology solutions provider.

ENPT, which will continue to hold 19.5 per cent in EGS, has presence in 44 states in the US and catering to several fortune 1,000 companies. This acquisition will not only give ADSL additional business for its IMS segment, but more importantly, access to ENPT’s rich clientele as well as its marketing network to cross sell ADSL’s NOC/ SOC services. ADSL is also in advanced talks to acquire another IMS company in UK.

Strengths
ADSL delivers services through its own facilities and centres, spread across 92 cities and follows a ‘direct’ model rather than a franchisee model, as adopted by its peers. This gives the company a direct control on the quality of service and helps it maintain the desired level of efficiency due to uniformity in training.

Also worth noting is the fact that, ADSL has a vendor neutral approach and does integration based on the customer’s requirement. This has led ADSL to be a solution partner for some of the big names in the industry and develop technical expertise over a vast range of products.

Since security compliance would be a subject of meeting regulatory requirement, US economic slowdown will pose minimal risk to ADSL’s prospects, while the currency risk is limited as more than 90 per cent of ADSL’s revenue come from domestic operations.

Financials and valuation
ADSL’s revenues and profits have grown at a CAGR of 45 per cent and 70 per cent, respectively in the last three years.

The company is expected to deliver a phenomenal CAGR of 90 per cent in revenue and 97 per cent in profit during FY08-FY10E on the back of exponential growth expected in the RMS segment and recent acquisitions. For instance, ADSL’s Q2FY09 numbers would see contribution from EGS, which has an order book of $49.5 million to be executed in next 12 months.
 

In terms of working capital management, debtor days for ADSL increased to 90-120 days during FY05-08 period, primarily due to increased focus on large projects in system integration business which typically have a longer execution period. The company however has started encouraging its clients to buy hardware directly from vendors (hardware selling is low margin business).

Secondly, the share of RMS in total revenues is likely to go up to 25 per cent by FY10 as compared to 5 per cent in FY08. Here, ADSL receives quarterly advances from clients in its RMS vertical. These two moves would bring down the debtor days to 80-90 days, which will improve its profitability and working capital management. At 13.9x and 7.9x its FY09 and FY10 estimated earnings, ADSL is an attractive long term growth story.

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