A tough test

While growth prospects appear healthy, there is limited room for upside in the medium-term.

Thinksoft Global Services is a software testing enterprise focused on the banking financial services and insurance (BFSI) domain. Thinksoft is coming out with an IPO to expand its operations. It plans to plough back 36 per cent of the total IPO proceeds to create a facility in a Chennai SEZ as part of its expansion plans, with the balance IPO proceeds going to existing investors who are offloading their holdings through an offer for sale.
 

ISSUE DETAILS
Price band:	Rs 120-130
Issue size:	Rs 43-47 cr
Issue opens:	Sept-22
Issue closes:	Sept-24

Business prospects
As per NASSCOM, the BFSI software testing segment is estimated to be one-third of the $2 billion testing market and is growing at 15-17 per cent annually. The company has done relatively well compared to industry growing at an average of 25 per cent over the last two years. This might suggest that the company is growing at a fast clip, but part of it is due to the low base effect. However, the business prospects of the industry took a beating ever since the slowdown engulfed all the major markets with the company being no exception. The tough conditions have meant that the company’s billing rates (stood at $20-21 per hour as of March, 2009) dropped by around 5-10 per cent. A nascent recovery in Europe (contributes around half of the revenues) is positive but it would be a while before the full benefits of the same can be felt. Meanwhile, the company is aiming to increase its footprint in the US which has seen a slight resurgence in the financial sector. These may be difficult times; the company’s specialised skills in software testing catering to BFSI segment can witness interest once the ground conditions improve.

Expansion
The company is setting up a new software testing facility at Madras export processing zone in Chennai with a capacity of 380-400 seats at an estimated outlay of about Rs 16 crore. This would double the existing seat count. The new capacity, which would be exempt from paying income-tax on profits for five-years, is expected to be completed by March 2011, reflecting a delay of seven months compared to the original plan. The new capacity addition, however, would give additional scalability to Thinksoft to attain orders and improve its economies of scale.
 

GROWTH PHASE
in Rs crore	FY08	FY09
Net sales	74.2	92.1
EBITDA (%)	16.4	18.7
Profit after tax	9.8	14.5
EPS (Rs) *	12.8	16.7
P/E (x) at Rs 120 *	9.4	7.2
P/E (x) at Rs 130 *	10.2	7.8
* Based on Pre-IPO equity capital  * Post-IPO, equity will rise by 15.5%.

Conclusion
The company has observed that clients are increasingly going for long-term contracts suggesting stable revenue road map besides, indicating enhanced confidence in Thinksoft. This is observed for the existing clients; however enrolment of newer clients has slowed down. The company has taken several steps to manage its cost structure including consolidating office space, which should help maintain operating profit margins at around 16-19 per cent, going ahead. The positives are its specialised focus in the software testing space and a decent track record, while the flip side is its relatively small size and over-dependence on a single segment.

In this light and considering the cash worth Rs 25 per share (post-IPO) it has on hand, valuations look a tad expensive, and leaves little for investors to gain in the medium-term.