i-flex: Rise tempered

The i-flex stock's underperformance this year is justified

The i-flex solutions stock had had a dream run in calendar year 2003. Even though the CNX IT (industry benchmark) index had risen just 22 per cent, i-flex jumped almost 90 per cent.

The picture has reversed rather dramatically this year. While the CNX IT index has fallen less than 10 per cent so far this calendar year, the i-flex stock has dropped 35 per cent.

What could be the reason for the underperformance this year? For starters, the outperformance in 2003, in hindsight, seemed unjustified. i-flex had had a great run, in terms of financial performance, in FY03. Profit in the period had jumped 72 per cent.

The markets, obviously, liked to believe that a similar performance will follow. Especially so, because Flexcube (the company's flagship product) was at the top of the charts for the highest numbers of banking systems sold.

Also, around 70 per cent of the world's banks were prospective clients who needed a change in the core banking systems. i-flex, as the fastest growing player in the segment, was expected to benefit the most.

So much so, that when the CNX IT index fell 25 per cent in just two days after Infosys' guidance bomb last April, i-flex's stock price declined a mere five per cent. The stock was further propped up after news of the company's tie-up with IBM, which would market Flexcube on the DB/2 platform.

But, as things turned out, although the company added clients at a fast pace in FY04 and grew revenues by 27 per cent, it did not result in higher profit. In fact, net profit (before adjustments) fell 3.44 per cent last fiscal.

Margins in the core products business fell over 400 basis points (bp) on account of investments on the Flexcube product to make it available on the DB/2 platform.

Besides, the company stepped up selling and marketing effort, resulting in an 80 bp jump in S&M expenses for the products business. At the operating level, margins were 400 bp lower.

The services business did slightly better, with a 80 bp increase in operating margin. But this was primarily because of a low base in FY03. On a quarter on quarter basis, operating margin of the services business was down 230 basis points.

After the sharp correction in the share price, i-flex's valuation has tempered down to 24 times FY04 earnings. It definitely better reflects the volatility in the company's earnings, but at the same also captures the company's premium positioning in the banking products segment.

with contributions from Mobis Philipose