Stay put in Persistent, exit Hexaware

While both the stocks outperformed in September, growth prospects appear stronger for Persistent

Even as the S&P BSE IT index was among the top gaining indices in September 2014, two mid-cap companies, Persistent Systems and Hexaware Technologies outpaced this index as well as the Sensex. Persistent has gained about 15 per cent, while Hexaware's gain has been 27 per cent. S&P BSE IT and S&P BSE Sensex could manage eight per cent and -1 per cent returns, respectively, for the month.

While the gains are driven by strong business growth potential in case of Persistent, the buzz of a potential de-listing and increase in promoter stake in recent times have boosted the Hexaware scrip. At current levels, Persistent trades at 15.7 times FY16 estimated earnings, while Hexaware trades at 15 times CY15 estimated earning, leaving little scope for further upsides, believe analysts.

Persistent's key strength is its first mover advantage in the newer and high growth segments such as social, mobile, analytics, cloud (SMAC) technology and continued traction in its intellectual property (IP)-led business, which accounts for 20 per cent of total revenues. The company's efforts at cross-selling its offerings to existing clients even as it continues to add new clients and stepping up share of IP revenues in the overall pie, will drive growth going forward, believe analysts. Its services business, too, is likely to grow well.

"We expect revenue growth of the legacy outsourced product development business to accelerate due to greater investment of product companies in developing products. We expect revenue and Ebit (earnings before interest and taxes) annual growth of 18 per cent and 16 per cent, respectively, over FY14-FY17," says Mohit Jain of Anand Rathi Securities. Persistent also invests in small technology start-up companies that are a strategic fit to its business model in a bid to monetise and scale up their investments as these companies show consistent growth. Key downside risks, though, remain near-term margin pressure as the company continues to invest for future growth and the volatile nature of IP-led businesses, which makes quarterly results inconsistent. However, given its unique business model, strong execution and future prospects, most analysts prefer Persistent among mid-cap IT companies.

The Hexaware scrip made a record high of Rs 208 a share on September 30 with promoters HT Global IT Solutions Holdings acquiring nine per cent stake via the open market, taking its total stake to 63 per cent. The company has carved a niche for itself in the travel/transportation, capital markets, enterprise application services and testing service segments. Hexaware provides high-value services around Oracle's Peoplesoft application, which is a key growth driver for this mid-sized IT firm. While the deal pipeline remains healthy, analysts expect Hexaware's margins to trend downwards given the high proportion of onsite revenues in newer deals.

"Hexaware's substantial margin deterioration limits upside, despite the significant dividend yield and improving growth outlook. Also, the high dividend payout in the past few quarters is likely to heighten the noise on potential de-listing of the stock," says Ashish Chopra of Motilal Oswal Securities. Hexaware is dependent on top 10 clients for 51 per cent of its revenues and any weakness in the same could be a key risk.