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Costly software

Ram Prasad Sahu  |  Mumbai 

While has a strong base of clients, improving margins and good growth prospects, the IPO pricing appears a bit stiff.

Mid-tier IT services company, is seeking to raise Rs 190 crore from an IPO to partly fund its acquisition and expansion plans. The issue will also help Whiterock Investments, a part of Singapore-based which currently holds just under 10 per cent, to exit from the company. Of the Rs 190 crore, about Rs 95 crore will be available for the expenditure programme of the company while the rest will go to investors such as Whiterock and the promoters.

The promoter’s stake will come down from 72 per cent to 58 per cent on part sale of their equity holding and on an expanded base. The issue constitutes 26 per cent of expanded capital of the company.

Business model
Infinite has three lines of business or service offerings—application management or IT services, infrastructure management and product and IP-leveraged solutions. The company which counts IBM, Fujitsu, and Verizon, America’s largest wireless carrier, as its clients is focussed on generating business from large companies operating in verticals of telecom, media, healthcare and utilities. While Infinite has had to make do with smaller margins initially due to its Fortune 500 company focus, it has gained in terms of the size of contracts, experience in handling large projects and steady revenues.

However, analysts say that the company is taking a big risk on its thin roster of clients (the top 5 contribute 84 per cent of revenues, with Verizon alone contributing nearly 40 per cent) and can cause problems if vendors are switched or work is downsized. The company however believes that the scale, complexity and familiarity with the critical processes ensure the “stickability” of the vendor. The company also faces geography risk with 90 per cent of its business flowing from the US.

While the long-term outlook for software services is strong and recent uptick in hiring is a positive, the recovery in the US and other developed continues to be shaky. Though a predominant share of the future business will continue to come from the US, the company signed a multi-million dollar deal with a European company in 2008 and is looking to diversify its geographic risk further.

Acquisitions, expansion strategy
In addition to expanding its existing businesses, Infinite is looking at acquiring companies or intellectual property-based products from customers which can be developed further. About Rs 38 crore of the IPO proceeds are earmarked to fund its acquisitions. The company is keen to acquire IP-products and move to a revenue share model, which fetch good margins. Currently, only 5 per cent of its revenues come from this route. The company had acquired US-based company Comnet in 2006 to expand its offerings and tap the entire telecom value-chain rather than limiting itself to just telecom service providers such as Verizon. Infinite is likely to maintain its focus on the telecom space, which fetches it over half of its revenues, by offering solutions. It has four development centres across the country and plans to expand its existing campus at Bangalore and set up a new facility at Gurgaon at a cost of about Rs 26 crore. Further, the company plans to retire a part of its debt of Rs 24 crore through the issue proceeds which would be to the tune of Rs 8.5 crore.

 
IMPROVED SHOW
  FY07 FY08 FY09 FY10E* FY11E
Net sales  349.0 341.0 495.0 636.0 759.0
Ebdita 16.2 26.3 64.4 115.0 147.0
Ebidta margin (%) 4.6 7.7 13.0 18.1 19.4
Net profit  10.0 17.4 45.0 74.0 110.0
P/E (x) @ 165      -      - 14.0 9.8 6.6
           @ 155      -      - 13.1 9.2 6.2
* annualised                                                                                                           E: Estimates 

Improving numbers
While the company’s sales, operating profit and net profit have grown at a rapid clip since 2005-06, much of the growth has come in recent times. Sales jumped 45 per cent year-on-year in 2008-09 to Rs 496 crore while operating profit margins went up 540 basis points to 13.2 per cent.

The company says that the jump in operating profit margins (which have since improved to 18 per cent in the first half of 2009-10) has been on counts of change in service delivery, segment and revenue model mix. At the segment level, the company has been reducing its share of application development and maintenance business from 80 per cent in 2005-06 to 61 per cent in 2008-09 and increasing its share of higher margin business namely, IP-leveraged solutions and remote management services.

Further, the contribution from the lower margin time and material or labour hour model has decreased from 81 per cent to 50 per cent while fixed price contracts, which ensure steady revenues and are a better bet in these times, increased from 19 per cent to 43 per cent during the same period. In terms of service delivery, the share of offshore business which was at 4 per cent in 2005-06 has increased to a quarter of revenues and has helped margins.

Valuations
Based on the annualised first half numbers, the company’s revenues will increase by about 28 per cent year-on-year to Rs 636 crore in 2009-10 and net profit by 65 per cent to about Rs 74 crore. At an EPS of Rs 16.9 on expanded post-issue equity, the stock is available at 9.17-9.7 times its price band of Rs 155-Rs 165. While there are no other similar-sized players with revenues predominantly from the telecom software space (larger companies such as are in a different league), when compared to mid-tier companies the asking price seems to be a touch stiff. Infotech Enterprises (2009-10 estimated sales at Rs 945 crore and OPM of 22 per cent) for example despite higher sales and profit margins is available at similar valuations (10.7 times estimated FY10 EPS of 27.1). Also, the high client and geographic concentration substantially increase the risks to its business. Investors with a longer-term perspective may apply at the lower price-band.

First Published: Mon, January 11 2010. 01:14 IST
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