Saturday, August 4, 2012


Persistent Systems Ltd. (PSL) reported its Q1FY13 results which were inline on the revenue front but disappointed at the operating level. The revenue in $ terms grew 1.3% sequentially and 9.8% Y-o-Y to $54.9 mn due to higher IP-led revenues (grew 16.4% sequentially and 150.2% Y-o-Y to $7.6 mn) however linear business remained muted.

EBITDA margin contracted by 166 bps sequentially to 26.8% compared to expectations of significant expansion on the back of rupee depreciation. This was primarily due to unexpected wage hike of 4.2% for onsite employees, product acquisition (leading to hiring of 72 people in Malaysia and 12 in US) and higher SG&A expenses. Offshore salary hike of 10% is due in Q2FY13 hence margins will be under pressure going forward.

Net profit stood at Rs 416 mn up 50.8% Y-o-Y and only 0.9% sequentially despite strong rupee depreciation of 9.7% in the quarter due to EBITDA margin contraction and forex loss of Rs 92mn.

Linear business performance modest but PSL's IP focus bearing fruit
IP revenues contributed to 13.9% of the total revenue as against 12.1% in Q4FY12 while it more than doubled Y-o-Y to $7.65mn. The network performance management product acquired from IBM contributed to ~$0.75mn while the full-quarter contribution from Openwave of ~US$0.6mn also added to the incremental revenue sequentially. The linear business on the other hand continued to remain subdued as revenue declined 0.8% sequentially (0.6% Q-o-Q decline in volumes).

Revenues from four focus areas grew faster at 5.3% sequentially
The four focus areas of cloud, collaboration, mobility, and BI contributed ~39% to the overall revenues in Q1FY13 and grew 5.3% sequentially.

Wage hikes & headcounts
The company has given a wage hike of 4.4% to its onsite employees and a hike of 9.9% is in the offing to its offshore employees in the Q2FY13. Headcount declined for the 3rd quarter in a row with attrition increasing by ~60 bps sequentially to 18.9%. PSL absorbed the full employee cost (72 employees in Malaysia and 12 in the US) related to the end-of-life product acquisition from IBM (present for 2/3rds of the quarter) whereas revenue contribution from the same was modest in the quarter.

The large Forex loss in Q1FY13 could reverse in H2FY13
PSL reported forex losses of ~Rs121mn comprising of Rs91mn loss on the hedges and Rs30mn loss on asset translation. However, given that the hedges in Q3-Q4FY13 are at favorable rates, i.e. upwards of Rs57/$, we expect forex gains on hedges in H2FY13 if the exchange rate remains at similar levels.

Management guidance
Management has guided that the company would surpass Nasscom's industry growth forecast of 11-14% Y-o-Y (USD revenue) for FY13 with incremental growth driven by growth from the key focus areas of cloud, analytics and collaboration from partnerships with companies such as, IBM, Cisco etc. It expects to maintain or improve EBIDTA margins. Though the IP revenues are expected to remain volatile going forward, the company expects good growth from it.

Revenue momentum should pick up in the next few quarters (from revenue contribution from the
product acquisitions). We would expect margins to remain under pressure in Q2FY13 as well, given the impact of offshore wage hikes. We believe that the full-year revenue contribution from the Openwave location business ($6-7mn) and the IBM product takeover ($8-9mn) should together contribute nearly 6% to FY13 growth, lowering the burden on the organic business. PSL is into pureplay offshore product development (OPD), which is highly discretionary in nature and, thus, exposes the company to higher amount of risk as posed to its peers if situation deteriorates further. We revise our revenue and EPS estimates upwards from Rs 12.04bn/Rs 42.2 to Rs 12.04bn/Rs 42.2 respectively taking into account the depreciated Re and higher contribution from IP.

PSL is one of the cheapest midcaps which has operating margins much higher margins than its peers and comparable to some of the large caps. We believe PSL would in due course undergo a re-rating and trade inline with other good growth mid cap stocks like KPIT Cummins, Mindtree etc. However currently we value the company at 9x FY13E earnings, thus arriving at a target price of Rs 460, 9% higher than our earlier target of Rs 422.

On the margin front, GPM expanded by 94 bps. On the negative side it was impacted by three factors, increasing on-site salaries, the additional Visa cost and acquisition of people in U.S. and Malaysia which was offset by currency gains. On S&M front, the increase was mainly due to increase in on-site salaries and participation in couple of marketing events.

On employee related expenses, PSL witnessed 7.7% sequential increase, mainly due to 4.2% pay hike for its onsite delivery team effective April 1, 2012. As part of its acquisition of Network Performance

Management product, PSL added 72 employees in Malaysia and 12 employees in USA.
PSL's project related expenses went up by 67% sequentially. A higher VISA fee coupled with higher VISA applications was the main reason for this increase. PSL's sales and marketing cost increased due to increments given to the sales team in U.S. effective April 1, 2012 and also due to the participation of some of the branding and marketing events in U.S. The administrative cost increased by 6% due to hiring of additional premises in the SEZ.

PSL's investment income for the quarter came in at Rs75 mn, which was offset by hedging losses of Rs 121 mn, thus resulting in a net loss of Rs 47 mn in the other income portfolio.
The effective tax rate for the quarter was 27.9%, higher sequentially which also impacted the PAT in Q1FY13.

PSL's PAT for the quarter came in at Rs 415.7 mn, up 1% sequentially.
As on 30th June, PSL's hedge position stood at Rs 107.75 mn at an average rate of Rs 52.91. The management mentioned that PSL has consistently followed the policy of hedging ~50% of its net open position on 12 months rolling basis.

PSL's cash and investments as on 30th June stood at Rs 3,596 mn while the total CapEx for the quarter came in at Rs 104 mn. As PSL completed the Hinjawadi and Nagpur projects in Q4FY12 the CapEx for Q1FY13 was on a lower side.