Persistent Systems Ltd (Q1 FY12)

CMP Rs365, Target Rs430, Upside 17.8%

• Persistent Systems Limited (PSL) posted marginally better than expected dollar revenue growth at 6.3% qoq. Decent traction from sell-with business (8 new customers acquired) and the four focused verticals were the key growth drivers. Inorganically, Infospectrum contributed US$1.4mn to the revenues. In rupee terms, the revenues were up 5.2%, on the back of appreciation in the Indian currency vs. US dollar.
• Pricing was positive with the onsite rates increasing 2.3% while offshore rates were higher by 1.3%. Management remains sanguine on mixed based improvement in pricing due an expected increase in technology consulting, sell-with and IP led revenue streams.
• Management attributed the top Client de-growth (6% qoq) to seasonal weakness in the IP sales. As a result, the IP revenue contribution also decreased to 6.1% of revenues (from10.3% in Q4FY11). Non-top-10 clients drove the overall growth (+13% qoq). The company added 10 new clients during the quarter. Among geographies, NA grew by a modest 2% while Europe grew by 35% on the back of inorganic contribution (Infospectrum and French software business of Agilient Technologies).    
• PSL’s OPM remained flat qoq at 17.9% lower than our expectation of 18.5%, despite the fact that no major wage hikes were given during the quarter. Management cited pending onsite hikes, additional people on board and increased S&M costs as the major reasons for the flat margins. Utilization (restated after excluding IP based effort impact) increased to 72.7% (71% in Q4FY12) supported the margins. Net profit was down 17% qoq due to increase in tax rate to 31.1% (from ~5% last quarter). Management expects high-end services like tech consulting (having higher margin), IP led revenues, increased utilization and strong fresher addition to help improve the margin. 
• The Company added 260 employees (4% of Q4FY11 base), of which ~28 were added due to acquisitions (part of Agilient’s software business). On the back of proactive salary hikes in Q4, attrition reduced further to 18.4% as compared to 19.6% in Q4FY11. As expected, the company has guided for another round of wage hikes (7% offshore) in Q2FY12. The Company has also guided addition of ~2300 employees (1000 freshers and rest laterals).
• Persistent has maintained its guided dollar revenues for FY12 at US$220mn (~US$8mn from Infospectrum). The company sees strong IP led revenues (US$25mn for FY12E) in H2FY12 as a result of its ongoing investments with one of its top clients. However, we believe, the company guidance on improving on its FY11 net profit (Rs1395mn) is aggressive and expect net profit fall of ~12% yoy.
• We are satisfied with the decent qoq revenue performance posted by the company. Its investments in the four focus areas of cloud computing, mobility, collaboration and analytics continue to see traction as commented by the management. On-going investments in partnerships (e.g Cisco, Realcom), inorganic growth (Agilent’s French software business) and joint go-to-market strategy (e.g. Life Technologies) is expected to drive medium term growth. However, the flat margin in Q1FY12 and the strong wage related headwinds in Q2 means that the positives on revenue traction will not fully reflect in the earnings. Reduce FY12/13 EPS estimate from Rs31.3/41.6 earlier to Rs31/37.6. We expect the wait for investors to elongate post Q1FY12’s margin performance. Maintain BUY but reduce TP to Rs430 (Rs475 earlier).