IDEA 2 ACT: Persistent Systems Limited

Buy - PERSISTENT

CMP (NSE) 09:24, 24 Sep

3,819.30 47.31.25%

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Sector

Information Technology

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Reco. Price

680

Period

1-Year

Target Price

809

upside

19%

Stop Loss

0

Last updated on

20 Jun, 2017

IBM - IoT deal in Alliance business to lead revenue growth
We expect strong traction in Alliance business on back of Persistent’s deal with its top customer IBM (28% of revenues). As per the revenue sharing deal; Persistent will help deployment of IBM’s Watson IoT (Internet of Things) platform. Persistent will also support IBM’s Continuous Lifecycle Management/Continuous Engineering (CLM/CE) product suite on Watson for the clients. Given the robust pipeline; US$ revenue from this deal may deliver 20% CAGR (FY17‐FY19E). Apart from the deal, Persistent provides services and product support to IBM and few other clients. Thus, Alliance’s (29% of revenues) US$ sales is likely to grow at 14.5% CAGR (FY17‐FY19E).
 
Digital and IP (Accelerite) - emerging growth drivers
Persistent is focused on Healthcare and Financial Services in Enterprise digital transformation and has sizable new contracts. Moreover, recent partnerships with Partners Healthcare and USAA (United Services Automobile Association) - a US based insurance & financial services company; provide decent revenue visibility. Its Digital segment’s US$ revenue grew by 50% YoY in FY17 on a lower base and is likely to grow at 30% CAGR over FY17-19E. Persistent’s IP business - Accelerite has strong portfolio of IPs - Radia, Aepona, Cloudstack, location etc. in product development services. We expect Accelerite’s US$ sales to grow at a CAGR of 12.5% (FY17-19E)
 
Operating leverage to lead margin recovery; minuscule H1B visa impact
We expect margins to improve as the IBM deal gains traction resulting into higher sales and cost rationalization (Persistent can realign employee cost after the first year of the deal). Also, increasing revenue share of higher margin segments - Digital (investment phase in this segment is over now) and Accelerite will help margin improvement. Therefore, owing to increase in blended utilization levels; we expect operating margin to go up to 17.4% by FY19E. Also, risk from tightening of H1B visa norms is limited since 45-47% of existing workforce in US is locals.
 
Outlook and Valuation
Persistent with its IBM deal and growing digitization business is the best bet in the niche IoT segment in the mid-cap space. We believe its timely shift of focus on IP and Digital will help it weather the changing dynamics in its traditional Services business (46% of revenues). The stock currently trades at 13.5xFY19E. The stock’s 5 year historical average is 17x1 yr fwd EPS.  Strong revenue visibility, margin recovery and strong net cash (Rs. 918 cr) and attractive valuations make us optimistic about its prospects. We recommend Buy with a TP of Rs. 809 (16xFY19E).
 
Financial Summary   
Rs. Cr FY15 FY16 FY17 FY18E FY19E
Revenue 1,891 2,312 2,878 3,109 3,449
Revenue (US$ mn) 309 352 429 475 531
EBITDA 390 414 465 522 600
EBITDA Margin % 20.6 17.9 16.2 16.8 17.4
Net profit 291 297 301 351 404
% Growth YoY 16.6 2.3 1.4 16.3 15.4
EPS Rs. 36.3 37.2 37.7 43.8 50.5
P/E (x) 18.7 18.3 18.0 15.5 13.5
ROE (%) 20.7 17.9 16.5 16.3 16.6
ROCE (%) 21.1 19.1 16.5 16.9 17.7
Source: Company, IIFL Research

Company Background
Persistent is a leading offshore product development player that helps build software products with services across all phases of the product lifecycle. Its services span around design, development, maintenance and enhance the functionality of the software products. The company caters to Infrastructure and Systems, Telecom and Wireless, Life science, Healthcare, and Financial Services. Its subsidiaries include Persistent Systems France S.A.S., Persistent Systems Malaysia Sdn. Bhd. and Persistent Systems Pte. Ltd. Given its adoption of a non-linear business model, the company’s business now is divided into Services, Digital, Alliance and Accelerite.
 
Services unit comprises of traditional software and product development services to customers. Alliance Unit is primarily focused on working with IBM on its Watson IoT platform. In this deal, Persistent’s engineering, analytics, and enterprise development expertise is leveraged to help IBM and its customers develop and continuously upgrade IoT applications. In Digital unit, Persistent has successfully become a trusted partner of Platforms like Appian and Salesforce. Accelerite unit is the products business of Persistent where the company takes over non-strategic products from other technology companies and adds value to these legacy products and delivers them to its customers. The company generates highest revenue from North America followed by Europe and Asia. 

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