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Spark Capital: Persistent Systems 1QFY14 result review - Margin reset likely; Retain Add




Spark Capital Advisors(India) Private Limited


01 Aug 2013





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Persistent Systems 1QFY14 result review - Margin reset likely; Retain Add Persistent (PSYS) reported inline revenues of US$ 63 mn(up 1.5% qoq and 15% yoy) led by growth in services business (4.5% qoq). EBITDA margins declined 312 bps qoq to 19.7% owing to increased additions in technical and Sales front. HPCA revenues is expected to flow from 2Q and also to have a strong 2HFY14. Services revenues registered strong growth after few quarters of soft performance. We note that composition of growth is moving towards higher professional services resulting in higher onsite contribution. Management noted that they would reinvest benefits from rupee depreciation in driving higher revenue growth and targets PBT margin of 18%. We believe the reset of margin’s downward is a concern and reduce our EBITDA margin expectation by 250bps on a constant currency basis. We retain our ADD recommendation with a price target of Rs. 575, based on 9x FY15E EPS. US$ revenue growth of 1.5% qoq: US$ revenues grew 1.5% qoq led by growth in traditional business of 4.5% qoq. IP declined 12.9% qoq and grew 24% yoy. Growth in OPD business was led by strong onsite revenue growth of 14.6% qoq.(10.5% qoq volume growth and 3.9% qoq realizations). Growth was led by non top 10 clients, which grew 3% qoq. The company added 6 new accounts including 2 large multibillion dollar accounts. HPCA has an annual run rate of US$ 25 – 30 mn and revenues are expected to flow in as and when client contracts are renewed. Thus, it would take a year from acquisition (Feb. 2013) for the full impact to set in (i.e. 4QFY14) and incremental revenues flowing in from HPCA from 2QFY14 would drive better IP revenue growth in the rest of the year. Margins decline 312 bps qoq: EBITDA margins declined 312 bps sequentially on the back of onsite salary hikes, visa costs utilisation decline, HPCA transfer (290 bps decline) and increased S,G&A spend (160 bps decline) partial offset by currency gains (180 bps). 2QFY14 EBITDA margins would be impacted by offshore salary hikes of 8%-9% effective July and is expected to decline around 200 bps. For FY14E, we have modeled EBITDA margins of 20% vs. 25% in FY13. Retain ADD: We believe PSYS provides an opportunity to play the macro tech spend in the areas of cloud, mobile, social and analytics. But however for FY14E,US$ revenues growth could be inline with industry at 13.4% compared to 15% in FY13. We retain our ADD recommendation with a price target of Rs. 575 based on 9x FY15E EPS, in discount to other mid cap peers like Mindtree (10x FY15E EPS) to account for lower return ratios and FCFF yield.

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