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Spark Capital: 1QFY15 outlook review of Persistent Systems (Rating- Sell TP- Rs.910)




Spark Capital Advisors(India) Private Limited


31 Jul 2014





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1QFY15 outlook review of Persistent Systems (Rating- Sell TP- Rs.910) How does our one year outlook change? With flat US$ revenue growth in 1QFY15,Persistent (PSYS) requires at least 6% revenue growth in 2Q to clock in ~16% US$ revenue growth in FY15E to meet street expectations. Below 6% growth in 2Q would lead to substantial downgrades in both earning and multiple. With more corporate embracing SMAC especially cloud and Digital, Persistent would continue to see good momentum in both Platform and IP services. However with Traditional OPD still contributing ~60% of revenues, sustaining high revenue growth would be hinged on high growth in IP revenues Margins declined ~500 bps qoq owing to the increased investments in S&M and visa costs. With smaller deals sizes and higher client ramp up time than traditional IT in the SMAC space, it is inevitable for Persistent to make increased investments in its S,G&A activities. Margins would decline 110 bps to 17.9% in FY15E. Being in a sweet spot, PSYS provides an unique opportunity to play the macro tech spend in the areas of cloud, mobile, social and analytics. However trading at 15x FY16E earnings, in line with most Tier 1’s, we believe the risk reward is unfavourable. Further, being a quarterly volatile business current valuations are rich. Retain SELL with TP of Rs.910 (11x FY16E EPS) How does our 3 year Outlook change? With industry dynamics changing faster towards SMAC, having a early lead, could help PSYS sustain more than industry average growth in the medium term We expect continued addition to IP portfolio through taking over products from clients. We expect PSYS to have ~30% of revenues from IP and would aid margins Valuing PSYS at 15x FY18EPS yields a three year out price target of Rs.1,870 implying a 14.5% compounded return over a three year period. We believe the risk-reward is not attractive and our assumptions have downside risk from US macro-economic weakness.

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