Persistent Systems Ltd - Initiating Coverage

8/4/2019 Persistent Systems Ltd - Initiating Coverage

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UniconWealthManagement

www.unicon.in

ong TermInvestmentCall

Initiating Coverage

CMP :309Rating:BuyTarget:381

Sector:InformationTechnology

0-Aug-11

PersistentSystemsLtd.

Investment Rationale:

Valuation:

Strong Presence in the Outsourced ProductDevelopment (OPD) Sphere

Growth in Emerging Technology Domainsto boost Top LineGrowth:

Intellectual Property (IP) driven Revenue to improve Operating ProfitMargins:

:

Investment in Sales & Marketing to boost Client Mining:

According to Zinnov, only 5% of the total global software development budget

is currently outsourced to third party OPD players. This is expected to grow in

the coming future and PSLis well equipped to capitalize on this situation. PSLs

estimated market share in the OPD space is around 15% in India. The

company's proven management and its strong relationships across the producteco-systemwill aiditsgrowthas outsourcing increases going forward.

PSL is focusing on four key themes Cloud Computing, Business Analytics,

Collaboration and Mobility to drive future revenue growth. PSL sees a big

opportunity to develop its capabilities within these sectors early on. As these

arehighgrowthsegments,thisfocuswillgiveitanedgeoveritspeersassoonas

these themes gain furthertraction. Currently, PSLderives nearly 40% of its total

revenue from these themes alone.

PSL dedicates nearly 4 - 6 % of its technical work force especially for high

yielding IP driven product development at any given time. Currently, revenue

from IP driven initiatives contribute only 6.1% to total revenue. We believe this

will increase to approximately 10% and 15% by FY12 and FY13 respectively, as

more IPunder development comes online andready for deployment.

Most of PSL's 300 active clients provide small sized (less than USD 1 mn)business to the company. Also 37 of its clients have annual revenue in excess of

USD 1 bn with R&D budgets of nearly 10 20% of their total revenue. This

provides a significant opportunity for PSL to tap into its current client base for

increased business. The company is investing in its sales & marketing teams to

aidinthisprocess.

We believe PSL, given its niche offerings and higher than average operating

margins, deserves a premium in comparison to its listed peers. The stock is

currently trading at 9.8x and 8.5x its FY12 E and FY13 E earnings. Historically,the stock has traded at 11.3x its Trailing Twelve Months (TTM) earnings. We

value the company at 10.5x its FY13 earnings estimate arriving at a price target

of INR 381 per share. We initiate coverage on PSL with a BUYrating, indicating

anupsideof23%fromcurrentlevels.

(INR mn)

Source:Bloomberg,UniconResearch

AasimBharde| [email protected]

Persistent Systems Ltd. (PSL) is a leading player catering to the unique outsourced product development space within the software

development industry. The company operates in the telecom, computer infrastructure and life sciences domains and is focusing on

developing capabilities in niche areas like cloud computing, business analytics, collaboration and mobility to complement its OPD

service portfolio.

270

320

370

420

470

520

570

Aug Sep Oct Dec Jan Feb Mar Apr May Jun Jul Aug

P ersisten t Nifty

KeyData

YearEnd

FaceValue(INR)

NSECode

ReutersCode

BloombergCode

SharesOutstanding(Mn)

MarketCap(INR Mn)

52WeekHigh/Low

BSESensex/CNXNifty

1-Year AverageVolume

KeyFinancials FY10 FY11 F Y12E FY13E

NetSales 6,012 7,758 9,984 11,631

EBITDA 1,464 1,583 1,902 2,254

EBITDA Margin(%) 24.3% 20.4% 19.1% 19.4%

NetProfit 1,150 1,397 1,258 1,452

NetProfitMargin(%) 19.1% 18.0% 12.6% 12.5%

EPS(Diluted) 32.1 34.9 31.5 36.3

KeyRatios FY10 FY11 FY12E FY13E

P/E(x) 9.6 8.9 9.8 8.5

P/B(x) 1.9 1.7 1.5 1.3

EV/EBITDA (x) 6.7 6.8 6.1 5.0

ROE(%) 18.0% 18.7% 14.9% 15.2%

ROIC(%) 36.9% 27.9% 15.8% 15.5%

ShareHoldingPattern June'10 June'11

38.9% 38.9%4.3% 7.0%

23.9% 24.6%

32.9% 29.6%Public

RelativePricePerformance

PromotersFIIs

DIIs

16,416/4,920

40.0

11,779

475/284

March

10.0

PERSISTENT

PERS.NS

PERSIN

65,210


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Persistent Systems Ltd.

Unicon Wealth Management

www.unicon.in

CONTENTS

Particulars Page

Company Background ..............................................................................................................................................3

Industry Overview .....................................................................................................................................................5

Investment Rationale ..................................................................................................................................................9

Financial Analysis & Projections .............................................................................................................................12

Risks & Concerns ......................................................................................................................................................15

Peer Comparison ......................................................................................................................................................16

Valuation & Outlook ................................................................................................................................................17

Management Profile .................................................................................................................................................18

Achievements & Triumphs .......................................................................................................................................19

Facilities .....................................................................................................................................................................20

Persistent Systems Service Bouquet .......................................................................................................................20

Financial Statements ................................................................................................................................................22


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Founded in 1990, Persistent Systems Ltd. (PSL) is a leading player in the niche Outsourced

Product Development (OPD) market within the Information Technology sector. The com-

pany caters to Independent Software Vendors (ISVs) across the entire product develop-ment value chain - product conceptualization, design, development, testing and support.

With its constant focus on innovation and improvisation in this niche sector, PSL has devel-

oped a strong employee base of nearly 6000+ employees to cater to its large clientele (239 as

of Q1FY12). The company's expertise and experience has helped it contribute to more than

3,000 product releases for various customers in the past five years. A major portion of the

company's revenue comes from the North American region (86% in FY11) due to a large

presence of ISVs in the continent. However, the company is increasing its presence in the

European and Asia - Pacific markets through acquisitions and setting up of delivery centers.

COMPANY BACKGROUND

Key Industry Verticals:PSL operates in three primary industry verticals viz. 'Infrastructure & Systems', 'Telecom &

Wireless' and 'Life Sciences & Healthcare'.

Infrastructure & Systems: PSL derives a majority share of its total revenue (69% in FY11)

from the 'Infrastructure & Systems' vertical. Under this vertical, PSL offers complete analyticsand data infrastructure solutions or components to its clients' software platforms. This data

is used to analyze company operations, thus allowing clients to gain comprehensive knowl-

edge about various factors affecting their business and develop solutions to improve effi-

ciency.

Telecom & Wireless: Around 20% of total revenue in FY11 was generated from the 'Telecom

& Wireless' vertical. Using its in-depth knowledge and expertise of existing and emerging

telecom technologies and business practices, PSL offers software solutions to telecom prod-

uct development companies and carriers across handset, wireless and wire-line industries.

Life Sciences & Healthcare: The 'Life Sciences & Healthcare' vertical's share is the smallest

in terms of the company's total revenue, contributing around 11% of total revenue in FY11.Under this vertical, the company provides data management, integration & warehousing,

data analysis - algorithms & visualization, data curation (automation of pipeline), web-based

portals & web services, and connectors to seamlessly interface with third party applica-

tions.

Telecom

&

WirelessInfrastructure

&

Systems

LifeSciences

&

Healthcare

Persistent

Systems

Ltd.

Source: Company, Unicon Research

Revenue Break - up Industry wiseIndustry Verticals

75% 68% 66% 69%

25%

20% 23% 20%

12% 11% 11%

0%

20%

40%

60%

80%

100%

FY08 FY09 FY10 FY11

Infrastructure Telecom LifeSciences


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New Initiatives focused on Growth:

The Indian IT industry is dominated by the traditional linear revenue growth model which

entails proportionate growth in revenue as employees are added to the client's billing pay-

roll. To break out of this model and prepare for the business environment of the future, PSLhas begun exploring new technology themes which will define the IT industry in the future.

The company has also dedicated a small portion of its technical workforce (around 4 - 6%) to

develop intellectual property (IP) to complement these themes.

The following table illustrates these new themes:

Going forward, these new technological themes can be key value generators for the com-

pany. Currently, these themes account for around 40% of total revenue.


Provides for better resource utilization through resource sharing and flexible pricing models like

pay-per-use.Thiswouldreduceexpensesandtimetomarketforproductcompanies.PSL isworking

with its clients to build the necessary components to enable them to deliver a high-performance

cloud computing platform so that their products function in a high resource sharing environment.

Allowscompaniestoidentifyandunderstandmeaningfulpatternsintheirday-to-daywork.This

permitsdecisionmakerstomakeeffectivedecisions.PSL assistsitsclientsbybuildinganddeploy-

ingtoolsandotherinfrastructurethatprocesseslargevolumesofdatathroughdatamining,statis-

ticaltechniquesandvisualizationtodeliverdomainspecificinsights.

Largefirmsaredevelopingcollaborationstrategiesinvolvingacommonplatformthatwouldper-

mitemployees,customersandpartnerstoconnectandinteractwitheachother.PSL developssuch

customizedframeworksforitsclientstointegratedifferentcollaborationtechniqueswithintheir

firms.

Overthelastdecade,smartphonepenetrationinthecorporatemarkethasgrownsignificantly. As

a result, mobile telephony product companies are selling mobile internet connectivity products to

handset manufacturers, wireless network manufacturers, etc. PSL has partnered with all major

playersinthiseco-systemandbuiltframeworkstoprovideanintegratedofferingtoclients.

CloudComputing

BusinessAnalytics

Collaboration

Mobility


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INDUSTRY OVERVIEW

The global software market is valued at approximately USD 300 - 320 bn in FY09. The Research

& Development (R&D) component of this market accounts for only 15% of this value or USD

45 - 48 bn. With almost half of the Independent Software Vendors (ISVs) in the United Statesof America (USA), almost 73% (USD 33 - 35 bn) of the total R&D spending comes from this

geography alone. Emerging markets like India and China have a minority share of around

15% in the R&D pie.

Furthermore, as most ISVs (especially those in the USA) have their own software development

teams, a major portion (95%) of the global R&D spending budget is done in-house. The

remaining 5% is outsourced to third party software developers.

GlobalSoftwareProductMarket

USD300-320Billion

TotalR&DSpend(15%)

USD45-48Billion

Others(85%)

USD272-285Billion

Concept(8%)

USD3.6-3.8Billion

Development(37%)

USD16.7-17.8Billion

QA/Testing(31%)

USD14.0-14.9Billion

Support/Sustenance(23%)

USD10.4-11.0Billion

UnitedStates(73%)

USD32.9-35.0Billion

*OtherDeveloped(12%)

USD5.4-5.8Billion

**EmergingGeo(15%)

USD6.8-7.2Billion

India=USD3.8-4.2Billion

China=USD2.0-2.4Billion

MatureProducts(75%)

USD33.8-36.0Billion

NewProducts(25%)

USD11.3-12.0Billion

TotalIn-House(95%)

USD42.8-45.6Billion

TotalOutsourced(5%)

USD2.3-2.4Billion

Note:

1.In-houseincludesoff-shoringto

Captivecenters

2.Outsourcedisonlytothirdparty

serviceproviders

A B DC

Source: Zinnov


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Outsourced Product Development:

Outsourced Product Development (OPD) is a niche portion of the Information Technology

(IT) industry wherein OPD service providers assist ISVs in the entire product development

cycle right from the conception stage to the maintenance stage. Different stages of theproduct development value chain are outsourced by ISVs to various OPD players depending

on the expertise and the track record of the latter.

During the growth stage (early stage) of an ISV's product, a small part of the development

process is outsourced. Processes like prototype design and evaluation are normally

outsourced to third party providers. Core processes like conceptualization remain with the

ISV. As these products enter the mature stage, a whole host of processes in the production

chain are outsourced, especially client specific upgrades to existing software, professional

services and deployment. As products enter the decline stage, ISVs' come to OPD players

for assistance regarding client migration to newer software and assistance with customer

support.

Technology Adoption

LifeCycleTime

Mature

MarketDeclining

Market

FaultLine!

Endof

Life

E

DC

B

Growth

Market

IndefinitelyElastic

MiddlePeriod

Market

Grow

th

A

Source: Investor Presentation - May 2011

Product Development Lifecycle

With products almost on the way of being phased out, ISVs usually share the IP of the product

with their third party OPD partners in exchange for royalty revenue at times.


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Difference between Regular IT Services and OPD:

In the IT industry, most projects are defined by three key variables viz. 'Client Requirements'

and the 'Time' and 'People / Money' needed to implement these requirements. In regular IT

services, projects with fixed requirements are handed to vendors who use 'Time' and 'Money'as variables to arrive at a cost estimate for the project. After the project is completed, it goes

under maintenance mode.

In the OPD segment, requirements are less clearly defined as the product objective is

broad-based at times and more than one version needs to be prepared before the product is

ready for launch. Hence requirements are not fixed. Instead, most product developers are

given deadlines before which the product should be ready for deployment. Once these

deadlines are decided, the budgets for the product are fixed.

Outsourced Product DevelopmentIT Services

Requirements(Variable)Requirements( )Fixed

Time(Fixed)Time( )Variable

People/Money(Fixed)People / M oney( )Variable


Thus, unlike a typical IT project where requirements are fixed and time & money are variable,

a product development project starts with fixed time and money constraints, keeping

requirements variable. However, in OPD projects, all requirements can never be completely

fulfilled in a particular version. As a result, developers plan multiple versions for their product.

Benefits of Outsourcing:

In the fast moving technology-heavy world of today, ISVs face intense competition to come

out with newer versions of products in shorter periods of time while making optimum use of

their limited resources on hand. ISVs efforts to achieve this short time-to-market is often

constrained by shorter product life cycles, technological obsolescence, increasing design &

engineering complexity and mounting cost pressures.

By outsourcing product development to third party OPD players, ISVs are able to:

Reduce costs

Utilize resources on hand efficiently

Focus on newer technologies

Reduce risk of failure (in case of established OPD players)


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Future Trends:

International Data Corporation (IDC) has forecasted a five-year compound annual growth

rate (CAGR) of 14% for R&D / Product Engineering (PE) services, reaching an estimated USD

65.7 bn in CY09 - 13 period. IDC defines R&D / PE Services as the taking over of the researchand development of a product company's value chain (in part or full) by a third-party services

organization. Over the same period, outsourced R&D spending (off-shore revenue) is expected

to grow at 19.1% CAGR to USD 16.1 bn.

As explained earlier, the current R&D spend that is outsourced to third party OPD players

constitutes only 5% of the total R&D budgets of ISVs. Going forward, with increasing costs

and an uncertain economic scenario in the Western markets, ISVs will be more inclined to

outsource more of their product development processes that do not form a core part of their

companies. As such, we believe the percentage of outsourced R&D in the global software

market would increase further allowing companies in the OPD space to capture this business.

Source: IDC

Worldwide R&D / PE Services SpendingWorldwide R&D / PE Services Offshore Revenue

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

0

5,000

10,000

15,000

20,000

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Spending(USDmn) Growth(%)

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

0

20,000

40,000

60,000

80,000

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Spending(USDmn) Growth(%)


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INVESTMENT RATIONALE

Strong Presence in the Outsourced Product Development (OPD) Sphere

Persistent Systems Ltd. (PSL) is one of the few players in the listed space whose core focuslies in the outsourced product development domain. PSL provides OPD related services

across the entire value chain spanning through different time stages of the software product

cycle. The OPD market is highly fragmented in India. However, PSL's 20+ years of experience

in this field sets it apart from its competitors. Also as per data from IDC, India's revenue

share from offshore product development is estimated at around USD 1.12 bn as of FY11.

PSL's USD 170 mn revenue suggests that it controls around 15% of the OPD market share in

India, making it one of the largest OPD players in the country.

With economic uncertainty looming over the western markets, there is a strong chance that

more R&D spending will be off-shored going forward as in-house R&D budgets of ISVs are

slashed while they continue to remain under pressure to roll out new products quickly. PSL is

well trenched to capture this growth by leveraging its expertise in this field and its specializedwork force. Having a presence across the value chain allows PSL to cater to ISVs with

products through different growth stages.

Unlike the usual IT services business, OPD players are seen as future development partners

of ISVs. We believe PSL is well on its way to scale up its business model going forward due

to its experience in this niche segment which spans over two decades as well as its

relationships with marquee clients like Microsoft, IBM, Agilent, etc. This would result in

better utilization of resources available on hand which would reflect positively on operating

margins.

PSL's strong and proven management team, its impressive client base and strong

relationships across the product eco - system will help it further consolidate its position in thevastly fragmented OPD space in India.

PSL Service Bouquet Early Market Growth Market Mature Market Declining Market

Product Engineering

New Technology Exploration

Time to Market Accelerators

Deployment & Support

Product Sustenance & End of Life Source: Company, Unicon Research

PSLs Services across the Product Development Lifecycle


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0Unicon Wealth Management

www.unicon.in

Growth in Emerging Technology Domains to boost Top Line Growth

In its bid to get ahead of its peers in the industry, PSL has identified key technology areas

which will fuel its future growth. These are:

Cloud Computing

Business Analytics & Intelligence

Collaboration

Mobility

Early investments in these key technology themes are yielding results for PSL. As of FY11,

nearly 40% of top line revenue was generated from these themes. Going forward, we believe

these themes will continue to improve revenue visibility for the company. Demand will be

fueled especially by Cloud Computing, which is expected to grow to nearly three times in the

CY09 - 13 horizon to USD 42.2 bn. Many large ISVs like IBM and Microsoft are planning to

allocate nearly 80 - 90% of their total R&D budgets on strategies regarding cloud computing.

This presents a significant opportunity for PSL to boost its revenues going forward. Suchcontracts also present PSL to improve revenues through the non - linear route (wherein fixed

investments yield higher top line growth).

Intellectual Property (IP) driven Revenue to improve Operating Profit Margins

A key factor that distinguishes PSL from its peers is its specific focus on developing IP

products, wherein it devotes around 4 - 6% of its technical workforce for the same. PSL's

focus lies in three main areas of innovation: platform innovation, product development process

innovation and domain specific innovation and has thus developed value added products

like time-to-market accelerators, connectors and integration service products. These high

gross margin products yield revenues to PSL in the form of revenue share agreements androyalty contracts.

In the FY08 - 11 period, PSL's IP driven revenue grew at a CAGR of 71%. As more of PSL's in-

house developed IP start to yield results, we expect PSL's IP driven revenue to grow at a

CAGR of 64% in the FY11 - 13 period.

We believe that IP-driven revenue as a percentage of total revenue can rise from the current

9% (FY11) to around 16% by FY13. Going forward, IP-driven revenue can easily touch 20 - 25%

in the next five years. This constant focus on non-linear growth would reflect positively on

EBITDA margins going forward. Despite the impact of wage hikes and investment in sales &

marketing staff, we expect margins to improve by approximately 75 bps in the FY11 - 13

period.

IP (% of Revenue)


0.00%

4.00%

8.00%

12.00%

16.00%

20.00%

Q1FY08 Q2FY09 Q3FY10 Q4FY11 Q1FY13E

IP(%ofRevenue)


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Investment in Sales & Marketing to boost Client Mining

Over the years, PSL has developed long term relationships with its clients through successful

project executions. As of FY11, PSL has nearly 300 active clients, of which nearly half of these

have had a relationship with PSL for over five years. Currently, nearly 240 clients generaterevenue for PSL in the 'less than USD 1 mn' range with average ticket prices in the range of

USD 500,000 - 750,000. As of FY11, nearly 94% of total revenue was generated from repeat

business. We expect this trend to continue with PSL increasing its business with a lot of its

existing clients going forward.

Also as of FY11, only 9 of PSL's clients contribute over USD 3 mn each to its revenues. This

figure has remained more or less constant over the past ten quarters. 37 of its clients have

annual revenue over USD 1 bn. These clients have R&D budgets in the 10 - 20% range of their

total revenue. The Top 10 clients account for nearly half of PSL's total revenue. This suggests

that there is a significant opportunity for PSL to increase revenue traction from its existing

clients going forward.

All this leads us to believe that besides improving on its niche offerings, the company can

benefit well by mining its existing client base. The company has increased investments in its

sales & marketing force significantly and has identified strategic accounts to enhance

business.

PSL has also adopted a 'Sell With' strategy wherein it partners directly with ISVs to develop

products. This has led to PSL develop the required expertise to deploy these products directly

for various clients of these ISVs. This strategy has unlocked access to potential new clients

who wouldn't necessarily approach third party OPD players like PSL for their requirements.

Access to new clients by piggy-backing on its existing clients does not need further

investments in sales personnel but provides additional business. This will give a boost to

PSL's top line in the coming quarters.

Top 1 / 5 / 10 Client Contributions No. of Large Clients (> USD 3 mn Revenue)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Q4FY09Q1FY10Q2FY10Q3FY10Q4FY10Q1FY11Q2FY11Q3FY11Q4FY11Q1FY12

To p 1 To p 5 To p 10

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.00

Q4FY09 Q1FY10 Q2FY10Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12


Strong Balance Sheet due to High Cash Reserves and Zero Debt

PSL has no debt on its books and has the capability to generate enough cash to sustain its

business going forward. The company has strong cash reserves on its books (approximately

INR 1 bn as of FY11) and is open to both organic and inorganic growth, especially in the

European and Asia - Pacific region as it tries to reduce its dependency on the North Americangeography (86% of total revenue as of FY11). In the FY11 - 13 period, we expect cash-flow

from operations to grow by 18% CAGR to INR 2.2 bn which in our opinion is more than

sufficient to spend on any capital expenditure that PSL may require during this period, pay

out as dividends or use for acquisitions.


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FINANCIAL ANALYSIS&PROJECTIONS

Revenue Building Forward on a Strong Foundation

Persistent Systems Ltd. (PSL)'s core focus in the unique outsourced product developmentspace and its' years of experience in this field provides it with a superior advantage over its

rivals. This is reflected from the company's revenues over the past few years which grew at

a healthy CAGR of 22% in the FY08 - 11 period despite flattish growth in FY10 which wit-

nessed the aftereffects of the financial crisis of 2008.

Revenue & Revenue Growth

Scaling up of PSL's existing client budgets, increased R&D spending all around and focus of

non - linear IP led initiatives like cloud computing, analytics, etc. would contribute to revenue

growth in the coming future. We build a 22% CAGR top line revenue for the FY11 - 13 horizon.

The management expects IP driven revenues to contribute 11% of total revenue in FY12. We

are building a 10% contribution to total revenue in FY12 by IP initiatives and expect this to

grow to 16% by FY13.

Operating Profit (EBITDA) Restarting its Gradual Uptrend

Historically, PSL has enjoyed healthy operating margins relative to its peers. However, the

company's increasing focus on investing in its sales & marketing resources as well as wagehikes to retain its talented and highly skilled workforce have led to pressure on margins in

the recent past. The company also dedicates 4 - 6% of its experienced staff especially for

development of in-house IP products which does not translate into revenues immediately.

PSL witnessed a nearly 400 bps decline in EBITDA margin in FY11 to 20.4% primarily due to

these reasons.

Investments in high growth technology areas and IP led initiatives will bear fruit in the near

future. As a result, we believe that margins should demonstrate a steady improvement in

the coming years. Going forward, PSL also has the following levers to improve margins:

Increased revenue growth from non linear sources (especially high margin IP

driven revenue) Uptick in billing rates

Increased utilization and improvement of the fresher experienced employee mix.

Decreasing impact of wage hikes

Reducing General & Administrative expenditure


0.00%

9.00%

18.00%

27.00%

36.00%

45.00%

0.00

3000.00

6000.00

9000.00

12000.00

15000.00

FY08 FY09 FY10 FY11 FY12E FY13E

Revenue(INRmn) RevenueGrowth(%)

CAG

R22%


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On the back of these levers, and the increasing focus of high margin IP driven revenue, we

expect operating margins to improve by around 80 bps by FY13 from current levels, despite

wage hikes and investment in sales & marketing staff in FY11. PSL's EBITDA has grown at a

CAGR of 21% in the FY08 - 11 period and is expected to grow at a CAGR of 19% going forward

by FY13.

EBITDA & EBITDA Margin


Billing Rate Trend (USD / ppm)Utilization Rate Trend

64.00%

68.00%

72.00%

76.00%

80.00%

Q1FY08 Q3FY08 Q1FY09 Q3FY09 Q1FY10 Q3FY10 Q1FY11 Q3FY11 Q1FY12


$3,300.00

$3,400.00

$3,500.00

$3,600.00

$3,700.00

$3,800.00

$11,200.00

$12,000.00

$12,800.00

$13,600.00

$14,400.00

Q1FY08 Q4FY08 Q3FY09 Q2FY10 Q1FY11 Q4FY11

OnsiteBillingRate OffshoreBillingRate

Ons

ite

Off

sh

ore

0.00%

6.00%

12.00%

18.00%

24.00%

30.00%

0.00

500.00

1000.00

1500.00

2000.00

2500.00


EBITDA(INRmn) EBITDAMargin(%)

CAGR

19%


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Net Profit Increased Taxes Spoiling the Party in the Near Term

PSL has so far enjoyed a low tax rate in the range of 2 - 7% as it had the advantage of the

Software & Technology Parks of India (STPI) tax breaks as well as benefits from being

present in Special Economic Zones (SEZ). This has permitted PSL to enjoy a healthy netprofit margin of around 18 - 20% in the past despite the increasing investment in IP led

initiatives. PSL has so far grown its net profits by 19% on an annual basis in the FY08 - 11

period. With the removal of these tax breaks, post the Union Budget of 2011 - 12, the effective

tax rate of PSL has shot up to 31% levels.

We have built a 31% tax rate in FY12 E and decrease it to 29.5% for FY13 E. We expect net

profit to decline by 10% (YoY) in FY12 due to the removal of the tax breaks. However, we

expect net profits to continue their uptrend going forward as top line improves, growing at a

CAGR of 2% in the FY11 - 13 period.

Net profit margins are expected to fall to 12.6% in FY12 from the current 18% due to the tax

hike and then improve to approximately 14% by FY13.

Profit & Profit Growth


Net Profit Margin Trend

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%


PATMargin(%)

-40.00%

0.00%

40.00%

80.00%

0.00

400.00

800.00

1200.00

1600.00


Profit(INRmn) ProfitGrowth(%)

CAGR2%


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Substantial Dependence on the North American Region for Revenue

Persistent Systems Ltd. (PSL)'s geographical revenue mix is largely skewed towards theNorth American (primarily USA) region. As of FY11, nearly 86% of total revenue came from

this region alone, while Europe and Asia - Pacific contributed 6% and 8% respectively. Economic

turbuluence in this region (as well as the Euro zone) could adversely impact PSL's revenues.

However, the company's geographical diversification, reflected by its recent acquisitions in

France and Japan, is a sign that the company is serious about this risk and would like to

mitigate it as much as possible going forward.

Rupee Appreciation Risk:

More than 90% of the company's revenues are in US Dollar terms while most of its expenses

are in Indian Rupees. PSL has an active hedging policy, as part of company strategy, whereinit hedges around 12 months of its net receivables with forward contracts. As of date, the

company has hedges around INR 48 per USD. However, any significant appreciation of the

Indian Rupee vis--vis major foreign currencies could significantly hurt our margin estimates.

Competition from Large Scale Players & Captives of Large ISVs:

PSL is a mid-sized player catering to the small but niche OPD space. Its larger peers like Tata

Consultancy Services have a small presence in the OPD space, but their focus lie in their

own respective domains. If these companies turn their attention in full-fledge to this space,

they will have the advantage of scale. Also multi-national product companies like IBM and

Intel have set up captive centers in India to outsource certain processes in their productdevelopment chain. Such competitors would eat into PSL's market share in the sector and

drive margins down.

Attrition & the Costs of Retention:

The Indian IT industry has always had attrition as its main problem. The issue becomes

more important for PSL as it employs only computer science graduates in its technical

workforce. In the world of ever increasing competition, we believe PSL's workforce could be

targets of poaching from rival firms, especially those who may be looking to expand in the

OPD space. A sudden rise in attrition could lead to shortage of bench strength and reduce

optimal usage of resources. As such, PSL will have to bear the pressure of wage hikes toretain and attract quality talent, affecting its margins going forward.

RISKS &CONCERNS


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PEER COMPARISON

Persistent Systems Ltd. (PSL) is a pure - play Outsourced Product Development (OPD) player.

There are no listed players in the Indian markets which are a perfect match for PSL as of now.

However, there are various listed entities that have a small to mid - level presence in theOPD space. MindTree gained a presence in this niche field after taking over Aztecsoft. Po-

laris Software, Geometric and Sasken Communication Technologies are the other peers

close to PSL in terms of its core business. Large cap players like Wipro, Tata Consultancy

Services, etc. too have a small presence in this space but for comparative purposes, we have

not included those in this evaluation.

PSL's forward operating (EBITDA) margins are strong compared to its peers. Its Return on

Equity (ROE) is comparatively less with respect to its peers. This is largely due to the effect

of taxes on its bottom - line. We believe that PSL can match this ROE going forward and evenbetter it in the future. The average peer-set ROE is 18.3% for FY13 E while that of PSL is 16.5%.

On the P / E front, PSL is trading at a slight premium relative to its peers in FY12 E. We believe

its unique position in the highly lucrative and niche OPD space justifies this premium over its

peers who don't have a presence as strong as PSL. For FY13 E, PSL is currently trading at 8.5x

its forward earnings, lower than its peer group. Also on the P / B parameter, PSL is trading at

1.5x and 1.3x its FY12 E and FY13 E book value per share which is similar to its peer group.

All of these evaluations lead us to believe that PSL is a strong value buy and there is tremen-

dous scope for a re-rating of this stock in the coming future.

Source: Bloomberg, Unicon Research*Hexaware Tech FY = CY = January - December

FY12 E FY13 E FY12 E FY13 E FY12 E FY13 E FY12 E FY13 E

Hexaware Tech. Ltd. 21068.3 14.2% 13.7% 18.8% 19.8% 11.6 10.3 2.0 1.8

MindTree Ltd. 13748.1 13.2% 13.9% 17.2% 17.4% 9.4 8.1 1.5 1.3

Polaris Software Ltd. 12906.0 14.0% 14.2% 18.3% 18.5% 6.2 5.4 1.0 0.9

Geometric Ltd. 2377.5 12.2% 12.8% 17.9% 18.8% 5.3 4.2 0.9 0.8

Sasken Comm. Tech. Ltd. 2566.6 14.2% 14.7% 10.2% 10.1% 5.3 4.9 0.6 0.5

Peer Average N.A. 13.8% 13.9% 17.8% 18.3% 9.1 8.0 1.5 1.3

Persistent Systems Ltd. 11779.0 19.1% 19.4% 14.9% 15.2% 9.8 8.5 1.5 1.3

P / E (x) P / B (x)Company

Market Cap

(INR mn)

EBITDA Margin (%) ROE (%)


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Persistent Systems Ltd. (PSL) is one of the few listed players in the niche outsourced product

development (OPD) segment of the software development industry. With increasing costs of

Independent Software Vendors (ISVs) and stricter deadlines to bring to market newer versions

of products, the outsourced product development industry is poised to grow strong in the

coming years. IDC is estimating a 19.1% CAGR in offshore OPD revenue growth in the CY09

- 13 period to USD 16.1 bn. PSL with its two decade long experience and expertise in this field

is a front running player to capture this growth momentum. PSL's increasing focus on the

non - linear revenue segments like Cloud Computing, Analytics, etc. and its IP product focus

would improve its operating margins, thus distinguishing it apart from its peers.

We are valuing PSL on a P / E valuation basis. The stock is currently trading at 9.8x and 8.5x

its FY12 E and FY13 E earnings. Historically, the stock has traded at 11.3x its Trailing Twelve

Months (TTM) earnings. We believe PSL, given its niche offerings and higher than average

operating margins, deserves a premium in comparison to its listed peers. Barring an adverse

negative economic slowdown in its western markets, PSL's future is very bright. We value

the company at 10.5x its FY13 earnings estimate arriving at a price target of INR 381 per

share.

We initiate coverage on PSL with a BUY rating, indicating an upside of 23% from current levels.

VALUATION & OUTLOOK


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MANAGEMENT PROFILE

Name Designation Background

Dr. Anand Deshpande Chairman, Managing Director & CEO

Dr. Anand Deshpande is a B. Tech graduate from IIT Kharagpur and has completed his

Masters and PhD in Computer Science from Indiana University, Bloomington (USA).He worked at Hewlett Packard Laboratories as an MTS from 1989 to 1990. In 1990, he

ounded Persistent Systems Ltd.

Hari Haran President, Persistent Systems Inc.

Hari Haran holds a BS in Engineering from IIT Kharagpur, an MS in Computer

Science from Illinois Institute of Technology, Chicago (USA) and an MBA from

University of Louisiana. He has over 22 years of work experience in the telecom, wireless

and broadband industry. His duties at PSL include Global Sales, Marketing and

usiness Development.

Nitin Kulkarni Chief Operating Officer

Nitin Kulkarni has a BE (Electronics) degree from Mumbai University and a ME

(Electronics) from Nagpur University. He brings with him over 18 years of work

experience delivering business solutions in various capacities in firms where he has

worked in the past like Infosys, Siemens and NELCO.

Dr. Srikant Sundararajan Worldwide Head of Corporate Strategy

Dr. Srikant Sundararajan is a B. Tech graduate from IIT Madras and has attained his

MS and PhD in Computer and Information Sciences from University of Illinois

Urbana Champaign (USA). He has nearly 20 years of experience that spans across

companies like HCL Technologies, Cognizant Tech Solutions, Hewlett Packard and

nformix (his own successful startup firm).

Ranganath PuranikEVP and Head, New Business

Initiatives & Portfolio

Ranganath Puranik holds a BE (Electronics & Telecommunication) from Karnatak

University and an MBA from Northwestern University, Chicago (USA). He brings with

him strong global experience in software, telecom, enterprise and global product

development having worked for GE, Motorola and Sasken in various roles spanning

almost 20 years. His duties at PSL involve business growth through new initiatives in

key technology verticals.

T. M. Vijayaraman Head, Persistent Labs

Vijayaraman has a BE (Electrical) from the University of Calicut and a post graduate

degree in Computer Science from IIT Madras. He brings to PSL over three decades of

experience in architecting, designing and building systems. He is responsible forcontributing technical insights from a customer facing perspective and guiding PSL in

investing for the future.

Rajesh Ghonasgi Chief Financial Officer

Rajesh Ghonasgi is a qualified Chartered Accountant, Cost Accountant and a Company

Secretary. His experience spans over 20 years in leading technology companies, handling

Finance and Legal functions. His responsibilities at PSL are managing all financial

activities like risk, planning and record keeping, as well as reporting to management.

Mike Kerr SVP - Sales

Based in Austin, TX (USA), Mike brings extensive sales and marketing executive

experience from his 30+ years with IBM. As Senior Vice President at Persistent, Mike is

responsible for leading the IBM sales effort and is driving work to build the overall

company value proposition and brand, executive level marketing messages and strategic

marketing.

Dr. Hemant Pande Chief Planning OfficerDr. Hemant Pande has completed his B. Tech in Computer Science from IIT Bombayand his MS, MPhil and PhD in Computer Science from Rutgers University, NJ (USA).

rior to joining PSL, he worked with Siemens and TCS.

Dr. R. Venkateswaran SVP, Head of Telecom Business Unit

Venkateswaran has earned his B. Tech and M. Tech in Computer Science from IIT

Bombay and has a PhD in Computer Science from Washington State University. He has

over 19 years of experience in the software industry, mainly in the telecom domain. Prior

to joining PSL, he was at Bell Laboratories and Lucent Technologies.

Vivek SadhaleCompany Secretary & Head Legal &

Investor Relations

Vivek Sadhale earned a BCom from Mumbai University in 1995 and a LLB from Pune

University in 2001. He is an Associate member of the Institute of Cost and Works

Accountants of India and a fellow member of the Institute of Company Secretaries of

India. He also passed Chartered Secretary exam the Institute of Chartered Secretaries and

Administrators, UK in the year 2002. He holds overall responsibility for legal,

compliance, governance investor relations and corporate secretarial matters.

Amrita Tahiliani Joshi Chief Marketing Officer

Amrita Joshi graduated Magna Cum Laude from UCLA with BA in Business Economics

and received her MBA with Honors from the Anderson School of Management at

University of California at Los Angeles. Her experience spans from buyer to consultant

to service provider. At PSL, she heads up all marketing efforts for the companys

roducts.


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www.unicon.in

Nagpur

Development

Centerbecomes

operational

Enteredastrategic

partnershipwith

Realcom(Japan).

Started

operationsat

'Pingala

Aryabhatta'

(Pune,India)

Setupa

branchoffice

atEdinburgh,

UK

Acquired

ControlNet

(India)Pvt.Ltd.(Goa)

Setupa

branchoffice

atTokyo,Japan

Convertedintoa

PublicLimited

Company.

Openedabranch

officeat

Rotterdam,

TheNetherlands.

Jointinvestment

byNorwest&

Gabriel.Investment

byIntelMaritius.

AcquiredPaxonix,

Inc.

AcquiredInfospectrum(US).

SetupPersistent

SystemsInc.,

Whollyowned

subsidiaryin

theUSA.

SuccessfulIPO

listingonthe

BSEandNSE.

EnteredintoJV

withSprintNextel.

Investmentby

Intel64LLC.

FormedPersistent

Systems&Solutions

Ltd.(Pune,India),

awhollyowned

subsidiary.

FormedPersistent

SystemsPte.Ltd.,

whollyowned

subsidiaryinSingapore.

Started

operationsat

'Panini'

(Pune,India).

Introduced

ESOPSfor

companystaff.

Incorporated

asPersistent

SystemsPvt.

Ltd.

2003-04 2004-05 2005-06 2007-08 2008-09 2009-10 2010-112001-022000-011998-99 1999-001990-91

Started

operationsat

'Bhageerath'

(Pune,India).

Completes20

yearanniversary.

Acquired Agilent

Technologies

(France).

Setupbranch

officesatOttawa

andVancouver,

Canada.

ACHIEVEMENTS &TRIUMPHS

Source: Company


20/24



www.unicon.in

Research: Persistent Systems Ltd. (PSL) tracks new developments in the technology and

software world on a constant basis. PSL develops a good understanding of the context and

market requirements through this research which enables it to stay ahead of the curve and

help customers incorporate new ideas into products.

Usability Engineering: Usability engineering is an approach to product development that

incorporates direct user feedback throughout the development cycle in order to reduce

costs and create products and tools that meet user needs.

Research

UsabilityEngineering

Prototyping

DevelopmentTesting&QA

PerformanceEngineering

Porting

Documentation

Training

SalesSupport

Deployment

TechnicalSupport

Maintenance

SenapatiBapatRoad,Pune(Operational) KarveRoad,Pune(Operational) SenapatiBapatRoad,Pune(Operational)

Verna,Goa(Operational) UnderConstruction(ArtistImpression) UnderConstruction(ArtistImpression)

Bhageerath AryabhataPingala Panini

Goa Hinjawadi,Pune Nagpur

FACILITIES

PERSISTENT SYSTEMS SERVICE BOUQUET

Source: Investor Presentation - May 2011

Source: Company Red Herring Prospectus


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www.unicon.in

Prototyping: Prototyping is the process of modeling, where PSL creates either throw-away

or reusable software pieces that are used to provide customers with a 'first-look' at how the

final product will look. Over the years, PSL has created an in - house pool of prototypes in

various domains to speed up any future development in those areas.

Development: PSL provides software development services to its customers either by tak-

ing complete ownership for an entire software product, or a portion of the product, or PSL

operates as an extended software engineering arm of its customers.

Testing & Quality Assurance: PSL's capabilities include performing a wide range of testing

services requirements testing, architectural and design verification, functionality testing,

usability testing, compatibility testing, compliance and certification testing and

internationalisation testing - i18N/L10N testing.

Performance Engineering: PSL provides a whole host of services to its customers regarding

Performance Engineering which include Performance Modeling, Evaluation, Analysis and

Optimization.

Porting: This is the process of adapting software so that an executable program be created

for a computing environment that is different from the one for which it was originally de-

signed.

Documentation & Training: PSL provide its customers with user guides and support docu-

mentation in connection with the systems they implement. PSL also develops comprehen-

sive training materials for its products.

Sales Support, Product Deployment and Technical Support: PSL provides its customers with

wide-ranging pre-sales, deployment and after-sales support. It also provides customers

with flexible teams to deploy and integrate with their customers' systems.

Deployment: PSL helps customers deploy products in their environments'. This also enables

PSL to learn about any shortcomings that arise in the product during deployment and can

also take feedback back to their engineers.

Technical Support: PSL provides 24 x 7 x 365 days support for several of its customers, who

are normally experienced systems operators. Hence PSL has a dedicated team comprising

software engineers and domain specialists to cater to such support calls.

Maintenance: PSL has long-term contracts to provide maintenance services to enhance and

optimize deployed software, to correct defects and deficiencies found during field usage as

well to add new functionality to improve the software usability and applicability.


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www.unicon.in

(INR Mn) (INR Mn)

(INR Mn)

FINANCIAL STATEMENTS


Profit & Loss Statement FY10 FY11 FY12 E FY13 E Cash Flow Statement FY10 FY11 FY12 E FY13 E

Net Sales 6,011.6 7,758.4 9,983.7 11,630.8 Profit Before Tax 1,240.7 1,503.5 1,831.0 2,065.8

Depreciation 335.2 423.9 596.2 779.0

Pe rs onne l Cos ts 3,687.4 5,123.0 6,875.4 8,097.7 Changes in Working Capital 126.4 48.1 (243.1) (321.6)

Ge ne ra l & Adminis tr ative Expe nse s 860.5 1,052.4 1,206.3 1 ,279.4 Tax Expe nse (247.5) (342.3) (573.0) (613.7)

Total Expenditure 4,547.9 6,175.4 8,081.8 9,377.0 Cash Flow from Operations 1,238.6 1,575.3 1,611.1 1,909.5

EBITDA 1,463.6 1,583.1 1,902.0 2,253.7 Purchase of Fixed Assets (476.4) (971.7) (2,100.0) (750.0)

Depre ciation 335.2 423.9 596.2 779.0 Purchase of Investments (7,089.0) (15,527.8) 0.0 (450.0)

Cash Flow from Investing Activities (1,141.6) (2,528.7) (2,100.0) (1,200.0)

EBIT 1,128.4 1,159.2 1,305.7 1,474.7

Other Income 112.3 344.4 525.3 591.1 Dividends Paid (21.5) (239.7) (251.6) (290.4)

Tax on Dividends (5.5) (40.2) (42.8) (49.4)

Profit Before Tax 1,240.7 1,505.3 1,831.0 2,065.8 Cash Flow from Financing Activities 1,636.1 (712.3) (294.4) (339.8)

Provision for Tax 90.5 107.9 573.0 613.7

Opening Cash Balance 163.2 1,917.7 999.9 216.7

Net Profit 1,150.2 1,397.4 1,258.0 1,452.1 Net Increase / Decrease in Cash 1,733.1 (1,665.7) (783.2) 369.7

Closing Cash Balance 1,917.7 999.9 216.7 586.4

Balance Sheet FY10 FY11 FY12 E FY13 E Financial Ratios FY10 FY11 FY12 E FY13 E

Share Capital 432.0 434.8 434.8 434.8 EBITDA Margin 24.3% 20.4% 19.1% 19.4%

Reserves & Surplus 5,957.9 7,036.3 8,000.0 9,112.3 EBIT Margin 18.8% 14.9% 13.1% 12.7%

Shareholder's Funds 6,389.9 7,471.1 8,434.7 9,547.0 Net Profit Margin 19.1% 18.0% 12.6% 12.5%

Deferred Tax Liabilities 45.1 30.1 30.1 30.1 RoA 22.2% 20.1% 15.8% 16.1%

Total Liabilities & Equity 6,435.0 7,501.1 8,464.8 9,577.1 RoE 18.0% 18.7% 14.9% 15.2%

RoIC 36.9% 27.9% 15.8% 15.5%

Gross Block 3,714.8 4,542.8 6,642.8 7,392.8

Less: Accumulate d Depreciation 1,881.2 2,281.5 2,877.7 3,656.7 Current Ratio 2.5 2.3 1.8 2.1

CWIP 484.8 604.5 604.5 604.5 Days Receivables 73 69 64 67

Net Block 2,318.4 2,865.8 4,369.5 4,340.6 Days Payables 104 75 66 64

Investme nts 1,561.7 2,500.4 2,500.4 2,950.4

Per Share Data:

Sundry Debtors 1,363.3 1,582.1 1,922.3 2,345.2 Diluted EPS 32.1 34.9 31.5 36.3

Cash and Bank 1,917.7 999.9 216.7 586.4 BVPS 159.7 186.8 210.9 238.7

Other Current Assets 339.9 226.2 233.0 241.1

Loans and Advances 637.5 869.2 969.1 1,095.1 Valuation Ratios (x):

Current Liabilities 1,710.3 1,602.3 1,806.1 2,041.5 P/E 9.6 8.9 9.8 8.5

Net Current Assets 2,548.1 2,075.1 1,535.0 2,226.3 P/B 1.9 1.7 1.5 1.3

Total Assets 6,435.0 7,501.1 8,464.8 9,577.1 P/S 2.1 1.6 1.2 1.1

EV/EBITDA 6.7 6.8 6.1 5.0

SOURCES OF FUNDS:

APPLICATION OF FUNDS :

Profitability Indicators (%):

Liquidity Ratios:


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www.unicon.in

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DisclaimerThis document has been issued by Unicon Financial Intermediaries Pvt Ltd. (UNICON) for the information of its customers only. UNICON is governedby the Securities and Exchange Board of India. This document is not for public distribution and has been furnished to you solely for your information andmust not be reproduced or redistributed to any other person. Persons into whose possession this document may come are required to observe theserestrictions. The information and opinions contained herein have been compiled or arrived at based upon information obtained in good faith from publicsources believed to be reliable. Such information has not been independently verified and no guarantee, representation or warranty, express or impliedis made as to its accuracy, completeness or correctness. All such information and opinions are subject to change without notice. This document has beenproduced independently of any company or companies mentioned herein, and forward looking statements; opinions and expectations contained hereinare subject to change without notice. This document is for information purposes only and is provided on an as is basis. Descriptions of any company

or companies or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as an offer, orsolicitation of an offer, to buy or sell or subscribe to any securities or other financial instruments. We are not soliciting any action based on this document.UNICON, its associate and group companies its directors or employees do not take any responsibility, financial or otherwise, of the losses or the damagessustained due to the investments made or any action taken on basis of this document, including but not restricted to, fluctuation in the prices of the sharesand bonds, reduction in the dividend or income, etc. This document is not directed to or intended for display, downloading, printing, reproducing or fordistribution to or use by any person or entity who is a citizen or resident or located in any locality, state, country or other jurisdiction where suchdistribution, publication, reproduction, availability or use would be contrary to law or regulation or would subject UNICON or its associates or groupcompanies to any registration or licensing requirement within such jurisdiction. If this document is inadvertently sent or has reached any individual in suchcountry, the same may be ignored and brought to the attention of the sender. This document may not be reproduced, distributed or published for anypurpose without prior written approval of UNICON. This document is for the general information and does not take into account the particular investmentobjectives, financial situation or needs of any individual customer, and it does not constitute a personalised recommendation of any particular security orinvestment strategy. Before acting on any advice or recommendation in this document, a customer should consider whether it is suitable given thecustomer's particular circumstances and, if necessary, seek professional advice. Certain transactions, including those involving futures, options, and highyield securities, give rise to substantial risk and are not suitable for all investors. UNICON, its associates or group companies do not represent or endorsethe accuracy or reliability of any of the information or content of the document and reliance upon it is at your own risk.

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Unicon Investment Ranking Methodology

Rating Buy Accumulate Hold Reduce Sell

Return Range >= 20% 10% to 20% -10% to 10% -10% to -20%

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Persistent Systems Ltd - Initiating Coverage

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