Infinite Computer Solutions |
Credible transformation in play |
BUY
CMP: Rs170 Target Price: Rs250
n Infinite is a ‘credible transformation in play’ offering the highest EPS growth(26% CAGR over FY10-13E) in our mid cap IT coverage universe at attractive valuations
n Apart from strong revenue growth ( driven by aggressive client mining within a marquee client base), Infinite is likely to enjoy benefits of multi year margin tailwinds, in our view
n Estimate a 25%, 23% and 26% revenue, EBITDA and profit CAGR (28.4% US$ revenue CAGR assuming INR/US$ of Rs 45/$ for FY11, Rs 44/$ for FY12/13) over FY10-13E
n Growth at attractive valuations- Infinite trades at ~6x/4.7x FY12E/13E EPS, factoring in risks from high clients/vertical concentration. BUY with a March’12 TP of Rs 250
Credible transformation in play
Infinite Solutions is a ‘credible transformation in play’, given its transformation from a
‘nearly all onsite’ player to a ‘hybrid onsite-offshore’ player. To elaborate, while
Infinite’s revenues have grown at 22% CAGR over FY07-10, margins have
expanded by ~1400 bps over the same period, driving a near 8x jump in profits.
Infinite continues to gain from traction within its top client accounts (marquee names like
Verizon, IBM, ACS) wherein Infinite has been able to compete successfully against
more formidable Tier I competition helped by aggressive pricing/engagement terms.
This, in our view should drive (1) higher than peer revenue growth (we expect ~25%
revenue CAGR over FY11E-13E, (2) further uptick in margins as proportion of offshore
revenues and non linear revenues increase (we build in a modest margin expansion of
~100 bps over FY11-13E). We estimate a 28% US$ revenue CAGR over FY10-13E,
driving a 23% EBITDA and 26% profit CAGR over FY10-13E.
Large deals lend revenue visibility; should drive further improvement in
margins
A number of large deals with marquee client names like Motorola, ACS and iYogi etc
lend strong revenue visibility for Infinite ( Expect US$ 20 mn/40 mn revenues from
Motorola in FY11E/12E, iYogi ramping up to full capacity by Q4FY11). Further, despite
a 1100 bps+ margin expansion over FY07-11E to 16.2%, we see further scope for
margin expansion as (1) non linear deals ramp up ( eg Motorola) , (2) offshore % of
revenues increases ( offshore % of revenues has increased by ~570 bps YoY to 33.8%
in FY10) and (3) proportion of revenues from higher margin/ IP driven/non ADM
services increases (Share of non ADM revenues has increased from 22% in FY07 to
42% of revenues in Q2FY11)
Growth + Reasonable valuations, Initiate with a BUY and a TP of Rs 250
We estimate a 26% EPS CAGR over FY10-13E. Infinite currently trades at 6x/4.7x
FY12E/FY13E earnings of Rs 28.5/36.3 respectively. Despite some investor
apprehensions on high client concentration (top 5 clients accounted for ~82% of
revenues in Sep’10 quarter), more riskier revenue sharing large engagements, high
single vertical focus (revenues from Telecom and media accounted for 61%+ of
revenues in Sep’10 quarter) and poor free cash generation in the past, we believe that
valuations are attractive and warrant a re-rating given ~40% P/E discount to mid tier
peers. Initiate coverage on the stock with a BUY rating and a DCF based March’12 TP
of Rs 250.
About the company
Infinite Computer Solutions (India) Limited was incorporated in 2000 and is a leading global
provider of Application Management Services, Infrastructure Management Services (IMS)
and Intellectual Property (IP) Leveraged Solutions.
Infinite operates out of five delivery centers in India (including subsidiaries) – with two in
Bangalore, one each in Chennai, Gurgaon and Hyderabad. Company closed FY10 with
revenues of $141 Mn. The company had a total headcount of 4,178 at the end of Q2 FY11.
Infinite primarily focuses on Telecom & Media (57% of FY10 revenues), Healthcare (20% of
FY10 revenues) and Manufacturing (8% of FY10 revenues). The company has several
marquee client names like Verizon, IBM, ACS , Fujitsu and Motorola amongst others with
top client revenues at ~38% of revenues and Top 5 client revenues at ~84% of FY10
revenues.
Investment Rationale
Credible transformation in play
Over FY06-10, Infinite has transformed itself from an ‘almost onsite services vendor’ to a
‘hybrid onsite-offshore services vendor’, thereby driving an overall improvement in its
financial profile. We highlight that although the company saw a relatively subdued 16% US$
revenue CAGR over FY06-10, its operating profits grew by ~150%+ CAGR over the same
period (driven by ramp up in offshore delivery, which saw company expanding overall
EBITDA margins from near break-even levels in FY06 to 18.3% in FY10).
We see continuation of Infinite’s superior financial growth and hence, forecast ‘higher than
peers’ US$ revenue CAGR of 28% over FY10-13E, driven by ramp-up in existing marquee
client accounts
Top clients traction to drive ‘higher than peer’ revenue growth
Infinite’s top 5 clients account for 80%+ of FY10/H1FY11 revenues - significantly higher
than other mid-tier peers, where top 5 client concentration hovers around 30-40%.
However, high client concentration has not deterred Infinite’s revenue growth due to its
ability to mine several marquee client names like Verizon, IBM, ACS, Fujitsu, GE, Tellabs
etc. amongst others, resulting in a healthy US$ revenue CAGR of 22% over FY07-10.
Infact, Infinite’s revenues grew by ~34% in FY10 over a 24% YoY growth in FY09 as
compared to negative /flat YoY growth for other mid-tier peers.
‘Superior client mining’ helped by long standing relationships and flexibility
on pricing/engagement models
Infinite’s ‘superior than peers’ revenue growth has been driven by admirable client mining
within several marquee client names like Verizon, IBM, ACS, Fujitsu amongst others,
wherein in some cases, Infinite competes head on with much more formidable Tier 1
competition. In certain instances, Infinite has not only survived several rounds of vendor
consolidation exercises, but has also emerged as a credible alternative vendor.
Infinite’s success has been driven by more flexibility on pricing and engagement terms in
the form of
- more aggressive pricing as Infinite’s onsite rates are ‘atleast 20%’ lower than Tier 1 players,
- Willingness to enter into non linear/revenue sharing engagements, which require upfront investments on the part of IT vendors as well.
Infinite’s success with large clients is very well reflected in the fact that Infinite has 3 US$ 20
mn+ p.a client accounts (including the top client, which contributes US$ 50 mn p.a). In
comparison, peers like Mindtree and Hexaware have only 1 US$ 20 mn+ p.a client
accounts, despite having higher number of US$ 10 mn+ p.a accounts.
The secret sauce to Infinite’s success in our view has been its strong long standing
relationships with several marquee names and its ability to mine them over time. To cite an
example, Infinite’s relationship with its top client is almost a decade old with Infinite
surviving several rounds of vendor consolidation exercises. Infinite’s success at its top client
is not only evident from its ability to survive vendor consolidation but also from the fact that
it has the highest market share within the account. This is despite competing head on with
Tier I Indian offshore players like Infosys, TCS and Wipro. Infinite has seen a 37% revenue
CAGR from the top client as compared to 22% overall revenue CAGR over FY07-10.
Though top client concentration at ~33% of revenues remains higher than other mid-tier
peers, we expect top client revenue proportion to come down as ramp ups in other big client
accounts and new client won during FY10/FY11 kick in.
Recent deals reflect Infinite’s flexibility on engagement terms
Infinite’s deal with Motorola is a very good example of Infinite’s flexibility in engaging with
marquee client names. Under this deal, Infinite has taken over Motorola’s software enabled
short message service (SMS) and multi-media messaging service (MMS) platform. The
revenues (support fees+ variable charges) for Infinite have been linked to the messaging
volumes in such a way that fixed fees cover all of Infinite’s costs. Infinite expects revenues
of US$ 20 mn from this deal in FY11 and ~US$ 40 mn p.a starting from FY12 onwards.
APDRP contract: Reference point for similar deals in the international
markets
Infinite has also won a large domestic contract worth ~Rs 1.3 bn under the Restructured
Accelerated Reforms Program (R-APDRP), an initiative driven by the Government of India
in collaboration with State Governments. In this contract, which aims at reducing
transmission losses, Infinite is working primarily as a System Integrator. Despite being a
hardware loaded contract, company maintains that this project satisfies its cut off margin
levels of 15%+ over the entire life. Moreover, it believes that a successful execution of such
a large engagement would serve as a good reference point for similar opportunities in the
international market.
Ramp up on the iYogi contract to fully reflect in FY12 financials
Infinite signed a 3 yr engagement with iYogi Inc in Q4FY10 to provide L2 and L3 support to
iYogi’s customers across US, Canada, UK and Australia. Company has ramped up delivery
on the contract to ~700 associates by Q2FY11 end and expects to reach steady state
delivery stage by March’11 quarter ( at around 1,000 associates). We expect full impact of
the iYogi contract to reflect from FY12 onwards.
Multi year margin tailwinds provide comfort to our modest expansion
assumptions
Infinite’s operating margins have expanded by ~1400 bps over FY07-10 to 18.3% on
several counts namely (1) higher offshore delivery (offshore % of revenues have increased
to 34% in FY10 V/s 24.3% in FY07), (2) higher growth in non ADM business, primarily IP
driven /product development services and Testing services (non ADM revenues grew ~3x
over FY07-10 and accounted for ~37% of revenues in FY10) and (3) increase in proportion
of fixed bid and revenue sharing engagements (share of fixed bid and revenue sharing
business has increased from ~21% in FY07 to ~50% in FY10).
We see several margin tailwinds for Infinite that could possibly drive margins way higher
than our ‘modest margin accretion’ of ~100 bps over FY11E-13E in the form of
Higher proportion of business from non- traditional service lines – Infinite’s business
from IP driven /Product development services, Testing Services and RIM services
continues to increase faster than ADM services (note that revenues from ADM services
increased by ~14% CAGR, non ADM services grew by ~44% CAGR over FY07-10).
We believe that increasing proportion of business from non- traditional service lines
and newer clients are likely to further expand Infinite’s margins.
Increase in offshore delivery - Although Infinite has seen a reduction in offshore
proportion of revenues in H1FY11 on account of onsite ramp ups in some client
accounts; we see this reversing going forward. Infact, we believe that despite the
significant enhancement in delivery capabilities for Infinite, its onsite proportion of
business still remains significantly higher than peers and is a multi -year margin
tailwind.
DSO bloated on account of managed relationship with software major
Infinite’s receivables days appear bloated on account of its relationship with IBM, wherein
apart from the services that Infinite provides, it also manages relationships for other sub tier
vendors. Hence, the sub tier vendors route their billing and collections transactions through
Infinite, thereby inflating the values for both debtors as well as creditors. We note that while
Infinite only recognizes revenues net of pass through, receivables include the entire pass
through revenues thereby appearing high. We note that the DSO (after adjusting for Pass
through Sales) is significantly lower at 96 days at the end of Q2FY11.
Poor cash generation in the past, should improve going forward
Infinite’s acquisition of the Motorola platform in FY10 and acquisition of Comnet in FY08
has been a drain on its cash generation. We believe that its cash generation should
improve going forward as (1) company’s investments both on the Motorola platform as well
as the iYogi deal get completed and (2) company improves its collection from clients,
thereby reducing its debtor days
Estimate revenue, EBITDA and PAT CAGR of 25.5%, 23% and 26% over
FY10-13E
Infinite has reported a 24%, 99% and 97% CAGR in revenues, EBITDA and profits over
FY07-10, on account of the 1400 bps expansion in its operating margins. We expect Infinite
to sustain this impressive performance and have modeled in a 25.5%, 23% and 26%
revenue, EBITDA and profit CAGR over FY10-13E. We have assumed a 28.4% US$
revenue CAGR over FY10-13E, and model in exchange rates of Rs 45/$ for FY11 and Rs
44/$ for FY12/13 respectively. We expect Infinite to report earnings of Rs 23.7, Rs 28.5 and
Rs 36.3 for FY11, FY12 and FY13 respectively.
Growth + Reasonable valuations; Initiate with a BUY and a March’12 TP of
Rs 250
We estimate a 26% EPS CAGR over FY10-13E. The stock currently trades at 6.1x/4.7x
FY12E/FY13E earnings of Rs 28.5/36.3 respectively. Despite some investor apprehensions
on high client concentration (top 5 clients accounted for ~82% of revenues in Sep’10
quarter), more riskier revenue sharing large engagements, high single vertical focus
(revenues from Telecom and media accounted for 61%+ of revenues in Sep’10 quarter)
and poor free cash generation in the past, we believe that valuations are attractive. We
initiate with a BUY and a DCF based March’12 TP of Rs 250.
Financial Overview
Estimate 25.5% revenue CAGR over FY10-13E
Infinite has seen a 22% US$ revenue CAGR over FY07-10. Infact, Infinite’s revenue growth
has been outstanding at a 34% YoY growth in FY10 (over a 24% YoY increase in FY09)
while other peers have reported negative/flat growth in revenues. We estimate a 25.5%
YoY growth in INR terms over FY10-13E (28.4% US$ revenue CAGR over FY10-13E
assuming INR/US$ exchange rates of Rs 45/$ for FY11 and Rs 44/$ for FY12/13
respectively). Our revenue growth hypothesis hinges on ramp ups in existing large client
accounts as well as ramp up on new client wins like Motorola, iYogi etc.
Expect operating margins to expand by ~100 bps over FY11E-13E
We see several margin tailwinds kicking in for Infinite going ahead in the form of higher
proportion of revenues from (1) non traditional ADM business (non ADM higher margin
businesses have grown at 44% CAGR V/s 14% for ADM businesses over FY07-10), (2) non
T&M engagement models (fixed bid and revenue sharing engagements now account for
almost 50% of revenues for Infinite, For eg. Margins on the Motorola contract could be twice
the company’s overall margins at steady state) and (3) offshore delivery( Infinite’s offshore
% of revenues expanded by ~500 bps over FY10 alone before falling in H1FY11 on account
of ramp ups in large deals, which should reverse going forward). We expect a modest
expansion in operating margins by ~100 bps to 17.2% over FY11E-13E.
Estimate profit CAGR of 26% over FY10-13E
Infinite’s profits have grown nearly 8x over FY07-10, driven by a 22% US$ revenue CAGR
and ~1400 bps improvement in operating margins over the period. We see continuation of
Infinite’s financial profile and estimate a 26.4% profit CAGR over FY10-13E. We expect
Infinite to report earnings of Rs 23.7, Rs 28.5 and Rs 36.3 for FY11, FY12 and FY13
respectively. Infinite is unlikely to see a steep increase in tax rates (FY10 effective tax rate
at ~22%,which would increase to 25% for FY12/13 respectively) unlike peers, who are likely
to see a sharp increase in tax rates due to expiry of STPI tax holiday.
Key Risks
High dependence on fewer clients
Infinite suffers from high client concentration risk as compared to other mid-tier peers with
top 5 clients contributing ~82% of revenues. Higher dependence on a fewer number of
clients could impact Infinite’s financial performance adversely in case any large client
decides to shift business elsewhere. We remain cognizant of the above risk. However, we
point out to the fact that Infinite has not only survived several rounds of vendor
consolidation exercises but also grown its business with marquee client names like Verizon,
IBM and ACS.
Currency appreciation- a key risk. However, margin sensitivity lower on
account of higher onsite delivery
Infinite, akin to other IT services vendors is exposed to the vagaries of exchange rates.
However, we note that the EBITDA margin sensitivity for Infinite is lower as compared to
other mid-tier players on account of higher onsite delivery of revenues. Our calculations
suggest that for every 1% change in US$/INR , EBITDA margins get impacted by ~32 bps
for Infinite as compared with a 35-50 bps impact for other peers.
Valuations and Recommendation
Growth + Reasonable valuations. Initiate coverage with a BUY rating and a
Mar’12 TP of Rs250
We expect a 26% EPS CAGR over FY10-13E with earnings of Rs 23.7, Rs 28.5 and Rs
36.3 respectively for FY11, FY12 and FY13 respectively. Despite some investor
apprehensions on
(1) high client concentration (top 5 clients account for ~82% of revenues),
(2) high single vertical focus (Telecom and media alone accounted for 60%+ of
revenues) and
(3) riskier revenue sharing/non linear engagement models, we believe that
valuations are attractive and warrant a re-rating given ~40% discount to mid tier peers.
Initiate coverage with a BUY rating and a DCF based March’12 TP of Rs 250, which implies
~9x/7x FY12/FY13E earnings. Key risks to our call emanate from
(1) lower than expected revenue trajectory,
(2) higher than expected US$/INR appreciation.
