Why gung-ho about Persistent Systems IPO?

Firstly, a strategic investor is different from a financial investor. If some has love for product development and cutting edge technologies and want to be invested in Persistent Systems (PS), it is ok. However, a financial investor is quite picky as to what he is getting into and at what price. This piece is for a financial investor.

The question is “Should one be gung-ho about Persistent Systems (PS)?” I am trying to rationalize such optimism.

“We are different”: How clichéd this has become? The company says: “No really! We are different from other listed players?” PS delivers IT services to R&D wings of product companies. At the end of the day, it provides services as do other IT players. More importantly, R&D is discretionary in nature. So, this is the company which would get affected more than diversified IT player.

Revenue per employee: If they are really in a niche space where only the crème de la crème is recruited, why is their revenue per employee low? Assuming they do Rs 580 crores topline with 4500 employees, their revenue for employee is 13 lakhs. Its low compared to its midcap peers like KPIT -15 lakhs, Mindtree -15 lakhs and Sasken – 19 lakhs. It is even lesser than a large cap company like Infosys – 21 lakhs (with an employee strength of 1.1 lakh). PS only fares better compared to Infotech Enterprises which generates 13.3 lakhs per employee. All figures are FY10E. What niche are we talking about?

“Revenue growth CAGR of 40% in 5 years”: I struggled to figure out which five years. It was from FY05 – FY09. What about the recent five years? From FY06-FY10E, PS’s revenue growth is 22% CAGR. A change in one year reduces the impressive figure by almost half. It does only better than Sasken which has a Revenue CAGR of 16%. All others have fared well. KPIT – 23%, Mindtree – 23% and Infotech Enterprises – 35%. Interesting to note that both PS and Infotech Enterprises did sales of Rs 216 cr FY05. While Infotech will clock Rs 960 cr this year, PS will languish at Rs 580 cr.

“Impressive EBITDA & PAT margins”: PS’s EBITDA margin would be at 23% while that of KPIT & Infotech Enterprises are about the same. Mindtree & Sasken are lower at 19%. PAT of PS stands at 19% which is better than KPIT & Infotech which is at 16% and Mindtree & Sasken which is at 12%. The margins are just passable and there’s more story in RoE.

RoE:
KPIT has RoE of 34% which is 7% more than that of Mindtree and 15% more than PS. PS’s RoE is 18.7% which is comparable to 17.8% of Infotech and better than 13.7% of Sasken. The large cap stocks have much better numbers. For instance, Infosys has RoE of 31%.

At upper band, PS is valued at 11.3x FY10E. KPIT and Mindtree which have better RoE are valued at 10.3x and 11.1x FY10E numbers. Infotech has RoE of 12.7x. On a relative valuation basis, PS could have an upside of 12% to catch up with Infotech Enterprises.

Fairly valued at EV/Sales:
On EV/Sales metric, PS is at 2.1x which is same has that of Infotech Enterprises. It is higher than KPIT - 1.4x and Mindtree – 1.8x

According to me the gameplan should be the following:
Due to the salability of the management and the investments bankers, the issue will get a good response for sure. In terms of growth, the diversified players have a better opportunity than PS. Though the grey market premium is to the tune of 40% above the upper band of Rs 310, I think it would list and trade above 20% to upper band at around Rs 370. Better would be to shift to Mindtree or Infotech Enterprises which have better metrics and opportunities among the IT midcap players.