initiating coverage psys in equity june 13, 2016...

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Lacks winning ingredients

Persistent lacks domain expertise and full-service offering; this will negate advantage of early entry in digital as competition intensifies. Management has been too cautious in pivoting from legacy business (ISV) and is ill-placed, especially in contrast to a true digital company like Globant (3x digital revenues despite starting 20+ years later). Further, recent IBM deal is unlikely to be a saviour (closer analysis reveals it is an ISV deal with a new pricing model). Consequently, EBIT growth will likely taper faster than consensus expects (our FY17-19E EBIT is 5-11% below consensus) with further risks from short-term nature of ISV/digital projects and client concentration (IBM at 25% of Mar-16 quarter revenue). So our TP implies 14x FY18E EPS vs current 17x 1-year forwardP/E (consensus). Initiate coverage with SELL (6% downside).

Competitive position: MODERATE Changes to this position: NEGATIVE Unique elements but not ‘successful’ digital Persistent has a 100% agile approach towards delivery, deep relationships with leading software companies/start-ups and specialist positioning. However, digital remains small (~US$100mn, Mar-16 annualised) and accounts for just 26% of revenues. In contrast, Globant was able to pivot quickly away from ISVs due to more aggressive investments (lower margin, more digital acquisitions) and is now a strategic partner for marquee clients (e.g. Disney, Electronic Arts).

Under threat from larger competitors As digital project sizes grow, larger competitors (e.g. TCS) are better placed givendomain expertise (salespeople can talk customer’s language), full-service offering (UX, analytics, cloud, testing, mainframe-integration under one roof) and low-cost structure (better pyramiding, utilisation). TCS is already working with marquee clients and its ability to reinvest in business keeps threat real.

Growth will start tapering Digital segment growth will taper to 16% by FY19E (vs. 35% in FY16A). Projectsfrom independent software vendors (ISVs) and enterprises are short-duration, making the business volatile and reducing scalability. Sales of software, often to small customers or through third party, have inherently low visibility and acquisitions have driven growth. The IBM deal will also not add materially to growth (FY17-19E CAGR of 20%).

Does not deserve more than 14x FY18 P/E To justify buying at CMP, the stock would have to be valued at 19-20x FY18 EPS. TCS trades at 19-20x given track record of remaining relevant for clients through multiple technology changes and pricing power (5-year EPS CAGR of 23% vs 16% for Persistent). Our TP implies 14x FY18 EPS which is at a slight premium to mid-sized peers (13x) that have a lower proportion of digital revenues.

INITIATING COVERAGE PSYS IN EQUITY June 13, 2016

Persistent Systems SELL

Technology

Recommendation Mcap (bn): `58/US$0.9 6M ADV (mn): `85.7/US$1.3 CMP: `717 TP (12 mths): `680 Downside (%): 6

Flags Accounting: GREEN Predictability: AMBER Earnings Momentum: RED

Catalysts

Slowing growth in digital segment as clients give large orders to larger peers (QoQ revenue growth rate to drop to 6-8% in FY17 from 10-15%)

370bps drop YoY in 1QFY17 EBIT margin.

Key upside risks to target price

The possibility of more deals like the IBM deal, which contributes 18% to our target price.

Acquisition bids by a strategic as well as a private equity firm, at a significant premium to market price.

Performance (%)

Source: Bloomberg, Ambit Capital Research

70

80

90

100

110

Jun-1

5

Jul-

15

Aug

-15

Sep-1

5

Oct

-15

Nov

-15

Dec

-15

Jan-1

6

Feb-

16

Mar

-16

Apr

-16

May

-16

Sensex Persistent

Research Analysts

Sagar Rastogi

+91 2 3043 3291 [email protected]

Kushank Poddar +91 22 3043 3203

[email protected]

Key financials Year to March FY15 FY16 FY17E FY18E FY19E

Net Revenues (` mn) 18,913 23,123 29,990 33,617 36,697

EBIT (̀ mn) 2,967 3,205 3,590 4,605 5,405

EBIT Margin (%) 16% 14% 12% 14% 15%

Diluted EPS (`/share) 36.3 37.2 41.4 48.0 56.2

RoE (%) 22% 20% 19% 19% 18%

P/E (x) 19.8 19.4 17.4 15.0 12.8

EV/EBITDA (x) 13.5 12.6 11.2 9.0 7.8

Source: Company, Ambit Capital research

June 13, 2016 Ambit Capital Pvt. Ltd.

Snapshot of company financials Profit and Loss (Consol) Year to March (̀ mn) FY16 FY17E FY18E FY19E

Revenue (US$ mn) 352 451 506 552

Revenue 23,123 29,990 33,617 36,697

Cost of goods sold 15,270 20,252 22,120 23,769

SG&A expanses 4,648 6,148 6,891 7,523

EBITDA 4,170 4,695 5,818 6,742

Depreciation 965 1,105 1,213 1,336

EBIT 3,205 3,590 4,605 5,405

EBIT Margin 14% 12% 14% 15%

Other Income 750 943 697 802

PBT 3,956 4,534 5,302 6,207

Tax 983 1,224 1,458 1,707

Rate (%) 25% 27% 28% 28%

Reported PAT 2,973 3,310 3,844 4,500

PAT Margin 13% 11% 11% 12%

Diluted Adj EPS 37.2 41.4 48.0 56.2

DPS 8 10 13 15

Company background

Persistent Systems is a mid-sized IT services company based in Pune. It helps independent software vendors (ISVs) like IBM and Microsoft build software products, helps enterprise clients implement digital platforms like Force.com or Skype and also does digital projects (e.g. mobile app development)for them. It derives revenues from sale of acquired products (IP-led). It recently signed a large product engineering deal with IBM, from which it would get a share of IBM’s revenues from two product suites instead of a typical time-and-material structure.

Persistent was founded in 1990 by Anand Deshpande. Its revenue has grown from US$10mn in 1996 to US$352mn in FY16. In its early years, it received funding from Intel Capital. It listed on BSE/NSE in 2010. Intel Capital exited its investment in 2011. Promoters hold 39% of the company and the estimated free float is 61% (Mar-16). It has about 9,300 employees (FY16) with offices across the globe.

Balance sheet (consol) Year to March (̀ mn) FY16 FY17E FY18E FY19E

Net Worth 16,393 18,766 21,394 24,490

Liabilities 27 27 27 27

Capital Employed 16,420 18,793 21,420 24,517

Net Block 4,453 4,848 5,316 5,815

Goodwill 175 175 175 175

Investments 1,348 1,348 1,348 1,348

Other Non-current Assets 1,954 2,263 2,521 2,724

Receivables 4,275 5,408 6,062 6,618

Unbilled Revenues 1,600 2,023 2,268 2,476

Cash 6,260 7,302 8,855 10,950

Other Current Assets 1,001 1,159 1,291 1,395

Current Liab. & Prov 4,646 5,732 6,415 6,983

Net Current Assets 8,490 10,160 12,061 14,456

Application of Funds 16,420 18,793 21,420 24,517

Cash flow (consol) Year to March (̀ mn) FY16 FY17E FY18E FY19E

PBT 3,956 4,534 5,302 6,207

Depreciation 965 1,105 1,213 1,336

CF from Operations 4,838 5,032 5,818 6,742

Working Capital Changes (724) (628) (348) (299)

Net Operating CF 3,102 3,180 4,011 4,736

Net Purchase of FA (1,647) (1,499) (1,681) (1,835)

Net Cash from Invest. (1,162) (1,202) (1,241) (1,236)

Proceeds from Equity - - - -

Dividend Payments (1,251) (936) (1,217) (1,404)

Others (15) - - -

Cash Flow from Fin. (1,266) (936) (1,217) (1,404)

Free Cash Flow 1,454 1,680 2,330 2,901

Net Cash Flow 674 1,042 1,553 2,096

Closing Cash Balance 6,260 7,302 8,855 10,950

Digital remains a small proportion of revenue

Source: Company, Ambit Capital Research; Note: * includes IBM deal.

Revenue growth will quickly taper for digital even as the rest of the business remains moribund

Source: Company, Ambit Capital Research

Revenue split (FY16)

ISV, 52%Project-based work for tech co.'s, many of which are gettingdisrupted by digital.

~25% of ISV revenue contributed by start-ups.

IP-led, 21%Sale of niche, mostly acquired software. Some of these were ISV projects, which now have a revenue-share pricing model e.g. recent IBM deal.

Digital, 26%Project-based work; mostly digital platform implementations

1%

35%

NA

21%

0%

21% 20%

10%

0%

12% 14%9%

0%5%

10%15%20%25%30%35%40%

ISV Digital IBM IP

Revenue CAGR (USD)

FY15-17 FY17-19 FY19-26


Exhibit 1: Porter analysis for the IT services industry (in context of a mid-sized company like Persistent)

Source: Ambit Capital research

Exhibit 2: SWOT analysis Strengths Weaknesses Delivery mindset suited to digital: Unlike peers, Persistent is used

to a more iterative development approach due to its work with ISVs. Early to identify new technology trends: Thanks to its work with

start-ups, Persistent is early to identify new technology trends (e.g. identified SMAC in 2008 whereas peers identified it in 2012).

Focus: Unlike peers who also offer legacy service-lines for enterprises like IMS, ADM for mainframes, Persistent only works on new technologies.

Relationships with leading digital platforms: Persistent has helped build some of them (like Salesforce) and is now able to sell through them to enterprises (e.g. it is Platinum partner of Salesforce for SMBs)

Poor domain knowledge: Persistent has been used to selling highly technical services to highly technical clients in ISVs but will need to build domain knowledge to sell to enterprises.

Volatile revenue stream: Its services revenue is project-based and can be shut down at 30 days’ notice and sales of its software, often to small customers or through a third-party have low visibility. For instance, its quarterly revenue growth has fluctuated from -2% to +4% in the past four quarters whereas TCS’s revenue growth has varied between +1% to +4% over this period.

Poor knowledge of legacy systems: To derive the full benefits of digital systems, they need to be integrated with legacy systems. Persistent does not have much knowledge of legacy systems.

Opportunities Threats Digital is a fast-growing market: We are in the midst of the biggest

technological change in the last 15 years. As per NASSCOM, Indian IT vendors would derive ~US$50bn of their revenues from digital, 23% of total IT-BPM industry then by 2020.

Internet of Things: With the acquisition of Aeopona and partnership with IBM Watson, Persistent now has a credible play in the Internet of Things opportunity. As per McKinsey, this could be a US$11tn opportunity by 2025.

High and increasing competitive intensity in digital: Given the large opportunity, all incumbents are moving towards digital and a number of new players have also entered.

High client concentration: In the Mar-16 quarter, Persistent derived 25% of revenue from just 1 client and 50% of revenue from 10 clients. This makes it vulnerable to any client-specific issues.

Difficult to scale: ISVs will not outsource work beyond relatively unimportant and non-core parts. Enterprises have been reluctant to award more than small, short-duration projects.

Highly acquisitive (5 acquisitions in FY16) and these carry high risks especially given the rapid changes in the technology sector.


Bargaining power of suppliers

LOW

India offers an abundant supply of cheap, qualified talent, especially at the entry-level.

Due to an under-developed manufacturing sector, there are few well-paying alternatives for engineers.

Bargaining power of buyers

HIGH

The global IT services industry is highly fragmented and Persistent's clients would have hundreds of alternatives to choose from.

Because Persistent's work is project-based, switching costs are also lower.

Competitive Intensity

HIGH

Growth has decelerated for almost all IT services companies and so competitive intensity has increased across all segments but more so in the fast-growing digital segment.

Barriers to entry

LOW

IT services is a low capital intensity business.

Large companies are increasingly open to giving one-off digital projects to relatively new, unproven vendors. Although, this is not the case for ISVs.

Threat of substitutes

LOW

Off-the-shelf software is the only, but poor substitute for the kind of work that Persistent does in the digital segment.

Offshore captives are a costly substitute for Persistent's work in the ISV segment.

Unchanged Improving Deteriorating


Good but not ‘successful’ digital play Unlike most competitors, Persistent has an agile mindset (rapid, iterative delivery suited for projects whose requirements are continuously evolving), deep relationships with leading software companies (including start-ups that helps it stay ahead of the technology curve), and specialist positioning (no legacy IT business). These have positioned Persistent well for helping enterprises execute small digital projects like building mobile apps and implementing digital platforms like Salesforce’s Force.com. The digital segment contributes US$104mn of revenue (Mar-16; quarterly annualised), which is good but not ‘successful’ in our minds; Globant, a much younger company, has built a completely digital business with revenue of US$293mn (Mar-16 quarterly annualised) and is a key vendor for large, marquee accounts like Disney and Electronic Arts.

Unique capabilities helped build franchise… Agile delivery mindset

Developing software for ISVs is different from traditional enterprise IT services projects. For instance, in a typical IT services project, the requirements or software features are fixed first and time and effort are the variables that are optimised later to get the best results. In contrast, software product companies typically start by defining the ship date first, budgets are planned next, and software features are the last to be fixed.

Digital work (for instance, creating mobile apps) is closer to building software products and requires a more iterative development approach, which makes Persistent better positioned than other IT services vendors.

Persistent also imparts agile development coaching to IT employees of some of its clients, which highlights its strong abilities in the area.

Also, it hires only computer engineers because its work requires significantly more technical knowledge than peers which hire engineers from different streams.

“Persistent was a top recruiter at my campus, not because of the salary but because we knew that it was going to be core development work from scratch. In contrast, I knew that if I joined TCS or Cognizant, I would spend a lot of my time on maintenance projects where I would just be staring at a screen waiting for alerts or at best, embedding small snippets in legacy code.”

- Ex-employee of Persistent Systems who worked in a delivery/engineering role.

"We are very keen to understand and capture the chronology of change that is being affected through Satyamev Jayate. Hence we were looking for a partner who can not only mine the relevant data, but also analyse and present it in a meaningful way. "

- Lalit Bhagia, VP, Digital, Star India on why it chose Persistent for analysing a TV series focused on social change, Satyamev Jayate

Early to identify new technology trends

Persistent works closely with leading software product companies and start-ups (~25% of ISV revenue, ~11% of overall revenue), which has provided it early insights into emerging technologies. Persistent identified SMAC as an important trend in 2008 much before Gartner did in 2012. Larger peers like TCS and Cognizant started talking about SMAC even later.

Its partnership agreement with IBM in February 2016 marks a similar foray into a promising future technology, IoT and continuous engineering.

Persistent’s ability to successfully grow in new technology areas by investing ahead of the curve differentiates it from its peers. While larger peers have been talking about IoT for a while, none of them have even 1% of their revenues from IoT today.

Digital work (for instance, creating mobile apps) is closer to building software products and requires a more iterative development approach.

Persistent identified SMAC as an important trend in 2008 much before Gartner identified it as a trend (2012).


Strong relationship with ISVs enables access to customers

Through its ISV business, Persistent gets insights into capabilities of various digital platforms and also a foot in the door for stitching partnerships with digital software providers like IBM and Salesforce. The company describes this as a “sell with” strategy, wherein it uses the ISV’s client relationships and brand to gain entry into large enterprise customers.

Exhibit 3: Persistent’s key digital partners

Partner What does it do?

Akumina Akumina’s platform, Interchange helps an enterprise’s employees collaborate more effectively for creating and managing digital content.

Amazon Web Services AWS is a collection of cloud computing services offered by Amazon.com.

Appian Appian’s tools are used for automating, measuring and optimising business processes.

Appnomic Systems AppOne’s performance benchmarking and monitoring platform and tools help to accelerate cloud migration and automate performance benchmarking.

Attivio Attivio’s Active Intelligence Engine allows customers to access accurate data quickly for strategic decision-making. Allotrope Partner Network Managing laboratory information for life sciences companies.

Bio-Modelling Systems

Bio-Modelling (BM) Systems and Persistent have collaborated in developing a solution that will address the pharma and cosmetic industries’ need for predictive modeling of skin-in-silico.

DataStax A database technology and transactional platform used by new age companies like Netflix, Adobe, Intuit, and eBay. Google Enterprise Professional Program

A partner program for developers, consultants, and independent software vendors interested in extending Google's enterprise search capabilities and in delivering complementary technology and services.

FIDO Alliance The FIDO alliance aims to work towards universal strong authentication which promises better security, more commerce and expansion of services throughout digital industries.

IBM Advanced Business Partner

In partnership with IBM, Persistent provides professional services for product customisation, cloud enablement, deployment, configuration, post implementation support and cross brand product integration.

LumenData LumenData is a leading provider of enterprise information management and predictive analytics solutions.

Mendix The Mendix App Platform enables companies to build, integrate and deploy web and mobile applications faster and with better results.

Motorola's PartnerSelect ISV Program Network

Persistent is working with Motorola in development of enterprise mobility applications on Motorola handsets and Enterprise Digital Assistants, for a variety of vertical domains.

Rackspace Rackspace is a managed cloud solutions provider. Rackspace delivers specialised expertise on top of leading technologies developed by OpenStack, Microsoft, VMware and others.

Sitecore Implementation Partner

Sitecore is a customer experience management company that provides web content management and multichannel marketing automation software.

Thunderstone Thunderstone Software develops and markets a suite of software applications and tools that search, manage, filter and retrieve information for individuals and global enterprises.

VMforce With VMforce’s enterprise cloud for Java, developers can build apps that are instantly social and available on mobile devices in real time.

VMware VMware provides cloud and virtualisation software and services.

Source: Company

For instance, a large US-based insurance company and a large US-based hedge fund first used Persistent Systems to deploy Appian. Similarly, Persistent got entry into a large US-based hospital and a telecom software provider through its relationship with Salesforce. Over a period of time, Persistent has been able to get other digital projects and generate revenue over several millions of dollars from each of these companies.

Differentiated positioning

Persistent positions itself as a niche vendor with differentiated capabilities. This makes the company’s pitch more effective when it markets itself to clients, technology partners, and employees.

No legacy to cannibalise

Unlike other IT service providers, Persistent does not have presence in businesses like enterprise package implementation and legacy application maintenance, which are getting cannibalised by digital initiatives. The company only provides digital-related services to clients. This makes Persistent more attractive to clients and also removes the inertia within the company that comes from disrupting one’s own business.

Persistent positions itself as a niche vendor with differentiated capabilities.


“Two speed IT model” to help ride digital wave

Persistent pitches its “two-speed IT model”, whereby clients use the services of niche vendors like Persistent for digital-related projects and depend on lower-cost players for maintaining legacy platforms and infrastructure. Technology research firm Gartner and McKinsey has also said that this “two-speed IT model” is an attractive way for enterprises to position their organisation for the digital wave while maintaining their legacy IT in an efficient and cost effective manner.

…but shift to digital is far from successful Strong growth, but on a modest base

Persistent has delivered robust revenue growth in the digital segment of 9% CQGR over the last seven quarters in USD terms (longer history is not available) to US$104mn (quarterly annualised basis), helped by: 1) a low base, 2) strong growth in the addressable market; the universe of digital software companies that we track registered an 8.1% CQGR over the period (USD terms), and 3) competitive advantages discussed above.

Exhibit 4: Persistent’s digital segment has seen strong growth due to rapid adoption of digital technologies and a low base

Source: Bloomberg, Company data. Note: W’day = Workday, S’now = ServiceNow, D’ware = Demandware, R’central = Ringcentral. S’force = Salesforce, C’stone = Cornerstone

Persistent’s enterprise digital transformation initiative has seen little success

Persistent has been aggressively marketing the concept of “enterprise digital transformation”, which involves end-to-end, large digital projects that larger companies are targeting. We reckon that it derives less than US$1mn of revenue p.a. (across clients) from such projects currently and even that is from Indian clients (a large media company and the state government of UP) which typically offer work at very low margins and, so, large IT services companies do not compete for this business.

Persistent has been opportunistic not strategic with respect to investments

A study of Persistent’s investments over the past few years reveals that while management has been value-conscious (most investments likely are expected to generate returns above cost of capital), it has not focused on building a successful digital business.

For instance, in 2011, Persistent invested `13mn in a JV with Sprint Telecom to offer telecom services in India. While small (1% of FY11 net income) and reasonably remunerative (11% IRR when it exited in 2015), this was a completely unrelated investment.

9.0%

12.9%

9.4% 9.1% 9.0%8.1% 7.4% 7.3% 6.7% 6.6%

4.7%

- 200 400 600 800 1,000 1,200 1,400 1,600

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thLast seven quarters CQGR (%, USD, LHS) Last quarter revenue (US$mn, RHS)

We reckon that Persistent derives less than US$1mn p.a. (across clients) from this.

A tiny proportion of its investments contribute towards building digital services capability.

http://www.mckinsey.com/business-functions/business-technology/our-insights/a-two-speed-it-architecture-for-the-digital-enterprise


It has also made three acquisitions which were similar to its existing ISV segment but did not add anything to push Persistent towards becoming a digital services company. These include Rgen (vendor to one of Persistent’s existing large ISV customers), the outsourced product development business of Infospectrum, and the captive of Agilent.

Persistent has to its credit made two acquisitions that add to its digital service capability. For instance, earlier this year, it acquired PRM Cloud Solutions, an Australia-based Salesforce partner. In 2016, it had acquired CloudSquads, a 20-people Bay-area-based start-up that had created social communities for over 70 global companies. The transaction size has not been disclosed, but we reckon that these account for only a tiny proportion of its overall investments.

IP investments add revenue/profits but do not add to digital capabilities

Persistent has acquired many software products from its customers. Persistent’s customers sell these products only for strategic reasons (change in focus, get rid of end-of-life software so that it can focus on newer products) and as long as the end-customers are happy, it is willing to let Persistent make high returns on its investment. For instance, Persistent worked with Intel on its IoT platform, Aeopona, and when Intel wanted to dispose it, Persistent was a natural choice. Persistent aims to achieve a payback period of less than three years in each of its investments.

Often, it appears that Persistent acquires these software products only to prevent a dip in revenue from the shutdown of its outsourced product development services to the client. Sometimes, these software product acquisitions also give Persistent a foot-in-the-door with large enterprises that would otherwise not have worked with it because of its small size. For instance, thanks to its acquisition of Location, Persistent got entry into a large Canadian telecom company. However, most of these projects are unrelated to digital (even the remaining are only tangentially related). We believe Persistent would have been better off investing in digital service capabilities, either organically or through acquisitions.

Exhibit 5: IP acquisitions have boosted revenue/profits but most of them are unrelated to digital service capabilities

Revenue (US$mn) FY16 FY14-16 revenue CAGR Description

HPCA/Radia 20 63% Helps management of servers, desktops, laptops, tablets, and smartphones as well as industry-specific devices like ATMs and POS devices.

IBM TNPM 13 0% Enables communication service providers (CSPs), large enterprises and utilities to manage network performance of both fixed and mobile networks.

Connectors 9 13% E.g. transfer data from Microsoft product from/to Salesforce product.

Rational + MDM 7 NA Software only tangentially related to IoT. See the section on the IBM deal on page 16.

Location 6 -11% Helps CSPs keep track of the location of the customers.

NovaQuest/PLM 5 0% Persistent is a value-added-reseller for Dassault Systemes’ software in the US.

Aeopona 5 NA Telco service enablement from creation, orchestration to execution; especially for IoT.

rCloud 4 0% Cloud-based recovery.

eMee 4 NA Tool for gamification.

Paxpro/Paxonics 2 -11% Software to ensure labels on FDA-regulated industries like Pharma are correct.

Cloudplatform NA NA Cloud management.

Akumina NA NA Digital content management solution.

Hoopz NA NA Contextual search.

Total 74 23%

Source: Company, Ambit Capital Research; Note: These numbers are approximate..

Case study of Globant makes the contrast very obvious

Globant is an Argentina-based digital services company. It is listed on the Nasdaq (mcap: US$1.3bn) with CY15 revenue of US$254mn and CY15 EBIT margin of 9%. Consensus expects CY15-17 revenue CAGR of 21% and the stock trades at 31x 1-year-forward earnings on consensus estimates.

Persistent aims to achieve a payback period of less than three years in each of its investments.

Globant’s strategy differs from Persistent in three key elements: (1) Focus; (2) Aggression of investments and (3) Aggression in capital raises.


It was founded in 2003, more than 20 years after Persistent. Like Persistent, its initial customers were ISVs like Google and Ebay, but it started shifting to offering digital services to non-technology firms in 2008 and today at least 40 Fortune 500 companies work with it.

Globant’s strategy differs from Persistent in three key elements: (1) focus; (2) aggression of investments and (3) aggression in capital-raising.

Within digital services, Globant has focused on only one aspect, which is to help its customers better connect with their respective end-consumers, i.e. the marketing budget. In line with this focus, about a quarter of its workforce consists of designers, so that the apps, web pages, etc. that it produces are of very high-quality. Globant even got WPP, one of the world’s largest advertising firms to invest in it in 2012. Sir Martin Sorell, the CEO of WPP, is on its board of directors and it leverages the WPP relationship to win new clients. It works with some of the world’s best brands like Coca Cola, Disney, Electronic Arts, one of the world’s largest banks and Southwest airlines.

Globant has been extremely aggressive with respective to investments. It operates at among the lowest EBIT margin in the industry (average of 6% over the past five years vs 17% for Persistent). It has made eight acquisitions, of which all except the first two added key digital capabilities.

Exhibit 6: Except for the first two, all of Globant’s acquisitions have added digital capabilities

Year Acquisition Capabilities

2008 Accendra Microsoft technologies

2008 Openware Security & infrastructure management

2011 Nextive Mobile and Social technologies

2012 Terraforum Innovation and Knowledge Management Consulting, Digital Marketing & Social

2013 Dynaflows Services over platforms

2013 Huddle Group Digital solutions for Media entertainment

2015 Clarice Internet of Things, Design

2016 WAE Digital marketing

Source: Company, Ambit Capital Research

Globant has frequently raised capital to fund its investments and the founders today hold only about 6% of outstanding shares (source: Bloomberg). In Persistent, the founder and his family own 39% of the outstanding shares.

For more details on Globant’s strategy and lessons for the broader Indian IT industry, see our note, “Digital lessons from Globant” dated 19th August 2015.

Organisational restructuring is directionally right step Persistent’s sales and delivery functions had been headed by different people. As we have seen in the case of Wipro in the past (see quotes below), such an organisation structure can hamper client mining and lead to volatility in margins because the sales and delivery heads are often forced to work at cross purposes. For instance, the sales head cares immensely about customer satisfaction but not so much about margins and so is likely to authorise work outside the scope of the project for free and/or overprovision resources. On the other hand, the delivery head’s performance is measured by margins and not revenue growth. So she/he is likely to adopt an aggressive stance when negotiating scope change requests and/or quickly replace senior resources on a project with junior resources. Wipro verticalised its organisation structure after TCS veteran Abid Neemuchwala took over as COO in 2015.

We like the fact that Persistent has also decided to verticalise the organisation structure by giving the responsibilities of both sales and delivery to the heads of each of four verticals (listed below).

http://reports.ambitcapital.com/reports/Ambit_Technology_DigitallessonsfromGlobant_19Aug2015.pdf


“Wipro takes a very short-term view and is immensely concerned with profitability. It quickly rolls off senior people, even when a project is in trouble. On the other hand, Cognizant takes a long-term view and ensures that our problems are solved. So when I need to decide who to give incremental work to, guess who I choose?”

- Regional CIO of a large financial services organisation which has both Wipro and Cognizant as its vendors (2012)

“Clients describe Wipro’s delivery as inconsistent—often in the same client, one project had excellent execution whereas another had bad execution. That’s probably because there is no uniform rule-book and these things get decided based on who’s the sales manager and who’s the delivery manager.”

- Industry analyst sharing feedback about Wipro’s delivery (2014)

Therefore, we like the fact that Persistent has verticalised the organisation structure by giving responsibilities of both sales and delivery to the heads of each of four verticals (listed below), who now report to the CEO, Anand Deshpande.

Digital Business is headed by Sudhir Kulkarni and includes enterprise digital transformation (EDT) projects and services related to the digital partner ecosystem.

Services Business is headed by Mritunjay Singh and includes business related to software development for ISVs except IBM and certain services provided to enterprises (e.g. data migration).

IBM Alliance Business is headed by Jitendra Gokhale and includes all the services related to IBM products (Watson IoT + existing software development work that the company is executing for IBM).

Accelerite is led by Nara Rajagopalan and includes the company’s IP-led business and internally created platforms.


Under threat from larger competitors We believe Persistent’s early entry into new technologies like digital and IoT will not be a competitive differentiator in the long run. Digital projects have already started to morph from small, point-based solutions to large, multi-service affairs which need to be integrated with the existing legacy systems to deliver full value – this provides an edge to traditional vertical-led, IT services vendors. Larger IT services companies have already built strong digital practices and have started investing in IoT. They have full-service offerings, stronger customer relationships, domain expertise, low-cost delivery capabilities that make them a preferred partner for customers.

Knowledge of legacy systems is now important Digital projects start as small, independent projects like building a mobile app or implementation of a standalone cloud-based ERP. However, to realise the full benefits of digital, clients need to integrate these with its existing legacy systems. They are unlikely to rip out the old systems and start from scratch because this would cause too much disruption to their business.

“A digital project goes through a number of stages - conceptualisation, design, maybe two or three different proof-of-concepts, then a final technology choice, then an implementation, first a point solution for the specific problem and then the integration with the back-end. The deal size is much larger at the stage where we need to integrate with the back-end.”

- Krishnakumar Natarajan, Executive Chairman of Mindtree

Domain-led culture is critical for larger digital projects To get the most value out of digital and other IT investments, it is crucial that the vendor has people with domain expertise in the industry vertical in which the client is operating. Clients prefer to work with vendors that have extensive experience and strong client references in a particular industry. Larger IT companies have an advantage here as they can justify investing in people with specialised domain expertise given that they can distribute this fixed cost over a larger revenue base. Persistent is not known for domain expertise in any particular industry (it focuses on Healthcare, Life-sciences, BFSI and Telecom verticals), although it is investing in this through new hires. However, we believe will find it difficult to change its culture to that of a domain-led company.

Also, vendors earlier needed capabilities in just one or two areas but now need to be experts in a number of areas and deliver these services in a holistic manner. This is easier for a company with a domain-led culture than a technology-led culture.

“Definitions of Digital are different for different companies. From our perspective, we have very specialised offerings in each of Personalisation, e-Commerce, Cloud, etc. for each of our verticals. For example, what personalisation means to an airline will be very different than what personalisation means to a retail company, which will be very different from what personalisation means to a hotel. We would have very deep understanding of how these trends affect each of our clients in a chosen vertical and that is why clients choose us as their partners to help them both mitigate the threats caused by Digital as well as leverage the opportunities thrown out by Digital.”

- Rostow Ravanan, CEO of Mindtree explaining how strong domain knowledge is a key differentiator for them in digital

Persistent has never worked on large, complex legacy systems of non-technology enterprises.

Persistent is investing in domain knowledge through new hires. However, it will find it difficult to change its culture to that of a domain-led company.


“For large digital projects, the success factors are not that different from large IT services projects. It is the ability to integrate a number of offerings in a holistic solution. These offerings will include user experience, content management, mobility, testing, customer relationship management, analytics, cloud. And then the integration with the back-end is supremely important. For a niche vendor that does not have capabilities in each service-line and has no experience of working with legacy systems, delivering a good customer experience will be a challenge.”

- Head of a digital practice at a large IT services firm

CIOs are again taking charge CIOs had limited role in small digital projects, which were often approved by just the marketing head, but had a bigger role in large projects. Leading IT services companies have strong relationships with the CIO organisations of large clients which are sticky in nature. This makes the tried and tested existing vendors a natural choice when clients seek to give out large projects, even in areas of new technologies. For example, at its recent analyst meet TCS said that 52% of its clients are working with it as their primary (exclusive or dominant) digital partner. Consequently, the scales are tilted against Persistent when it has to sell new services to clients that already have relationships with larger players.

“Yes, over the past 2-3 years, digital projects are being funded by the marketing budget and so smaller companies that attend the conferences that CMO’s go to have been more successful than traditional IT services companies that attend the CIO conferences. However, eventually, big digital work will happen through the IT budget. Business heads are highly involved, but they won’t start doing the CIO’s job.”

- Salesperson of a large IT services company

“The TCS salespeople are really tight with the CIOs of their clients and can make heaven and earth move instantly for them. For example, the CIO could request for 50 developers on a particular technology and the next week, if not 50, at least 40 will be available. There are very few companies that can do this and this matters much more to the CIO than expertise with any new technology. People can be trained in Agile, iOS development or AWS quite quickly.”

- Ex-employee in TCS’s R&D department

“The analytics team has been part of the marketing function so far. However, now it is being spun out into a centralised unit and we are also starting to work for the finance and HR teams.”

- Employee, analytics team, Fortune 500 retail company

Scale and low cost structure are important again

In the early days of digital, the cost factor was less important because project sizes were small and agility and quality were much more important than cost.

“Scale begets scale” in the IT services business. Large companies prefer to work with vendors with a proven track record in its area of expertise and employees prefer to work with larger companies because they get to work on larger, more complex projects. Apart from domain expertise, client relationships and a full suite of offerings, scale enables a company to better manage delivery processes and provide services at lower costs. Scale also benefits a company’s inorganic growth strategy as capabilities acquired from acquisitions could be instantly marketed to a larger pool of existing clients. Having a large scale also drives economies when investing in creating IP.

CIOs had limited role in small digital projects which were often approved by just the marketing head but they have a large role with large projects.

In the IT services business “scale begets scale”.


“There is tremendous pressure on CEOs and CMOs to deliver on digital, especially if they are facing a digital start-up or if one of their competitors has adopted digital. In such situations, they will go to anyone, even a small company, as long as it can say that it has done this before. Companies like Razorfish and Sapient Nitro, which are able to position themselves as hybrids of advertising and technology companies, are winning a lot of business. Right now, cost is no constraint, but eventually it will start to matter. Also, if you do business with a small company, there is no guarantee that it won’t get acquired or that the key people won’t leave. Finally, you need the company to have a strong recruitment and training engine so that it can offer resources on tap.”

- Salesperson of a large IT services company

Larger competitors are catching up in digital The digital projects that Persistent has been getting are of small ticket sizes (<US$1mn) as the digital wave is still at an early stage. Larger IT services companies with stronger client relationships and low-cost delivery structures are aggressively investing in building capabilities in digital through training, investments in IP and acquisitions (see our note dated 18 Mar 2016).

Despite being an early investor in digital (2008), Persistent has achieved only a US$100mn revenue run-rate. TCS, which entered digital only in 2013 (aggressively), has a run-rate of over US$2.6bn.

http://reports.ambitcapital.com/reports/Ambit_TataConsultancyServices_Evolvingbutstickingtobasics_18Mar2016.pdf


Growth to start tapering Persistent’s digital and ISV segments involve a high proportion of short-term projects which cloud visibility and make the business volatile. Sales of end-of-life software, often to small customers or through a third party, have inherently low visibility. This also keeps the company’s sales team busy in filling a leaking revenue bucket, which leads to increase in costs and pressure on margins. Hence, Persistent is unlikely to recover its EBIT margin even to its own peak of 20%. Further, we do not expect the IBM deal to add materially to revenue/profits.

Low visibility of revenue ISV segment

Many of its large ISV customers use Persistent only for a few weeks close to their annual launch dates and have no need for its services at other times. Also, in the current rapidly-changing technology environment, client priorities can quickly change with software product development efforts being shut down (with just a 30-day notice) despite Persistent doing a good job. This has happened several times in the past, making the revenue stream volatile. Also, Persistent generates 25% of its ISV revenue from start-ups, which are vulnerable to weakness in the funding environment and are likely to in-source their product development work as they become larger.

Exhibit 7: Persistent’s ISV segment has been very volatile


Digital segment

Persistent’s digital work is focused on change-the-business type projects (like building a mobile app or a Cloud-based tool) which have small ticket sizes (million dollar range) and short durations (a few months). Because these projects don’t impact day-to-day operations immediately, they can be deferred or cancelled if the client needs to quickly reduce costs or respond to changes in business strategy. Sometimes, employee churn at clients can also cause significant volatility. For instance, in early 2015, one of Persistent’s top-5 customers saw a change in management, which led to a shift in strategy and shutdown of some projects. So, Persistent’s enterprise digital segment delivered a revenue CQGR (USD) of 2.6% over the March 2015 and June 2015 quarters compared with its usual run-rate of 10-15% QoQ growth.

Larger companies, on the other hand, also provide run-the-business services like infrastructure management services or application maintenance which provide steady, annuity-like revenues. Contract durations for these services last for a minimum of three years and the total contract value of a large client can be easily over US$25mn.

Also, even as Persistent Systems is able to get entry into marquee logos, it is not able to mine clients effectively. Once the project (e.g., Salesforce implementation, building an app) ends after a few months, it often cannot find a new project to offer to the customer and the relationship dies. On the other hand, a large IT services company can keep growing by a “land and expand strategy” (see below).

1.6%

3.5%

0.5%

-3.1%

5.9%

-3.1%

0.0%

-6%

-4%

-2%

0%

2%

4%

6%

8%

Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16

ISV Revenue Growth (%, QoQ)

Due to the short-term nature of its projects and quickly changing client priorities ISV segment revenue growth has been very volatile.

Digital projects don’t impact day-to-day operations immediately, they can be deferred or cancelled.

Larger companies, on the other hand, also provide run-the-business services.

Lack of full-service capabilities also restricts accounting mining.


“In the Indian IT model, every person onsite is a salesperson and keeps looking for opportunities to add business. For instance, last year, we must have given my client some 200 ideas for application work across various technologies like SAP, Tableau, Java, .Net, etc. or for more offshoring, e.g. you have given us work in department X but if you give us department Y as well, your spend will go down even more. At least 100 of those were approved and we grew the account by 50% that year.”

- Software engineer working for a large Indian IT services firm

IP segment

Accelerite, Persistent’s brand which houses its key software products, positions itself as a provider of enterprise solutions for endpoint management, cloud, and mobility to organisations of all sizes — from small businesses to Fortune 500 enterprises. There is no focus on a specific vertical or customer size because most software products have been acquired by Persistent on an opportunistic basis.

This puts Persistent at a disadvantageous position compared to a similar-sized company (FY17E revenue of US$90mn) that was focused on a single product because it means that management bandwidth as well as sales and development effort would be split across multiple products.

Sequential organic growth in the IP-led segment (USD terms) for the past four quarters has been 0%, -7%, +9% and +17% respectively.

New IBM deal

The IBM deal suffers from the disadvantages of both the IP segment (lumpy revenue) as well as the digital segment (projects can be deferred or cancelled, unlikely to scale in a single client).

Low profitability To survive, the company needs to spend significantly higher (as a proportion of revenue) on sales and marketing, domain expertise and thought leadership, as well as development of intellectual property. This is because it has a smaller revenue base over which to spread these investments over compared to its larger competitors.

Persistent’s strategy is similar to successful digital companies like Globant, EPAM and Luxoft, which started out as companies focused on technology, often for ISVs, but have now successfully pivoted to working for enterprises. These companies have been able to grow at a faster rate but have done so by operating at lower margins.

So we are sceptical that Persistent will be able to recover its EBIT margin to its own peak-level of 20%.

“We are definitely concerned and looking at ways to improve margins but we have to run this as a long-term business rather than just as next quarter”; “…we are not going to hesitate to spend and invest if we have to get to where we need to go. And I think the opportunity is really good in the next few quarters and if we do not do that now we would regret it later. So, I do not want to let any growth go away at this time.”

- Anand Deshpande, CEO, Persistent Systems (Dec-15 earnings call)

Project-based nature of work also leads to higher S&M expenses

Given the limitations in increasing revenue from an existing client due to the short-term nature of projects, the company’s sales team has to focus on breaking into new clients and pitching new projects just to maintain revenue levels. The company also does not benefit from operating leverage with respect to these expenses because as discussed above, its mining ability is hampered.

There is no focus on a specific vertical or customer-size because most software products have been acquired by Persistent on an opportunistic basis.

We are sceptical that Persistent will be able to recover its EBIT margin to its own peak-level of 20%.


Exhibit 8: Persistent has to invest more in sales and marketing than peers

Source: Company, Ambit Capital research; Note: PSYS = Persistent Systems, NITT = NIIT Tech, HexW = Hexaware, LTI = L&T Infotech.

Exhibit 9: Persistent’s EBIT margin has been declining and is unlikely to recover even to its own peak levels


IBM deal: Not so great as it first appeared The company recently announced that it has partnered with IBM for two software product suites (Rational and MDM) that are integral to development of solutions around IBM Watson IoT offering. We expect revenue of US$55mn, ~12% of FY17E revenue from this deal (top-end of management guidance) and we expect it to scale to ~US$80mn by FY19. Because the costs are fixed, margins would be low initially (FY17E: -8%) but should eventually increase (FY19E: +9%, FY26E: +19%).

What is IBM’s role in IoT?

IBM is one of the leaders in the emerging field of IoT and has developed technology solutions for enterprises that combine the capabilities of its cloud platform (Bluemix), artificial intelligence platform (Watson) and IoT technology. IoT is a strategic focus for IBM; last year, IBM announced a US$3bn capital investment plan to develop IoT solutions. IBM supplies the underlying software platform and leverages its partner network for sensors, IoT devices, communication gateways, network, cloud and system integration.

What is continuous engineering?

IBM introduced continuous engineering in 2014 as an enterprise capability to develop sophisticated electronic products that are expected to empower IoT makers. These include: (1) analysing engineering data from multiple sources to enable better decision-making; (2) preventing rework by modelling physical systems though early simulations; and (3) maximising re-use. Click here for more information.

22.7%

19.5% 19.4%18.4%

14.2%

11.7% 11.3%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

22.0%

24.0%

Cyient PSYS NITT HexW KPIT Mphasis LTI

SG&A expense as % of FY15 revenue

13%

16%

19%

22%

25%

Jun-

12

Sep-

12

Dec

-12

Mar

-13

Jun-

13

Sep-

13

Dec

-13

Mar

-14

Jun-

14

Sep-

14

Dec

-14

Mar

-15

Jun-

15

Sep-

15

Dec

-15

Mar

-16

EBIT margin (%)

This could bring in additional revenue of ~US$55mn by FY17 and ~US$80mn by FY19.

http://www.ibmbigdatahub.com/blog/what-continuous-engineering


What are the key terms of the partnership?

As per the deal, Persistent will take over two software suites – Rational (excluding few old software products as per management, names not disclosed) and Infosphere Master Data Management (MDM) – that are integral to the development and maintenance of IoT solutions around IBM Watson. Rational contains software (see examples below) that help in the development of the IoT solution, running of the application (e.g. automated data collection from sensors which is forwarded onto IBM Watson) as well as maintenance (manage upgrades of the software on the sensors). MDM is a tool that ensures that there is a single master copy of the enterprise’s data.

Exhibit 10: Software examples (not exhaustive) in the IBM Rational software suite Software What it does?

Asset Analyser Analyses dependencies within various applications so that development teams can more efficiently deliver changes.

Application developer for Websphere Integrated tool for writing code, testing, analysis and delivery of distributed

applications, optimised for IBM platforms. Asset Manager A software library to enable fast development of code.

Change Change tracking and change control. Improves consistency and accountability when managing software changes.

ClearCase Version control, tool to enforce software engineering practices and automate certain code-building tasks.

ClearQuest Change and defect tracking, real-time reporting and lifecycle traceability. Collaborative Lifecycle Management Requirements management, quality management, change and configuration

management and project planning and tracking capabilities. Host Access Transformation Services

Extends legacy applications to the web, mobile, or as a web services without touching the existing application.

Performance Tester Validates the scalability of web and server applications.

Rhapsody Solution for modeling and design activities.

Stalemate Graphical design, simulation and prototyping solution for development of complex embedded systems.

Source: IBM website, Ambit Capital Research

IBM will continue to own the intellectual property for both products and sell these as before. However, Persistent Systems will be responsible for incremental development.

Persistent will add 500 employees as part of the deal, which includes taking over IBM employees (based in the US, the UK, Mexico and Israel) and facilities as well as hiring some additional resources in India and the new offices in Mexico and Israel for this. It will pay US$16mn to IBM (US$8mn upfront in FY16 and US$8mn in FY17) primarily on account of the facilities that have been taken over.

The timeline of the agreement has not been disclosed but management has indicated that the tenure is “fairly long term”. As per the agreement, Persistent will also get a preferred partner status for implementing IBM’s IoT solutions for enterprise clients.

What is the revenue model?

Persistent will generate revenue from three sources: 1) share of revenue from the products taken over; 2) developing its own custom solutions for clients on IBM’s platform; and 3) acting as a system integration partner.

Why is IBM parting with such an attractive product?

Any product or platform needs an ecosystem of system integrators to develop it. Also, IBM likely wants to focus on high-end software development work. Therefore, IBM is likely letting go of only the system integrator aspects and lower-end development work associated with this product. Also, it continues to own the intellectual property.

Why did IBM choose Persistent?

Persistent has a strong business relationship with IBM (1,000+ people working on IBM technologies at Persistent). We also noticed that the head of IoT at IBM, Chris O’Connor, who played a key role in this decision earlier headed IBM’s Tivoli product suite. Persistent Systems has been one of the main outsourcing vendors for Tivoli, which may have provided Chris comfort on its capabilities. Also, other larger system integrators like TCS may not have agreed to the level of investments (re-badging IBM’s employees, setting up offices and building IP) and/or the contract structure (revenue-share instead of fixed price or time and material-linked projects).

Persistent will add 500 employees as part of the deal, which includes taking over IBM employees (based in the US, UK, Mexico and Israel) and hiring of some additional resources in India.


“Persistent Systems, with more than 1,000 engineers dedicated to IBM platforms, will offer specialised services to help customers adopt the IBM Watson IoT stack and the IBM Continuous Engineering Solution. Anand Deshpande is one of many talented people at Persistent that makes me very excited we will be collaborating on developing IoT engineering solutions.”

- Chris O’Connor, General Manager, Internet of Things, IBM

“Yes, this deal is a positive for a small company like Persistent Systems. However, at our scale, we do not need to commit investments like rebadging employees or incurring R&D expenditure. If for a particular project, the client and us decide that IBM is best suited, IBM will happily work with us to make it happen. Also, we prefer not to take any sides in technology wars. For all you know, somebody else might beat IBM in IoT.”

- Senior employee of a large Indian IT services company.

What will be the impact on Persistent’s financial metrics?

We expect revenue of US$55mn (~12% of FY17E revenue) from this deal and expect it to scale to ~US$80mn by FY19, implying 20% CAGR over FY17-19E.

Costs for the IBM business mainly relate to employee expenses for the 500 people team that Persistent will build for development work. This total cost is likely to be US$60mn in FY17. The implied cost per employee would be US$120k, which looks high compared to the company average (US$30k/employee, LTM). However, it can be explained by the higher proportion of people in expensive locations like the US and the UK and a higher proportion of senior professionals with niche skills. Over time, the cost structure is also expected to improve as some of the higher paid resources will be replaced by resources in India. As the business grows, Persistent will only have to add people for the implementation of the product and sales. Because the costs are largely fixed, there is high operating leverage. We estimate EBIT margin of -8% in FY17E and +9% in FY19E.

Good deal, but growth likely to taper

Given the vast disparity in bargaining power between IBM and Persistent, we are sceptical of Persistent significantly benefiting from this deal.

IBM now contributes ~30% of revenue to Persistent Systems. IBM’s revenue is more than 200x Persistent’s (FY16) and there are thousands of IT services vendors that it could have partnered with. Our channel checks from the industry ecosystem (see below) are similarly sceptical.

“All product companies including IBM are extremely shrewd. They will not sell off a product or enter into a revenue-share agreement unless they know that it has stopped growing. Many vendors have tried, but not a single product deal like this has ever made US$100mn of revenue for a system integrator.”

- Senior employee at a large IT services company

We estimate EBIT margin of -8% in FY17E and +9% in FY19E.


Does not deserve more than 14x FY18 P/E On our proprietary CAPOM framework, Persistent significantly lags larger peers on almost all metrics and, therefore, deserves a lower valuation multiple. Dwindling competitive advantages should mean that growth will decelerate faster than consensus expects. We expect 5-11% lower EPS vs consensus over FY17-19 and we are pessimistic even further into the future. So our target price implies 14x FY18E EPS vs current 17x 1-year forward P/E (on consensus estimates). This is at a slight premium to mid-sized peers due to higher proportion of digital revenues. Because we model each segment separately, we can also express our target price as a sum of parts. The digital and IBM segments have been valued at 2.2x and 2.7x EV/sales (FY17) respectively which is not cheap considering that larger, faster-growing, pure digital companies trade at 3.0x. Our target price of `680, implies 6% downside from the current market price. So, we have a SELL stance.

CAPOM framework We use our proprietary CAPOM framework that we introduced in our thematic note, Expect continued divergence dated 10th July 2014, to analyse Indian IT services companies. The CAPOM framework ranks companies on Capital Allocation, Portfolio Mix, Operational Excellence and Management (soft issues).

Exhibit 11: Building blocks of the CAPOM framework

Component Sub-component

Capital Allocation Capex and acquisition efficiency, success of strategic acquisitions, excess cash on books

Portfolio Mix Current and aspirational geography/industry-segment/service-line mix, quality of work, client profile, client concentration

Operational Excellence Sales-related metrics (mining, hunting) and delivery-related metrics (attrition, utilisation, unbilled revenue days)

Management (soft issues) Organisation structure, management stability, management quality


Persistent lags its larger peers especially in terms of portfolio mix (poor revenue visibility and deteriorating competitive advantages in digital) and operational excellence (account mining is poor, low utilisation). Accordingly, we believe it should trade at a significant discount to large peers.

Our target price of ̀ 680 implies 6% downside from the current market price.

http://reports.ambitcapital.com/reports/Ambit_Technology_Thematic_10Jul2014.pdf


Exhibit 12: CAPOM framework – ratings summary

Component TCS CTSH Infosys Wipro HCL TechM LTI PSYS M’tree Comment

Capital Allocation

Persistent’s investment in ISV segment hasn’t been very successful and the company’s overall FY16 RoE of 20% is uninspiring.

Portfolio Mix

Persistent’s business is focused on short-term projects, which impacts growth and visibility. Also, Persistent’s enterprise digital business is not centered on strong domain expertise in certain focus verticals. However, the company now generates a high proportion of its revenue from fast growing enterprise digital and IBM IoT segments (39% of FY17E revenue). There is high client concentration risk given that a large share of its revenue (~25%) now comes from just one client.

Operational Excellence

Persistent has performed well on client hunting but has fallen behind on farming. Its employee utilisation is lower compared to large peers’ average.

Management and soft issues

Management has been successful in identifying new technology trends and leveraging its close relationships with ISVs to create new businesses. The recent verticalisation initiative improves the organisation structure of the company.

Overall

Overall, we believe Persistent should trade at a discount (14x) to the average multiple for large peers (16x).

Fair 1-year forward P/E (approx., assumes market at 16x)

20 20 19 13 17 15 14 14 15 We expect companies that rate higher on the CAPOM framework to have higher growth and margins in the long term, reflecting higher fair P/E multiple.

Current 1-year forward P/E* 19 19 19 14 14 13 NA 17 16

Source: Bloomberg, Company, Ambit Capital; Note: *Consensus for companies not rated; NR: Not Rated - Strong; - Relatively strong; - Average; - Relatively weak; CTSH: Cognizant, LTI: L&T Infotech, HCLT: HCL Technologies, M’tree: Mindtree, PSYS: Persistent.

We estimate 14% EPS CAGR over FY16-18E We have estimated revenue and margins segment-wise because of their wide variance across segments. So far, the company has reported only revenue segment-wise as many resources were shared across segments. However, we are hopeful that after the recent organisation restructuring, wherein each segment would have its dedicated sales and delivery team, the company could start reporting segment-wise margins as well.

Also, whereas the company plans to house the existing product engineering work for IBM (currently in the ISV segment) and the new product engineering work (IoT deal) under the same segment, we have separately modelled the new work because of the different pricing model. With a revenue-share agreement, Persistent should see sharp growth in revenue margins from this deal.

We estimate FY16-18E revenue CAGR (USD) of 20%. We estimate margins to be muted in FY17 due to the takeover of costs related to the IBM-IoT deal and later improve materially in FY18 and FY19 as the benefits from operating leverage kick in. This translates to FY16-18E EPS CAGR of 14%.

We have estimated revenue and margin segment-wise because of their wide variance across segments.


Exhibit 13: Key estimates

FY15 FY16 FY17E FY18E FY19E Comments

ISV (including existing business from IBM)

Revenue ($mn) 181 184 184 184 184 Management has indicated that it will exit some unprofitable contracts

Growth YoY NA 2% 0% 0% 0%

%age of revenue 59% 52% 41% 36% 33%

EBIT Margin (%) 16% 16% 15% 15% 15% Flat trajectory. Gains from exiting unprofitable contracts to be offset by wage hike pressures.

Digital Enterprise

Revenue ($mn) 69 93 125 157 183

Growth YoY NA 35% 34% 26% 16% Growth to taper as digital projects, where Persistent is less competitive, increase in size.

%age of revenue 22% 26% 28% 31% 33%

EBIT Margin (%) 16% 16% 15% 15% 15% Flat trajectory. Gains from operating leverage to be offset by continued investments in S&M.

IP-led

Revenue ($mn) 59 66 86 95 105

Growth YoY 20% 12% 30% 10% 10% High uncertainty due to inorganic component. We model 10% growth

% of revenue 19% 19% 19% 19% 19%

EBIT Margin (%) 14% 11% 13% 15% 17% Margins to recover as past investments pay off.

IBM deal

Revenue ($mn) - 8 55 69 80

Growth YoY NA NA NM 24% 16% We expect growth to decelerate sharply.

%age of revenue 0% 2% 12% 14% 14%

EBIT Margin (%) NA -16% -8% 4% 9% High operating leverage due to fixed costs.

Income Statement

Total revenues ($mn) 309 352 451 506 552

Growth YoY (USD) 13% 14% 28% 12% 9%

Growth YoY (Organic, CC) 13% 8% 13% 16% 13%

USD/INR 61.3 65.8 66.5 66.5 66.5 Spot rate

Revenues (` mn) 18,913 23,123 29,990 33,617 36,697

EBIT (̀ mn) 2,967 3,205 3,590 4,605 5,405

EBIT margin 16% 14% 12% 14% 15% Margin expected to dip in FY17 and recover in FY18/19 due to the impact of the IBM deal.

Interest income 463 527 606 697 802

Forex income 469 223 337 - -

PBT 3,900 3,956 4,534 5,302 6,207

PBT margin 21% 17% 15% 16% 17% Management had guided to an aspirational range of 18-20%.

Tax rate 25% 25% 27% 28% 28%

PAT 2,906 2,973 3,310 3,844 4,500

EPS 36 37 41 48 56

Growth YoY 17% 2% 11% 16% 17%

Balance sheet and cash flow

Receivables (days of sales) 69 67 66 66 66

Unbilled revenue (days of sales) 15 25 25 25 25

Capex as %age of sales 5% 7% 5% 5% 5%

Dividend pay-out ratio 32% 25% 28% 32% 31%

Source: Ambit Capital

Our margin growth estimates differ from consensus As seen in the exhibit below, our revenue estimates are in line with consensus but our EBIT margin trajectory is different. We believe the consensus EBIT margin of 13.1% for FY17 (110bps YoY decline) incorporates 200bps impact from the IBM deal but also builds in improvement in margins for other segments by pulling available levers (as suggested by management during the last earnings conference call). Our assumed margin trajectory reflects the operating leverage present in the new IBM deal and assumes little improvement in margins for other segments.

Our FY17-19 EPS estimates are 5-11% below consensus estimates.


Exhibit 14: Ambit estimates vs consensus FY16 FY17E FY18E FY19E

Revenue (̀ bn) Ambit 23.1 30.0 33.6 36.7

Consensus 30.0 34.4 37.2

% difference 0% -2% -1%

EBIT (̀ bn)

Ambit 3.2 3.6 4.6 5.4

Consensus 3.9 4.8 6.0

% difference -8% -5% -10%

EBIT Margin (%) Ambit 13.9% 12.0% 13.7% 14.7%

Consensus 13.1% 14.1% 16.1%

% difference (110bps) (40bps) (140bps)

EPS Ambit 37 41 48 56

Consensus 42 51 63

% difference -2% -5% -11%

Source: Bloomberg, Ambit Capital research

Expensive compared to peers Persistent’s FY17E P/E of 17x looks artificially high because of the IBM-deal-related margin dip. So for the purpose of relative valuation analysis, we compare Persistent’s FY18E P/E (15x) with peers given that it is based on more normalised margin estimates.

Persistent’s current valuation at 15x FY18 consensus EPS estimate puts it in line with large-sized peers and at a ~30% premium to mid-sized peers.

Exhibit 15: Comparative valuations

Company Mcap Rev CAGR Revenue Growth EV/Sales EV/EBITDA P/E RoE

US$ mn US$ FY13-16 FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 FY13-16

Persistent 851 13.9% 28.2% 12.1% 1.7 1.5 10.8 8.7 17.2 14.8 25.4

Indian Large IT Cognizant 36,952 19.1% 11.1% 13.0% 2.4 2.2 11.3 10.0 20.3 18.0 17.5

HCL Tech 15,869 11.2% 14.6% 14.0% 2.0 1.8 9.8 8.4 13.6 11.7 38.4

Infosys 40,620 8.7% 13.8% 14.9% 3.3 2.9 12.4 10.5 18.6 15.8 34.5

TCS 75,433 12.7% 10.5% 13.2% 3.9 3.5 14.1 12.5 19.2 17.0 58.6

TechM 7,815 15.3% 3.5% 10.6% 1.7 1.6 9.4 8.1 13.4 11.9 29.8

Wipro 20,183 5.7% 8.9% 9.8% 2.3 2.1 10.4 9.5 14.4 13.2 24.3

Mean 12.1% 10.4% 12.6% 2.6 2.3 11.2 9.8 16.6 14.6 33.9

Median 11.9% 10.8% 13.1% 2.4 2.1 10.8 9.8 16.5 14.5 32.1

Indian Small IT Cyient 839 11.0% 12.6% 12.9% 1.4 1.3 9.9 8.5 14.3 12.7 23.0

Hexaware 959 9.3% 10.6% NA 1.7 1.5 10.3 8.9 15.5 13.3 25.1

KPIT 547 5.9% 7.9% 9.1% 1.0 0.9 6.9 6.4 11.7 10.4 19.6

Mindtree 1,607 17.9% 18.0% 15.2% 1.8 1.6 10.5 8.8 15.7 13.2 32.6

Mphasis 1,686 -4.6% 3.7% 10.0% 1.4 1.3 9.0 8.1 14.0 12.8 22.3

NIIT Tech 488 3.2% 7.9% 10.6% 1.0 0.9 5.7 5.1 10.6 9.5 24.7

Mean 7.1% 10.1% 11.6% 1.4 1.2 8.7 7.6 13.6 12.0 24.6

Median 7.6% 9.3% 10.6% 1.4 1.3 9.4 8.3 14.2 12.7 23.9

Digital Companies EPAM 3,717 27.8% 28.1% 20.2% 3.0 2.5 16.3 13.6 35.1 28.8 16.1

Globant 1,355 24.9% 24.9% 19.6% 4.1 3.4 20.1 17.4 35.5 29.0 12.7

Luxoft 2,061 NA 25.1% 21.7% 3.0 2.5 15.9 13.8 31.2 26.0 36.0

Mean 26.4% 26.0% 20.5% 3.4 2.8 17.4 14.9 33.9 27.9 21.6

Median 26.4% 25.1% 20.2% 3.0 2.5 16.3 13.8 35.1 28.8 16.1



Comparison with large peers: Persistent deserves to trade at a discount to the larger IT companies (vs in-line currently) because it lacks competitive advantages related to scale (cost structure, domain expertise, ability to invest in IP, full service offering, and diversification). Besides, Persistent’s business model offers low visibility compared to sticky client relationships and annuity-like projects enjoyed by the large peers. However, the fact that Persistent has no exposure to legacy IT business lines like ERP implementation is a positive.

Comparison with mid-sized peers: Persistent deserves to trade at a premium to mid-sized peers due to its better portfolio mix (higher exposure to fast-growing digital segment). Currently, it trades at a 30% premium.

Comparison with Mindtree: Given its high share of revenue from digital, Mindtree is Persistent’s closest peer. Persistent trades at a 10% premium to Mindtree despite the latter having a much better execution track record (started 10 years after Persistent but had double the revenues and profits in FY16) as well as fundamental reasons for better performance going forward (relationships with marquee clients which are early digital adopters and domain expertise).

Digital-focused international peers: Persistent’s strategy is similar to that of successful digital companies like Globant, EPAM and Luxoft, which started out as companies focused on helping ISVs build software products but have now successfully moved to working for enterprises. Persistent trades at a 45% discount to digital-focused peers (27x FY18E P/E). However, this is justified because it is growing far slower (FY16-18E EBIT CAGR of 19% vs 24% for digital peers), generates a much smaller proportion of revenues from digital, and still has presence in challenged segments like ISV.

Trading at a premium to historical average Based on consensus estimates, Persistent currently trades at 16x 1-year forward earnings, a 30% premium to its average historical multiple of 12x since its IPO in 2010. We expect the multiples to come off when the enthusiasm related to digital fades and larger IT companies start emerging as winners in the digital race.

Exhibit 16: Share price and P/E trends since IPO in 2010

Source: Bloomberg, band-charts based on consensus EPS estimates

Our DCF-based target price is `680 The underlying assumptions for revenue growth and margins for each of Persistent’s segments are shown in the exhibit below.

ISV business (1% EBIT CAGR over FY16-26): Many of Persistent’s large legacy customers will continue to be buffeted by rapid changes in technology and, in turn, reduce spend towards Persistent. On the other hand, Persistent will continue to see growth from its digital, born-in-cloud customers and also by increasing volume share in legacy customers. Based on management commentary which signals a higher focus on profitability, we build flat revenues but a slight improvement in margins.

0100200300400500600700800900

1,000

May-10 May-11 May-12 May-13 May-14 May-15 May-16

EPS grew by 17% CAGR over FY10-13, with ~20% RoE.The stock traded at 9x 1-year forward earnings, in-linewith other mid-sized IT companies.

Re-rating led by re-positioning as a digital co.and EPS growthacceleration to 25% (FY13-15) with RoE of ~20%


Enterprise segment (18% EBIT CAGR over FY16-26): The EDT segment has grown rapidly but will start decelerating as larger players with strong capabilities and better cost structures (TCS, Infosys, etc.) start winning large digital deals. However, margins will trend up as Persistent benefits from operating leverage on investments in sales and marketing and domain expertise.

IP-led segment ex-IBM (20% EBIT CAGR over FY16-26): Our assumption of 12% revenue CAGR reflects growth from launch of early stage products like Aepona (for IoT), ShareInsights (for analytics), and acquisition of new products. We expect margins in this segment to improve from currently depressed levels as the company benefits from the investments it has made in the past.

IBM IoT business (38% EBIT CAGR over FY18-26): Our 20% revenue CAGR assumption for the IBM IoT segment reflects the early stage nature of IoT technology and the potential for Persistent to generate additional revenue by developing its own IP around this core product and also taking up related system integration work. We expect margins to improve materially in the next 2 years as revenue grows at a faster pace than costs but eventually plateau as revenue growth naturally moderates.

The model does not capture the additional risks related to: 1) short-term nature of ISV and digital projects, 2) high client concentration (Persistent’s largest account, IBM, accounted for 25% of Mar-16 quarter revenues).

Exhibit 17: Segment-wise growth and margin assumptions

FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 FY26 FY16-29

Revenue (US$ mn)

ISV 184 184 184 184 184 184 184 184 184 184 184

Enterprise 93 125 157 183 210 242 278 311 349 383 406

IP-led 66 86 95 105 116 127 140 154 169 186 198

IBM 8 55 69 80 93 107 123 141 162 187 198

Total 352 451 506 552 603 660 725 790 864 940 986

Growth YoY

ISV 2% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

Enterprise 35% 34% 26% 16% 15% 15% 15% 12% 12% 10% 6% 16%

IP-led 12% 30% 10% 10% 10% 10% 10% 10% 10% 10% 6% 12%

IBM 0% nm 24% 16% 16% 15% 15% 15% 15% 15% 6% 15%

Total 14% 28% 12% 9% 9% 9% 10% 9% 9% 9% 5% 11%

EBIT Margin (%)

ISV 15.5% 15.4% 15.4% 15.4% 15.5% 15.5% 15.5% 15.5% 15.5% 15.5% 15.5%

Enterprise 15.5% 15.4% 15.4% 15.4% 15.5% 16.0% 16.5% 17.0% 17.5% 18.0% 18.0%

IP-led 10.7% 12.6% 14.6% 16.6% 17.0% 18.0% 19.0% 20.0% 21.0% 21.0% 21.5%

IBM -15.8% -8.2% 4.0% 9.2% 13.0% 16.0% 18.0% 18.0% 18.0% 18.0% 18.0%

Total 13.9% 12.0% 13.7% 14.7% 15.4% 16.2% 17.0% 17.4% 17.9% 18.1% 18.2%

EBIT (US$ mn)

ISV 29 28 28 28 29 29 29 29 29 29 29

Enterprise 14 19 24 28 33 39 46 53 61 69 73

IP-led 7 11 14 17 20 23 27 31 36 39 42

IBM (1) (5) 3 7 12 17 22 25 29 34 36

Total 49 54 69 81 93 107 123 138 154 170 180

Growth YoY

ISV -1% -1% 0% 0% 1% 0% 0% 0% 0% 0% 0% 0%

Enterprise 31% 34% 26% 16% 16% 19% 19% 15% 15% 13% 6% 18%

IP-led -17% 54% 28% 25% 13% 16% 16% 16% 16% 10% 9% 20%

IBM* NM NM NM 171% 64% 42% 29% 15% 15% 15% 6% 38%

Total 1% 11% 28% 17% 14% 15% 15% 12% 12% 10% 6% 14%

Source: Bloomberg, Ambit Capital research; Note: Persistent does not provide the breakup of margins by segment and the margin numbers for FY16 are Ambit estimates. *For the IBM business, revenue CAGR is FY17-26 and EBIT CAGR is FY18-26.


For our DCF model, we assume a cost of equity of 15%, terminal growth rate of 5% and no-long term debt (same as other mid-sized IT services peers). Our target price of `680 implies 16x/14x FY17E/FY18E earnings.

Exhibit 18: Persistent’s DCF valuation

` bn unless specified

PV of FCF until FY26E 22.0

Terminal value 25.1

Enterprise Value 47.1

Add: Net Cash 7.3

Equity value 54.4

Number of shares (mn) 80

Value per share (̀ ) 680


Exhibit 19: RoCE and cash flow profile


Exhibit 20: Sensitivity of WACC and terminal growth assumptions on TP

Target Price (̀ ) Terminal growth rate

3.0% 4.0% 5.0% 6.0% 7.0%

WACC

12% 864 913 975 1,059 1,176

13% 772 808 852 908 984

14% 698 724 756 796 848

15% 637 656 680 709 746

16% 585 601 619 640 667


Sum-of-the-parts valuation Because, we model each segment separately, we can explicitly assign value to the different segments of Persistent’s business. We find that the enterprise digital segment accounts for about a third of the target price and cash accounts for 13% of the value; the rest is roughly equally split between ISV, IP-led and new IBM deal.

Enterprise segment: As seen in the Exhibit 15 in the relative valuation section, digital-focused players like Globant, Luxoft and EPAM trade at average FY17E EV/sales multiple of ~3x. However, Persistent has a weaker competitive positioning due to its smaller size (Globant, Luxoft and EPAM are 3-10x of Persistent’s enterprise revenue base but are growing at around the same pace), and so implied forward multiple of 2.2x is justified.

IBM IoT alliance (new deal): This is an outsourced product development deal, but the revenue-model is similar to that of the IP-led segment. There are no clear comparables for this. Our implied valuation is 2.7x EV/FY17E sales.

22%

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` bn

PV of FCF (LHS) Pre Tax ROCE (Ex cash) (RHS)

The Enterprise digital segment accounts for 34% of the target price.

Cost of capital

Particulars Amount

Cost of equity (%) 15.0

Cost of debt (%) 9.0

Debt/(debt + equity) 0.0

WACC (%) 15.0



ISV segment: The implied forward EV/sales is 0.8x and forward P/E of 7x is justified given that the business appears to be structurally challenged.

IP-led segment: Persistent’s IP-led business consists of multiple software products that are near the end of their life cycle and some new early-stage products added recently. Given that multiple products of different nature are involved, we benchmark the IP-Led segment’s valuation with the universe of 49 software product companies (as per GICS classification) that have revenue between US$50mn-200mn (vs our FY17E estimate of US$86mn for the IP-led segment) and last three years’ revenue growth of 10%-20% (in line with our growth estimate for the IP-led segment). The universe of these 49 software companies (refer to exhibit 22 in the appendix section) trades at a valuation of 1.4x EV/LTM sales which likely translates to 1.6x EV/FY17E sales (estimates are not available for all companies). In that context, our implied valuation of 1.6x EV/FY17E sales for the IP-led segment is in line.

Exhibit 21: Sum-of-the-parts valuation

Value (̀ mn) Value (̀ /shr) %age EV/sales EV/EBIT P/E

Enterprise 18,353 230 34% 2.2 14.3 20

IBM 9,918 124 18% 2.7 NM NM

ISV 9,806 123 18% 0.8 5.2 7

IP-led 9,046 113 17% 1.6 12.5 17

Cash 7,276 91 13% NA NA NA

Market value of equity 54,399 680 100% 1.6 13.1 18.0

Source: Ambit Capital research; Note: Persistent intends to change the classification of its segments from the Jun-2016 quarter.

Risks to our SELL stance Persistent is likely to significantly benefit from the IBM deal. The possibility of

more such deals either with IBM or also with other large ISVs like Microsoft or Intel poses upside risks to our target price.

While the founder and majority shareholder, Anand Deshpande, has denied any intention to sell his holdings, Persistent is an attractive acquisition target for a strategic as well as to a private equity firm. In 2013, Apax Partners had acquired GlobalLogic, which operates in the same space and then had revenues of US$250mn, at a valuation of more than 10x EV/EBITDA (as per media reports). Given that Persistent has double the scale and also a digital positioning, it might get valued much higher than our implied target multiple of 10x EV/EBITDA (FY17E).

Technology continues to change rapidly. For instance, after moving to mobile-first interface (apps, mobile web) from a desktop-internet interface, enterprises might have to move to an AI-first/chat-bot interface. It is likely that Persistent will be able to once again invest in this new area and partner with key platforms (e.g. Google, Amazon) ahead of the peers, and thereby be rewarded with higher revenues/profits as well as higher valuation multiples.

Persistent is best-positioned to benefit from depreciation of INR against the USD given low proportion of USD-linked costs (onsite proportion of revenue was 26% in March 2016 vs 57% for Infosys), low exposure to non-US markets (14% in March 2016 vs. 46%/40% for TCS/Infosys) and a low margin level (14% in FY16 vs 26%/25% for TCS/Infosys). We estimate that 1% depreciation of the INR against the USD positively impacts Persistent’s EBIT margin/EBIT by 50bps/5% vs 30bps/2% for Infosys.

Catalysts We expect slowing growth in digital segment as Persistent loses its competitive

advantage. We expect the revenue growth rate (QoQ) to drop to 6-8% in FY17 from expectations of 10-15% currently.

We expect 370bps drop YoY in 1QFY17 EBIT margin. Consensus currently expects only a 110bps drop YoY in FY17 EBIT margin, which likely implies a drop of only 150-200bps YoY in 1QFY17.

http://timesofindia.indiatimes.com/tech/tech-news/Apax-buys-GlobalLogic-IT-outsourcing-firm-founded-by-four-IITians-for-420-million/articleshow/23750759.cms


Balance sheet

` mn FY16 FY17E FY18E FY19E

Net Worth 16,393 18,766 21,394 24,490

Other Liabilities 27 27 27 27

Capital Employed 16,420 18,793 21,420 24,517

Net Block 4,453 4,848 5,316 5,815

Goodwill 175 175 175 175

Cash & Bank Balance 6,260 7,302 8,855 10,950

Application of Funds 16,420 18,793 21,420 24,517


Income statement


Revenue (US$ mn) 352 451 506 552

Revenue 23,123 29,990 33,617 36,697

EBIT 3,205 3,590 4,605 5,405

EBIT Margin 14% 12% 14% 15%

PBT 3,956 4,534 5,302 6,207

Reported PAT 2,973 3,310 3,844 4,500

EPS (̀ ) 37.2 41.4 48.0 56.2


Cash flow statement


Net Operating CF 3,102 3,180 4,011 4,736

Net Purchase of FA (1,647) (1,499) (1,681) (1,835)

Net Cash from Invest. (1,162) (1,202) (1,241) (1,236)

Dividend Payments (1,251) (936) (1,217) (1,404)

Cash Flow from Fin. (1,266) (936) (1,217) (1,404)

Free Cash Flow 1,454 1,680 2,330 2,901

Net Cash Flow 674 1,042 1,553 2,096


Ratio analysis / Valuation parameters

FY16 FY17E FY18E FY19E

Revenue growth (US$) 14% 28% 12% 9%

EBIT growth (̀ ) 8% 12% 28% 17%

EPS growth (̀ ) 2% 11% 16% 17%

P/E 19.8 17.8 15.3 13.1

EV/EBITDA 12.9 11.5 9.3 8.0

Price/Book Value 3.6 3.1 2.8 2.4

RoE 20% 19% 19% 18%

RoCE 16% 15% 17% 16%



Appendix Exhibit 22: List of software companies for comparison with Persistent’s IP Led- business

Company LTM Revenue (US$mn)

3 year average sales growth

EV/Sales (LTM)

Market Cap (US$mn)

Mensch und Maschine Software S 185 10.6% 1.4x 248

Descartes Systems Group Inc/Th 185 13.5% 7.4x 1,408

Hangzhou Sunyard System Engine 181 16.1% -

Geometric Ltd 181 11.5% 1.2x 202

Sapiens International Corp NV 180 17.7% 2.7x 580

Magic Software Enterprises Ltd 176 11.7% 1.3x 302

KLab Inc 173 12.6% 0.8x 208

PROS Holdings Inc 162 13.9% 1.9x 350

Justsystems Corp 150 11.3% 533

Global Infotech Co Ltd 149 10.3% 9.4x 1,420

NSFOCUS Information Technology 144 18.8% 14.1x 2,192

OnMobile Global Ltd 139 10.3% 1.3x 186

ISRA Vision Parsytec AG 132 10.2% 0.5x 33

Boyaa Interactive Internationa 130 18.8% 0.8x 291

Jastec Co Ltd 124 14.4% 0.9x 160

AurionPro Solutions Ltd 121 15.2% 0.7x 49

Wasko SA 120 16.8% 51

WeMade Entertainment Co Ltd 112 13.0% 1.0x 382

Toho System Science Co Ltd 110 14.6% 0.2x 78

MDS Technology Co Ltd 104 17.6% 1.5x 163

MobilityOne Ltd 96 19.2% 0.1x 3

Absolute Software Corp 93 10.3% 1.9x 203

Softing AG 91 19.6% 1.1x 102

Actoz Soft Co Ltd 89 13.2% 2.2x 228

Kozo Keikaku Engineering Inc 88 10.6% 1.3x 96

Altium Ltd 85 13.4% 6.7x 613

SIOS Technology Inc 77 16.1% 0.7x 72

Vange Software Group AG 75 12.0% 1

Vitec Software Group AB 73 17.9% 3.5x 243

Sichuan Jiuyuan Yinhai Softwar 71 16.4% 17.6x 1,345

Silicon Studio Corp 68 13.0% 1.1x 98

Solteq OYJ 67 12.5% 0.8x 35

TXT e-solutions SpA 66 10.9% 1.5x 114

Exa Corp 65 10.3% 2.6x 192

Shenzhen Hirisun Technology In 65 10.0% 11.4x 784

Esker SA 65 13.7% 2.4x 173

Computer Modelling Group Ltd 64 11.6% 8.9x 642

GK Software AG 64 14.7% 1.6x 92

Cliq Digital AG 63 19.5% 0.7x 20

I'll Inc 61 15.4% 0.7x 55

Cranes Software International 60 10.9% 0.2x 4

YLZ Information Technology Co 59 11.8% 18.5x 1,158

Cybozu Inc 58 18.5% 2.2x 167

NetSol Technologies Inc 58 12.9% 1.3x 72

Integrated Research Ltd 57 13.8% 4.6x 268

Showa System Engineering Corp 55 12.1% 20

Dalet SA 55 14.8% 0.4x 26

Softbrain Co Ltd 55 13.4% 0.5x 49

Linewell Software Co Ltd 54 12.8% 14.8x 920

Median 1.4x Source: Bloomberg; Note: We took universe of all software product companies as per GICS classification and narrowed down the list by putting following filters to make the comparison similar to Persistent’s IP led segment: 1) Revenue between US$50mn-US$200mn and 3 year average revenue growth between 10%-20%.)


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research Analysts

Name Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected]

Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected]

Aakash Adukia Oil & Gas / Chemicals / Agri Inputs (022) 30433273 [email protected]

Abhishek Ranganathan, CFA Retail (022) 30433085 [email protected]

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Gaurav Khandelwal, CFA Automobile (022) 30433132 [email protected] Girisha Saraf Mid-caps / Small-caps (022) 30433211 [email protected]

Karan Khanna, CFA Strategy (022) 30433251 [email protected]

Kushank Poddar Technology (022) 30433203 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected]

Paresh Dave, CFA Healthcare (022) 30433212 [email protected]

Parita Ashar, CFA Metals & Mining / Aviation (022) 30433223 [email protected]

Prashant Mittal, CFA Strategy / Derivatives (022) 30433218 [email protected]

Rahil Shah Banking / Financial Services (022) 30433217 [email protected]

Rakshit Ranjan, CFA Consumer (022) 30433201 [email protected]

Ravi Singh Banking / Financial Services (022) 30433181 [email protected]

Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 [email protected]

Ritesh Vaidya, CFA Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Sagar Rastogi Technology (022) 30433291 [email protected]

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Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Hitakshi Mehra India (022) 30433204 [email protected]

Krishnan V India / Asia (022) 30433295 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Shaleen Silori India (022) 30433256 [email protected]

Singapore

Pramod Gubbi, CFA – Director Singapore +65 8606 6476 [email protected]

Shashank Abhisheik Singapore +65 6536 1935 [email protected]

USA / Canada

Ravilochan Pola - CEO Americas +1(646) 361 3107 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Jestin George Editor (022) 30433272 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

mailto:[email protected]


Persistent Systems Ltd (PSYS IN, SELL)


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PERSISTENT SYSTEMS LTD


Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >10%

SELL <10%

NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events

NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock POSITIVE We have a positive view on the sector and most of stocks under our coverage in the sector are BUYs

NEGATIVE We have a negative view on the sector and most of stocks under our coverage in the sector are SELLs Disclaimer This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities is available on request. Disclaimer 1. AMBIT Capital Private Limited (“AMBIT Capital”) and its affiliates are a full service, integrated investment banking, investment advisory and brokerage group. AMBIT Capital is a Stock Broker, Portfolio

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9. AMBIT Capital and/or its affiliates may from time to time have or solicit investment banking, investment advisory and other business relationships with companies covered in this Research Report and may receive compensation for the same.

Additional Disclaimer for U.S. Persons 10. The research report is solely a product of AMBIT Capital 11. AMBIT Capital is the employer of the research analyst(s) who has prepared the research report 12. Any subsequent transactions in securities discussed in the research reports should be effected through Enclave Capital LLC. (“Enclave”). 13. Enclave does not accept or receive any compensation of any kind for the dissemination of the AMBIT Capital research reports. 14. The research analyst(s) preparing the email / Research Report/ attachment is resident outside the United States and is/are not associated persons of any U.S. regulated broker-dealer and that

therefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

15. This report is prepared, approved, published and distributed by the Ambit Capital located outside of the United States (a non-US Group Company”). This report is distributed in the U.S.by Enclave Capital LLC, a U.S. registered broker dealer, on behalf of Ambit Capital only to major U.S. institutional investors (as defined in Rule 15a-6 under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”)) pursuant to the exemption in Rule 15a-6 and any transaction effected by a U.S. customer in the securities described in this report must be effected through Enclave Capital LLC (19 West 44th Street, suite 1700, New York, NY 10036).

16. As of the publication of this report Enclave Capital LLC, does not make a market in the subject securities. 17. This document does not constitute an offer of, or an invitation by or on behalf of Ambit Capital or its affiliates or any other company to any person, to buy or sell any security. The information

contained herein has been obtained from published information and other sources, which Ambit Capital or its Affiliates consider to be reliable. None of Ambit Capital accepts any liability or responsibility whatsoever for the accuracy or completeness of any such information. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the date of this document. Emerging securities markets may be subject to risks significantly higher than more established markets. In particular, the political and economic environment, company practices and market prices and volumes may be subject to significant variations. The ability to assess such risks may also be limited due to significantly lower information quantity and quality. By accepting this document, you agree to be bound by all the foregoing provisions.

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Additional Disclaimer for Singapore Persons 24. This Report is prepared and distributed by Ambit Capital Private Limited and distributed as per the approved arrangement under Paragraph 9 of Third Schedule of Securities and Futures Act (CAP

289) and Paragraph 11 of the First Schedule to the Financial Advisors Act (CAP 110) provided to Ambit Singapore Pte. Limited by Monetary Authority of Singapore. 25. This Report is only available to persons in Singapore who are institutional investors (as defined in section 4A of the Securities and Futures Act (Cap. 289) of Singapore (the “SFA”).” Accordingly, if a

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Disclosures 26. The analyst (s) has/have not served as an officer, director or employee of the subject company. 27. There is no material disciplinary action that has been taken by any regulatory authority impacting equity research analysis activities. 28. All market data included in this report are dated as at the previous stock market closing day from the date of this report. 29. Ambit and/or its associates have financial interest/equity shareholding in TCS & Infosys.

Analyst Certification Each of the analysts identified in this report certifies, with respect to the companies or securities that the individual analyses, that (1) the views expressed in this report reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly dependent on the specific recommendations or views expressed in this report. © Copyright 2015 AMBIT Capital Private Limited. All rights reserved.

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