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i-flex: Mixed performance - Views on News from Equitymaster
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i-flex: Mixed performance
Jan 30, 2006

Performance Summary
i-flex solutions, reported its consolidated financial results for the third quarter and nine-month period ended December 2005. The topline continues to witness strong traction, driven by strong order wins in its products business as also impressive growth in the services business. Margins saw a strong expansion, driven mainly by savings in selling and marketing costs. However, this margin expansion did not peter down to the bottomline, due to considerably higher depreciation and a big jump in taxes paid.

Consolidated financial performance: A snapshot
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net sales 2,999 3,880 29.4% 7,799 10,117 29.7%
Expenditure 2,343 2,977 27.1% 6,066 8,439 39.1%
Operating profit (EBDITA) 656 903 37.7% 1,733 1,678 -3.2%
Operating profit margin (%) 21.9% 23.3%   22.2% 16.6%  
Other income (14) (17) 21.4% 138 136 -1.8%
Depreciation 81 113 39.5% 210 318 51.3%
Share of profit in associate company - -   - 5  
Profit before tax 561 773 37.8% 1,661 1,501 -9.7%
Tax 107 237 121.5% 375 427 13.9%
Extraordinary items - 54   - 97  
Profit after tax/(loss) 454 482 6.2% 1,286 977 -24.0%
Net profit margin (%) 15.1% 12.4%   16.5% 9.7%  
No. of shares (m) 76.8 77.5   76.8 77.5  
Diluted earnings per share (Rs)*         26.0  
P/E ratio (x)*         44.5  
* On a trailing 12-month basis

What is the company’s business?
i-flex is India’s premier software products company, focussed on the banking and financial services (BFSI) vertical. The company’s portfolio of offerings comprises products (51% of revenues) like Flexcube, an end-to-end product suite for retail, corporate and investment banking, asset management and treasury. The company also provides software services (47% of revenues) like application software development and deployment, maintenance and business and IT consulting. During FY05, i-flex acquired a company called Equinox Corporation, which provides BPO services. This contributes to 2% of revenues. For the year 2004, International Banking Systems (IBS) ranked the company’s flagship product, Flexcube, as the number one selling wholesale as well as retail back-office banking solution in the world for the third year running. In fact, Flexcube has been rated among the top-selling banking solutions for the last six years. In recent times, i-flex has ventured into other related areas of the BFSI space, like risk management (ORTOS) and general insurance (Castek).

What has driven performance in 3QFY06?
All-round strengths: During 3QFY06, i-flex witnessed impressive growth, both in products and services businesses. Products business grew at a rate of 25.4% YoY, while the services business witnessed a healthy 28.6% YoY growth. Citigroup continues to contribute the lion’s share of revenues for this business (55% of total services revenues in 3QFY06). However, this is a considerable improvement from 3QFY05, when Citi-related business contributed as much as 64% to the total services revenues. The onsite revenues contributed a total of 66% to total services revenues.

On the other hand, the company’s products business, as mentioned above, showed a 25.4% YoY growth in revenues. License fees as a percentage of total revenues reduced from 31% in 2QFY06 to 30% this quarter. The company’s knowledge process outsourcing (KPO) company, Equinox, accounted for nearly 2% of consolidated revenues this quarter and grew at a sequential rate of 51%. Equinox recorded an operating loss of Rs 36.4 m during the quarter, lower than the Rs 45 m recorded last quarter.

As regards client metrics, Citigroup contributed to 38% of total consolidated revenues in 3QFY06, compared to 43% in 3QFY05 and 36% last quarter. The top client (non-Citi) contributed to 4% of revenues. Total clients added were 22, including as many as 20 in the products business. The tank size was at an all-time high of US$ 72.5 m, compared to US$ 61 m last quarter and US$ 50 m at the end of FY05. This shows good visibility on the products side. i-flex continues to win more deals across geographies, as core banking packaged software gains increasing acceptance. The Oracle deal also gives the company greater credibility and a huge customer base, particularly in the North American market. Oracle will be a reseller for i-flex’s Reveleus solution, which will enable better traction in this product line. Flexcube won as many as 14 customers this quarter. The insurance business, through Castek, won its first deal with Tokio Marine Insurance in the US.

Segment-wise performance…
(Rs m) 3QFY05 % of total 3QFY06 % of total Change
Revenue 1,593 53.1% 1,998 51.5% 25.4%
OP 560 85.3% 780 86.4% 39.3%
OPM 35.1%   39.0%    
Revenue 1,404 46.8% 1,805 46.5% 28.6%
OP 258 39.3% 364 40.4% 41.4%
OPM 18.4%   20.2%    
KPO Services          
Revenue - 0.0% 72 1.8% -
OP - 0.0% (36) -4.0% -
OPM 0.0%   -50.9%    
Joint ventures          
Revenue 2 0.1% 6 0.1% 146.1%
OP 3 0.5% 1 0.2% -55.7%
OPM 143.3%   25.8%    
Revenue 2,999   3,880   29.4%
OP 656   903   37.7%
OPM 21.9%   23.3%    
* including inter-segment adjustments

Margins soar: i-flex saw an impressive 140 basis points margin expansion during 3QFY06, as savings in costs on the selling and marketing (S&M) side resulted in operating profits soaring by 37.7% YoY, considerably higher than the topline growth. S&M expenses reduced as a percentage of sales from 16.4% in 3QFY05 to 11.7% this quarter. This could be partly as a result of cost synergies with Oracle, which are certainly expected to improve going forward. However, general and administrative (G&A) expenses increased from 8.8% to 13.2%. The company added a net of 441 employees during the quarter. At the end of 3QFY06, i-flex had 6,641 employees on its rolls. On a segmental basis, margins in the products business improved by as much as 390 basis points, while in the services business, the figure has been 182 basis points.

Higher depreciation and taxes restrict net profit growth: Due to considerably higher depreciation charges as well as a big jump in taxes, the impact of the higher margins was not reflected in the bottomline, which grew at an unenthusing pace. However, it should be mentioned here that there were extraordinary items relating to prior period items this quarter and if we exclude these, then net profit growth stands at 18.1% YoY.

Performance in the recent past
  4QFY05 1QFY06 2QFY06 3QFY06
Sales growth (%, YoY) 71.3 22.2 36.7 29.4
Operating margins (%) 35.4 9.0 15.1 23.3
Profits growth (%, YoY) 89.8 (73.0) (8.1) 6.2
Products (YoY, %) 24.7 (8.1) 35.4 25.4
Services (YoY, %) 73.3 56.7 34.2 28.6
Products tank size (US$ m) 50.0 60.0 61.0 72.5

What to expect?
At the current price of Rs 1,158, i-flex is trading at a price to earnings multiple of 20.0 times our estimated FY08 earnings, which is expensive. While we believe that the Oracle takeover will prove to be beneficial for i-flex in the long run, we believe that most of it has already been factored into the stock price. Also, issues such as the traditional reluctance of American tier-1 banks and financial institutions to go in for packaged software could make it difficult for the company to effectively tap the US market. The company has just signed a ‘Master Operating Agreement’ with Oracle, which provides a framework for collaboration between the 2 companies in the marketplace on various aspects like sales and marketing and product development. This will certainly help the company in the long run. The strong pipeline will ensure good topline growth. However, given the profit performance in the nine-month period so far, we will be revising our projections downwards for FY06.

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