i-flex: Taking the rough with the smooth!

i-flex solutions is India's premier software products company, operating in the banking, financial services and insurance (BFSI) space. It is the only software company in India that derives most of its revenues from software products (61% in FY04). Its flagship product, Flexcube, has been ranked as the number one selling retail and wholesale banking solution by International Banking Systems (IBS) for three years in a row. Flexcube is a comprehensive retail, corporate and investment banking solution for back office, middle office and front office functions. i-flex's services business, PrimeSourcing, provides custom application development and maintenance activities, apart from reengineering services, business integration and consulting services. This business accounted for 39% of revenues in FY04, and has been growing at a CAGR of 70%.

In this article, we take a look at certain factors that help i-flex stand out from the 'crowd' that comprises of a host of Indian technology firms and those that present big challenges to the company in its future growth.

What's good?

i-flex is the only software company in India that derives most of its revenues from software products. Products are at the highest end of the software value chain. The best example of a software product company is Microsoft. The products business is not as people-intensive as the services business. As a result, revenues from products flow straight to the bottomline after recovering costs associated with developing the product. Margins in products are among the highest, and i-flex enjoys operating margins of well over 40% in its products business.

The flagship product of i-flex, Flexcube, is the largest selling banking software product in the world. The company has been consistently tapping new business over the years. Its strategy of focusing exclusively on the banking, financial services and insurance (BFSI) vertical seems to be paying dividends, as this is a highly specialised space. This industry is the largest spender on technology worldwide, and the estimated market for i-flex is in the range of hundreds of billions of dollars. Given that i-flex is only a US$ 175 m company, the potential is huge, to say the least.

The management of i-flex has been focusing exclusively on the banking, financial services and insurance (BFSI) space. This focus has paid dividends, as it gains considerable expertise in this industry, and its products tap a greater number of banks and financial institutions globally. It also serves as an entry barrier for other companies planning to tap this sector, since the company is a fairly well entrenched player.

And, what's not!

Product companies' revenues are highly volatile, and i-flex has been no exception. Revenues depend upon the time taken to implement the product for the client, which could be delayed, resulting in quarter-on-quarter revenues fluctuating to a large degree. As a result, profits are also highly volatile, and an analysis of i-flex's profit growth over the past few years does show a bit of inconsistency.

Secondly, while the services business has been growing at a healthy rate in the past few years, the margins are considerably lower than those enjoyed by top tier companies in the sector. It is a highly people-intensive business, and is expected to grow at a healthy rate going forward. Given the fact that the company will need to recruit a large number of people to expand the business, margin pressure is expected to continue.

So, what to expect?

At the current price of Rs 606, the stock is trading at a price to earnings multiple of 27.2 times annualised 9mFY05 earnings. This is on the higher side of the valuations accorded to a company like i-flex. However, since the company is operating in a high-growth industry, and its flagship product is the worldwide leader, the valuations have traditionally been on the higher side. But, given the risk factors such as those inherent to the product business and the margin pressure in its services business, we believe that investors need to practice caution at this juncture.