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i-flex: Broadening portfolio

Mar 27, 2003

i-flex has had a dream run on the bourses. The stock listed on the bourses in June 2002 at Rs 530. It currently trades at a market price of Rs 933, a rise of more than 76% in less than a year. The company’s blockbuster product, FLEXCUBE, has been key driver behind the company’s success. Infact the product has been consistently ranked among the world’s best selling universal banking solution by International Banking Systems (IBS), UK – an independent research firm. Companies selling software products offer a more attractive investment opportunity as compared to services companies for a number of reasons. Products offer significantly higher margins as compared to the services business. i-flex’s margins from the product sales are as high as 50% as compared to margin of 20% from the services business. Also, the software companies that have managed to successfully create and sell products are placed higher up the value chain and therefore could be accorded higher valuations since, selling products that can run independently require a significant amount of technology related understanding and maturity.

i-flex: Leading the products pack
(Rs m) 2QFY03 3QFY03 Change
Products      
Revenues 1,085 1,134 4.50%
% Contribution 64.70% 65.10% -
Operating margins 52.30% 49.30% -
Services      
Revenues 592 607 2.50%
% Contribution 35.30% 34.90% -
Operating margins 17.90% 19.90% -
Total 1,677 1,740 3.80%

For i-flex, the revenues from the products business come from three sources. Firstly, the license fees. This is what makes the product business so lucrative. After the company breaks even on the development cost for its product, additional license fees goes straight to the bottomline. Equally large is implementation and customization fees that are earned after the software is implemented on client sites and custom modifications are carried out on the request of the clients. And finally there is a component of annual maintenance fees that is paid to keep the software up and running. A look at the table below highlighting i-flex’s revenue pie will give a better picture of what we mean.

i-flex product revenues break-up FY00 FY01 FY02
License Fees 53% 39% 35%
Implementation and Enhancement Fees 32% 47% 50%
Annual Maintenance Contracts 16% 14% 15%
Total 100% 100% 100%

With corporates increasingly looking at one-stop shops for all their IT requirements, companies like Infosys that have strong skills in IT services space and can offer end to end solutions, are likely to have an edge when selling their products. The revenue break-up for i-flex points to the fact that the share of implementation and enhancement fees has increased sharply. Also, as pointed out before, as banks evolve to universal banks, a number of software will have to work in tandem to support technologies that work to make all services under one roof a reality. Therefore, companies like Infosys that have a significant expertise in enterprise application integration can not only make their product more flexible to such requirements but also provide the services when required by the client. These skill sets would make the Indian IT firms that have a product offering, a preferred choice.

This very reasoning has led i-flex to broaden its portfolio by adding systems integration to the list of services being offered. The company plans to start with a group of 25 professionals and expand the size of the team to 100 by the year-end. Apart from the core banking solution banks needs other software like CRM (customer relationship management) solutions. In many cases these solutions are ‘islands of information’ i.e. one system cannot talk or exchange data with the other. However, for meeting the information need of an organisation in real time, all these solutions have to be seamlessly integrated.

Another service offering that i-flex is looking at is taking up third party package implementation. During the IT spending frenzy a large number of corporations had spent significant amounts in buying ERP and CRM packages like SAP and Siebel with a significant number of licenses. However, inspite of buying a large number of licenses, these organisations today are using only a few. But to get more from their existing investments they would like implement these package for as many users as possible.

Package implementation (PI): Hot …
Revenue growth FY02 9mFY03
Infosys 86.5% 39.6%
Satyam 207.3% 111.6%

At the current market price of Rs 933, the stock is trading at a P/E multiple of 15x its 3QFY03 annualised earnings. There is immense growth potential for the company’s core business banking solutions. The company has recently started to tap the US geography (contribution from US was just 4% in 3QFY02), despite which it has met with significant success (21% in 3QFY03). Considering the fact that US is a big market for banking products, and i-flex’s relatively nascent presence in that region, the company’s growth prospects are very exciting. However, the management has been in public eye for a very short time and therefore the possibility of surprise (both ways) is high.

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