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3i Infotech: Keep an ‘eye’! - Views on News from Equitymaster

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3i Infotech: Keep an ‘eye’!

Apr 20, 2006

Performance Summary
3i Infotech reported its results for the fourth quarter and full-year ended March 2006 yesterday. The topline has witnessed strong growth in FY06, driven by strong performances from both the products as well as services businesses. Margins expanded due to lower cost of revenues and savings in SG&A expenses. The margin expansion, combined with a more than doubling of other income and lower interest costs, led to a strong bottomline growth.

Consolidated financial performance: A snapshot
(Rs m) 3QFY06 4QFY06 Change FY05 FY06 Change
Revenues 1,120 1,200 7.1% 2,892 4,178 44.5%
Expenditure 886 944 6.6% 2,412 3,321 37.7%
Operating profit (EBDITA) 234 255 9.3% 480 858 78.6%
Operating profit margin (%) 20.9% 21.3%   16.6% 20.5%  
Other income 24 16 -32.3% 29 62 118.5%
Depreciation 66 65 -1.8% 188 261 38.3%
Interest 20 25 26.8% 108 80 -25.9%
Profit before tax 172 182 5.8% 213 580 172.6%
Extraordinary items - 9   - 9  
Tax 7 16 111.7% (108) 12  
Minority interest 2 1   - 2  
Profit after tax/(loss) 163 175 7.6% 321 574 78.9%
Net profit margin (%) 14.5% 14.6%   11.1% 13.7%  
No. of shares (m) 52.8 53.0   31.0 53.0  
Diluted earnings per share (Rs)       6.1 10.8  
P/E ratio (x)     17.3  

What is the company’s business?
3i Infotech is an IT company focussing mainly on the banking, financial services and insurance (BFSI) vertical. It was incorporated in 1993 as a back-office IT services provider to the ICICI Group and has since metamorphosed into a technology company providing IT services and solutions to over 500 clients in over 30 countries. 3i Infotech earns revenues from products as well as IT services. The company has products for the BFSI space, with a presence in insurance, treasury, asset-liability management, risk management, core banking and investment management. It also has an ERP product suite, providing solutions for the retail, manufacturing, distribution, trading, fashion, automotive, pharmaceutical and chemical industries. Its main focus in IT services is in the region of enterprise application integration, systems integration and e-governance. The company acquired four companies in FY06 with a focus on business intelligence, security consulting, anti-money laundering software, ERP software and a mutual fund product.

What has driven performance in FY06?
Products and services drive the topline: While the products business grew at nearly 52% YoY, the services business clocked a revenue run rate of just under 39% YoY. As regards to the products business, for FY06, this business increased its share in total revenues (from 44.5% in FY05 to 46.7% in FY06). The banking, financial services and insurance (BFSI) segment increased its share in total product revenues from 70% in FY05 to 72% in FY06. This segment grew a strong pace of over 61% YoY in FY06, while the other products business, ERP, grew at around 52% YoY.

This year was characterised by greater penetration into the US market. In this market, in the insurance space, the number of sites increased from just 1 till FY05 to over 7 in FY06. In the ERP space, the company moved from 3 sites till FY05 to over 20 by the end of FY06. The company acquired FormulaWare, a US-based corporation that provides ERP solutions for the process manufacturing industry, the area that 3i is focussing on for growth in this space. 3i Infotech also acquired SDG Software and Datacons, companies that have software products in the domains of anti-money laundering and mutual funds respectively. These acquisitions, while enabling 3i to skip the ‘learning curve’ and save time on developing new products, will also give the company greater penetration into the high-growth BFSI vertical.

As far as the services business is concerned, this business grew by nearly 39% YoY. This was helped partly by the acquisition Innovative Business Solutions (IBS) during the year. The company has said that it is seeing good traction in e-governance and systems integration.

Going forward, revenue visibility is good, with the total outstanding order book at Rs 1.3 bn in the products business (Rs 622 m at the end of FY05) and at Rs 1.3 bn in the services business (Rs 1.26 bn at the end of FY05). The client metric have improved as well, with the ICICI Group now contributing to around 18% of total revenues in FY06 (26% in FY05). The top 10 clients now contribute to 16% of revenues, as compared to 20% at the end of FY05. The US$ 1 m clients have also increased significantly, to 17 at the end of FY06 compared to just 2 at the end of FY05, indicating increasing engagements with its clients. The company also has 2 clients giving it revenues in excess of US$ 5 m.

Segment-wise performance…
(Rs m) FY05 % of total FY06 % of total Change
Revenues 1,288 44.5% 1,952 46.7% 51.5%
Gross profit 661 53.5% 1,022 55.9% 54.7%
Gross margins 51.3%   52.4%   1.1%
Revenues 1,604 55.5% 2,227 53.3% 38.8%
Gross profit 575 46.5% 805 44.1% 39.9%
Gross margins 35.9%   36.2%   0.3%
Revenues 2,892   4,178   44.5%
Gross profit 1,236   1,827   47.8%
Gross margins 42.8%   43.7%   1.0%

Cost savings power margins: 3i Infotech witnessed an impressive margin expansion during FY06. From 16.6% in FY05, operating margins saw a near-400 basis points increase to 20.5% in FY06. This was a result of good cost savings, particularly on the selling, general and administrative (SG&A) side. SG&A expenses as a percentage of revenues reduced by nearly 300 basis points, from 26.1% in FY05 to 23.2% in FY06. The cost of revenues also saw a near-100 basis points reduction as a percentage of sales, from 57.2% in FY05 to 56.3% in FY06. As regards segmental margins, product gross margins increased from 51.3% to 52.4%, while services margins increased slightly from 35.9% to 36.2%.

Higher margins drive the bottomline: Apart from margin expansion, higher other income and lower interest costs propelled net profit growth (79% YoY). This, however, considerably trailed the growth in PBT, which grew at as much as 173% YoY. This was a result of the taxes paid this year. While in FY05, 3i Infotech had deferred tax credits to the tune of Rs 163 m, this year, these stood at Rs 10 m. Excluding these items, the net profit growth stands at as much as 258% YoY.

Performance in the recent past…
  1QFY06 2QFY06 3QFY06 4QFY06
Sales growth (%, QoQ) 10.0 11.9 15.0 7.1
Operating margins (%) 13.4 20.5 20.9 21.3
Profits growth (%, QoQ) 21.0 11.7 22.0 7.6

What to expect?
At the current price of Rs 190, 3i Infotech’s stock is trading at a price to earnings multiple of 9.1 times our estimated FY08 earnings. Given strong visibility in revenues in both the products as well as the services businesses going forward and the strong possibility of margin improvement, we expect 3i Infotech to deliver superior revenue and earnings growth over the medium to long-term. The board has recommended a final dividend of Rs 2 per share (dividend yield of 1.05%). The management has guided for a growth of between 25% and 30% in revenues and for earnings per share (EPS) to be in the range of Rs 13.0 to Rs 13.5 (after preference dividend) in FY07. We maintain our positive view on the stock.

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