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3i Infotech: Bloodshed on exiting govt projects - Views on News from Equitymaster

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3i Infotech: Bloodshed on exiting govt projects

Apr 24, 2010

3i Infotech has announced its FY10 results. The company has reported a 7% YoY growth sales during Fy10. Its net profits declined by 88% YoY during the period. Here is our analysis of the results.

Performance summary
  • Consolidated sales increase by 5% QoQ and 7% YoY during 4QFY10 and FY10 respectively. Growth on account of some revival in business particularly for software services and transaction processing businesses.
  • Operating margins contract by 0.4% QoQ during the quarter on account of 6% increase in expenditure. Operating margins expand by around 1% YoY on back of improved topline and better cost management.
  • Bottomline falls drastically by 88% YoY during FY10, mainly on account of companyís decision of exiting some agreement with several state governments entailing a penalty of Rs 109.2 m under these contracts. Also disposing the assets earmarked for these projects at their realizable values results in loss of Rs 2.6 bn.
  • Recommends a dividend of Rs 1.5 per share of face value Rs 10.

Consolidated financial performance:
(Rs m) 3QFY10 4QFY10 Change FY09 FY10 Change
Sales 5,962 6,283 5.4% 22,856 24,485 7.1%
Expenditure 4,766 5,044 5.8% 18,512 19,656 6.2%
Operating profit (EBITDA) 1,196 1,239 3.6% 4,344 4,829 11.2%
Operating profit margin (%) 20.1% 19.7%   19.0% 19.7%  
Other income 57 43 -23.7% 191 202 6.0%
Depreciation 219 5 -97.7% 701 814 16.2%
Interest 362 381 5.2% 950 1,448 52.5%
Profit before tax 672 896 33.4% 2,885 2,769 -4.0%
Tax 57 53 -8.0% 221 110 -50.5%
Profit before exceptional items and minority interest 615 843 37.2% 2,664 2,660 -0.2%
Minority Interest (104) 20   106 (1)  
Exceptional Items (109) (2,497)   263 (2,327)  
Profit after tax/(loss) 610 (1,673)   2,821 333 -88.2%
Net profit margin (%) 10.2% -26.6%   12.3% 1.4%  
No. of shares (m)       130.8 168.8  
Diluted earnings per share (Rs)         2.0  
P/E ratio (x)*         38.6  
*On a trailing 12-months basis

What has driven performance in FY10?
  • 3i Infotech recorded 5% QoQ growth in topline during 4QFY10. Its topline grew by 7% YoY during FY10 backed by robust traction for its transaction processing (BPO, 37% of sales) business which grew by 26% YoY during FY10. The IT services business (31% of sales) segment remained flat during the year. The company's products (32% of total sales) saw a revenue decline of 3% YoY during the year.

  • 3i Infotech's operating profits increased by 11% YoY and 4% QoQ during FY10 and 4QFY10 respectively. However, its operating margins contracted by 0.4% QoQ on account of increase in salary expenses. For FY10, operating margins expanded by 0.7% YoY backed by improved cost management and increased volume growth.

    Revenue Breakup
    (Rs m) FY09 FY10 Change
    On the basis of offerings      
    Products 8,112 7,834 -3.4%
    Services 7,482 7,496 0.2%
    Transaction Services 7,262 9,155 26.1%
    On basis of geography      
    South Asia 6,354 6,293 -1.0%
    Asia Pacific 1,029 906 -11.9%
    USA 11,474 13,589 18.4%
    MEARC 2,354 2,155 -8.5%
    Western Europe 1,646 1,543 -6.3%
    On basis of segments      
    BPO 7,200 9,060 25.8%
    ERP 686 686 0.0%
    Insurance 2,080 2,057 -1.1%
    Banking 2,857 3,085 8.0%
    Capital Markets 2,446 1,959 -19.9%
    IT Services 7,588 7,639 0.7%

  • 3i Infotech's net profits fell by 88% YoY during FY10, with the net profit margin contracting by 11%. This happened on account of huge losses realized due to discontinuing some government operations. 3i exited 'Master Service Agreement' (MAS) that it signed with several state governments of India in 2007. On account of adverse business environment 3i exited several projects that required setting up and operating Citizen Service Centers across these states. This entailed a compensation of Rs 109.2 on these agreements. Further considering it unviable, 3i exited this line of business making the asset base amassed for these projects disposable. As these assets will be disposed at their realizable value, the company wrote them off resulting in a loss of Rs 2.6 bn. This severely dented the net profits for 3i. Excluding exceptional items, profits remained flat for FY10, while the same increased by 37% QoQ during 4QFY10.

What to expect?
At the current price of Rs 76, the stock is trading at a multiple of 3.6 times our estimated FY12 earnings. During the analyst meet, the management highlighted the companyís performance over the last 10 years as well as its current standing in the Indian IT industry. While revealing 3iís rationale in exiting government CSC (Citizen Service Centers) business, the management highlighted that it became unviable on account of lack of data as well as unfavorable regulatory environment in terms of banking and insurance distribution norms.

Adding to this were constant penalties and hassles with the government. As the business no longer promised future revenue visibility and was incurring operating cost which was as much as 3 times the revenue it generated, it was decided to be discontinued. However, this indeed resulted in a one-time loss of Rs 2.6 bn which sent 3iís net profits out of shape for FY10. Nevertheless, considering this a one-off event, the management continued to remain confident about the future growth of the company.

The management appeared satisfied with its efforts to restructure companyís debt in FY10. After two rounds of QIPs, it managed to lower its net debt to equity to 1.5:1 from the level of 1.8:1 in FY09. It targets to bring this down to 1:1 by end of FY11. It sees no risk in debt repayment and debt serving. In fact it has charted a debt repayment schedule wherein it targets to repay 16%, 11% and 30% of its debt respectively in the next 3 years. It is also restructuring its debt in the terms of replacing short term debt liability by long term debts so as to control cash out flows in short term. The management expects a growth of 11-14% YoY in revenues, clocking a net margin of 10-10.5% for FY11.

In our view, though short term concerns remain about the margin impact of discontinuing of some businesses and debt levels, we still believe the company has strong fundamentals and value proposition. We maintain our positive view on the stock.

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