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3i Infotech: 'Product'ive growth - Views on News from Equitymaster
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3i Infotech: 'Product'ive growth
Apr 28, 2007

Introduction to results
3i Infotech declared its results for the fourth quarter and full year ended March 2007. For FY07, while revenues grew by 57% YoY, net profits recorded a superior 81% YoY growth, mainly on account of higher other income and lower depreciation. Operating margins have, however, contracted by 30 basis points for the fiscal. The board has recommended dividend of Rs 2 per share (dividend yield of 0.7%) and has proposed a bonus in the ratio of 1:1 (1 additional share for 1 share held in the company).

Consolidated financial performance: A snapshot…
(Rs m) 3QFY07 4QFY07 Change FY06 FY07 Change
Sales 1,716 2,102 22.5% 4,178 6,553 56.8%
Expenditure 1,481 1,650 11.4% 3,321 5,232 57.6%
Operating profit (EBDIT) 236 452 91.7% 858 1,322 54.1%
Operating profit margin (%) 13.7% 21.5%   20.5% 20.2%  
Other income 61 8 -87.3% 62 155 148.0%
Depreciation 31 58 84.6% 261 169 -35.2%
Interest 71 61 -14.2% 80 209 162.0%
Profit before tax 193 340 75.8% 580 1,098 89.5%
Extraordinary items 210 -   - -  
Tax 4 20 392.5% 3 53 1669.9%
Minority Interest 3 2   2 7  
Profit after tax/(loss) 397 322 -18.7% 574 1,037 80.6%
Net profit margin (%) 23.1% 15.3%   13.7% 15.8%  
No. of shares (m)         56.3  
Diluted earnings per share (Rs)         18.4  
P/E ratio (x)         15.2  

What is the company business?
3i Infotech is a mid-size IT company focusing 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 45 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, and automotive, pharmaceutical and chemical industries. The company’s main focus in IT services is in the region of enterprise application integration, systems integration, security consulting and e-governance. 3i Infotech 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 FY07?
Products segment getting traction: 3i Infotech has a de-risked business model with an equal share in products and the services segments. For FY07, the products segment contributed to 51% of the overall revenue (47% in FY06) while the services sector contributed to 49% (53% for FY06). While in the products revenues grew by 70% YoY during the fiscal, the services revenues grew by 48% YoY. The long-term strategy of the company is to maintain a ratio of 60:40 for services and products. The company plans to scale up further in the BFSI segment from which it derives 82% of its products revenue (up from 71% in FY06) as well as concentrate on the BPO side. 3i Infotech started its BPO services about a year back and it already contributes 9% to its consolidated revenues.

Segment wise performance…
(Rs m) FY06 % of total FY07 % of total % change
Products          
Revenues 1,952 46.0% 3,319 49.5 70.1%
Gross Profit 1,022 54.1% 1,802 56.6 76.3%
Gross Margin 52.4%   54.3%    
Services          
Revenues 2,289 54.0% 3,388 50.5 48.0%
Gross Profit 867 45.9% 1,384 43.4 59.5%
Gross Margin 37.9%   40.8%    
Total          
Revenues 4,240   6,708   58.2%
Gross Profit 1,890   3,186   68.6%
Gross Margin 44.6%   47.5%    

Acquisitions aiding profits: 3i Infotech has been on an acquisition spree in the recent past and has acquired 6 companies in FY07 providing services across verticals like BFSI, retail and business intelligence. The growth in the topline as well as in the bottomline was largely driven by these acquisitions. The company has consolidated the results for Rhyme Systems for 4 months (acquired in November 2006) while the consolidated results does not include the revenues from Professional Access since the deal has not been closed as of now and the company has time till June 2007.

Inorganic growth forays
Acquisition Month Stake Price (US$ m) Revenue (US$ m) NPM Profile of acquired company
Datacons Apr-06 100.0% 9.1 5.0 12.0% Products in BFSI & retail segments
Delta Services Jul-06 51.0% 1.1 3.0 10.0% BPO services
Rhyme Systems Oct-06 100.0% 54.9 28.0 27.0% # Asset Management products
Professional Access Nov-06 51.0% 12.0 24.0 10.0% IT services
E enable Nov-06 51.0% 1.2 1.5 13.0% Business Intelligence services
Stex Pvt.Ltd. Nov-06 100.0% 1.0 1.5 10.0% Imaging & work flow products
# EBIDTA margins; Source: Company presentation

The headcount of the company stood close to 3,500 people of which 2,600 are working offshore while 900 are currently on onsite projects. The company added 15 US$ 1 m clients and 2 US$ 5 m clients in FY07 while the revenues from top customer (ICICI Group) came down from 21% of total revenues in FY06 to 17% in FY07. The BPO segment added 14 new clients during FY07. The order book in the products division grew by 110% YoY while the services order book recorded a growth of 117% YoY.

Higher software development costs debt margins: 3i Infotech’s operating margins contracted by a marginal 30 basis points during FY07, largely on account of higher software development costs. The pressure on margins was, however, pared as cost of revenues declined from 56% of sales in FY06 to under 54% of sales in FY07.

Higher other income, lower depreciation aids bottomline: Despite the contraction in operating margins, 3i Infotech’s net profit margins expanded by 210 basis points (2.1% during the year, led by higher other income and lower depreciation costs. The other income grew by 148% YoY which mainly constitutes foreign exchange gains and interest income while the depreciation was lower as compared to FY06 by 35% mainly due to change in accounting policy in 3QFY07. The substantial rise in tax expense is owing to a low base effect as the company had received a MAT credit in FY06.

What to expect?
At the current price of Rs 281, the stock is trading at 11.8 times our estimated FY09 consolidated earnings. The company has a robust business model and this is evident by the increased acceptance of its products in the industry and the huge pending order book. We believe that the company is well equipped to face any slowdown in the US economy as it draws only 28% of its revenues from the North American region. The strategy of the company going forward is to make further inroads in the BFSI segment and the existing markets and also to cross sell it products. We had recently recommended a ‘Buy’ on the stock and maintain our positive view on the same from a long-term perspective.

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