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i-flex: Research meeting extracts
May 12, 2005

We recently met with the management of i-flex solutions in order to get a first-hand perspective of the company’s performance in FY05 and what lies in the future. Here are the extracts of the meeting.

Company background
i-flex is India’s premier software product company focussed on providing a comprehensive range of solutions to the global financial services industry. Its flagship product, Flexcube, has been ranked as the number one selling core banking solution in the world for the last three years in succession by International Banking Systems (IBS), UK, an independent research and publishing house dedicated to the wholesale, retail and private banking systems market. The company has been growing its revenues and profits at an impressive rate of 40% and 26% CAGR respectively over the last three years.

Extracts of the meeting
View on the industry: The management is of the belief that there are far too many legacy systems in existence in the industry and not enough packages. Legacy systems tend to hamper business, as they do not enable the seamless flow of information through an organisation and as a result, delay decision-making. IT spend in the banking industry on core transaction processing is estimated at around US$ 70 bn. Of this, only 10%-15% is spent on packaged solutions like Flexcube. Thus, the market opportunity is huge for i-flex and the company does not see its future growth being hampered due to any lack of market potential. In the company’s opinion, the market is accepting packages as a necessity to remain competitive and with the increasing brand equity of Flexcube, this bodes well for i-flex, going forward.

Tank size touches US$ 50 m: For the first time in the company’s history, the tank size (unbilled license fees) touched US$ 50 m. Thus, this reflects good visibility on the products business side. It should also be noted that this tank size does not consist of a single dollar of Citibank license fees, which have already been booked. Therefore, this is a clear reflection of the fact that i-flex’s business has been quite robust and going forward, continued client diversification will be the key to growth.

Good traction in the products business: Apart from having a good tank size, the product business won three major orders with tier-1 financial institutions during FY05. These deals are for an average of two years each, apart from which the company will also earn implementation fees and annual maintenance contracts for a period of around five years. This shows that i-flex is witnessing increasing traction in its products business. Going forward, winning such contracts from large clients will increase the visibility of Flexcube and be a strong enabler to more business.

Products Vs Services: i-flex’s business is clearly segregated into two separate divisions – products and services. Each functions as a separate business unit and has its own resources. They are growing on their own steam. The services business has served as a platform for the company to further deepen its relationships with clients and offer its products to them. In the recent past, the services business has grown at a faster pace than the products business. This gives rise to a question as to whether the company will become a services-led business. However, the management has indicated that it will continue to pursue growth opportunities in both businesses and as long as these are growing profitably, it is not unduly worried as to which business is the dominant one.

Equinox acquisition: The company acquired Equinox Corporation during FY05, a BPO services provider to the financial services industry. Equinox has a revenue run rate of around US$ 1 m a quarter. It is a product-based BPO having its own intellectual property (IP). This acquisition is a strategic fit with i-flex’s strategy of providing comprehensive range of IT solutions to the financial services industry. Through Equinox, i-flex can provide transaction-processing services to its customers, which is highly complimentary to its strategy. In fact, even i-flex’s services business is geared towards providing clients a complete solution and not just the regular, low-end application development and maintenance (ADM) work.

‘Insurance intentions’: The management has indicated about its intentions to acquire an insurance product in the near future. At present, the insurance segment contributes to less than 5% of the company’s revenues. It has made some concrete plans, alliances and formed a dedicated team to take this initiative forward. i-flex has specifically said that it does not plan to develop its own product in this space and it will not get into life insurance as it is not a transaction-heavy space.

The profitability aspect: Margins of the services business have been considerably lower than its peers in the industry like Infosys and Wipro. The management has outlined the main reasons as higher investments in infrastructure, higher proportion of onsite revenues and a relatively higher proportion of domain experts employed by it. As the proportion of services revenues to the total has increased over the years, overall margins have taken a hit due to lower margins enjoyed by the services business. We believe that, going forward, as i-flex develops greater competencies in high-end services, it will be able to transfer these offshore and thus, pare the margin decline.

SG&A leverage: In the past, i-flex has operated in rented premises, which has pushed up the general and administrative (G&A) expenses. During the last two to three years, however, the company has started to consolidate its facilities and operate from fewer facilities. This has had the effect of reducing the G&A expenses as a percentage of revenues, which was around 10% in FY05 as compared to nearly 13% in FY04. As regards the sales and marketing (S&M) part of the expenditure, the company has been making continuous investments to expand its network and has leveraged on these past investments during FY05. S&M expenses as a percentage of revenues declined from 14.7% in FY04 to 13.4% in FY05. Going forward, the company expects to continue to leverage on this aspect.

Our view
At the current market price of Rs 645, i-flex’s stock is trading at a price to earnings multiple of around 14.0 times our estimated FY07 earnings, which is near the lower end of the valuation band assigned to i-flex. During the period FY05 and FY08, we expect revenues and profits of the company to grow at CAGR of 30.4% and 22.8% respectively. Given the company’s worldwide leadership position in banking software products, the recent traction witnessed in both its products and services businesses and the market’s acceptance of packaged software such as Flexcube, we believe that future prospects are bright.

Read our updated research report on i-flex solutions.

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