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3i Infotech: Conference call extracts

May 28, 2011

We recently had a conference call with the management of 3i Infotech to discuss the sale of its US-based Billing and Payments Unit. The management discussed the rationale behind hiving-off of this unit. It also discussed the issues related to reduction of debt from the company's balance sheet. However, the management refrained from touching on subjects like future growth prospects or the financial performance.

3i-Infotech (3i) is a mid-size IT company focusing on the banking, financial services and insurance (BFSI) industry.

Here are the key takeaways from the conference call:

Rationale behind sale of US-based Billing and Payment Units: 3i has recently signed an agreement for sale of US-based Billing and Payments Unit to an affiliate of Cerberus Capital Management, L.P. The deal is valued at US$ 137 m. The unit consists of Regulus Group, J&B Software as well as JP Morgan Chase's retail check processing division.

3i had acquired J&B Software in November 2007, Regulus Group in May 2008 and JP Morgan Chase's retail check processing division in June 2009. These companies were integrated to form the Global Billing & Payments unit of the company. At that time, both volumes as well as profitability of this business were rising. But due to economic slowdown in 2008, this business got a hit. However, over the past three years, this business witnessed a negative growth. Even future expectations of growth were hurt due to rapid shifting of the payment processes to the electronic platforms. The company was not in the position of consolidating this business further through more acquisitions. This was due to the highly leveraged balance sheet. As a result, the company has decided to hive off this unit.

Debt repayment was not the reason: Though debt repayment has been the concern for the company, but the management emphasized this is not the reason behind this hiving off. The main considerations were business performance and future growth of the unit.

At the same time, the management added that the divestment would reduce the leverage and strengthen the balance sheet of the company. The management intends to use the sale proceeds to reduce the debt positions in the company's books.

Divestment is not a loss: The management stated that acquisition cost including the restructuring costs for the unit was US$ 130 m. Considering the sale proceeds and revenues generated from the unit, overall return on investment from this unit is 54%. On the top of that, since the acquisition was done with the help of low cost debt financing, return on equity from this unit would be even higher, around 200%.

Targeting comfortable debt-equity ratio: The management is comfortable with the debt-equity ratio of 1:1. On the issue of current debt payment liability, the management stated that they would work with the banks for the repayment of the debt. They also plan to restructure some of the debt positions.

What to expect?

At the current price of Rs 45, the stock is trading at a multiple of 4.7 times of expected FY14 earnings.

The US unit's sale transaction will take 2 months to close, subjects to customary closing conditions and any regulatory approvals. The proceeds would be utilized to reduce the debt positions in the company's books. However, it remains to be seen how much debt is actually repaid by the management and what steps the management takes to reduce the debt positions of the company going forward.

Going forward the company will concentrate on its continuing core business, i.e. IT solutions, a combination of IT products and services. The management has not given any growth guidance as of now.

The company has added 400 employees on net basis in the last financial year, FY11. The management stated that new recruitments would be done on the business requirement basis and didn't give any guidance on the same. The management plans to give average salary hike of 15% in the current year. This will bring margins under pressure.

Regarding concerns over working capital, the management said that it would come down in absolute numbers but it would increase in terms of the number of number of months. The reason is the product business generally needs more working capital. The company also has to refinance some foreign currency loan, which would lead to a slight increase in the interest cost of borrowing.

In the light of recent changes in the company, we recommend a 'Hold' View on the stock with a 3 years perspective.

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