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Geometric Software: Research meet extracts - Views on News from Equitymaster
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Geometric Software: Research meet extracts
Jun 8, 2005

Geometric Software Solutions (GSS), a niche software company operating in the area of product lifecycle management (PLM), recently announced its FY05 results. We met the management of GSS in order to get greater clarity on the company’s performance in FY05, its long-term strategy and key future growth drivers. The following are the extracts of the meeting. Industry growth prospects:  The global PLM market is expected to grow to around US$ 25 bn by 2009 as per CIMDATA, a PLM research and consulting organisation. This translates into a CAGR of around 8% per annum over the next few years. Companies are increasingly realising the value of PLM as a growth tool that shortens time-to-market for their products. Trends that show decision-making moving from the engineering department to the CIO confirm this. Another trend being witnessed is that the user base has been expanding, from the traditional domains such as automotive and aerospace, to non-traditional domains such as finance, FMCG and hospital care. This is an opportunity that has not been sized up as yet, but could increasingly be a possible trend, going forward.

We believe that this reflects strong growth opportunities for the PLM industry in general and GSS in particular. The fact that the manufacturing and core sector industries in countries like India have grown at a strong pace have resulted in the PLM market growing at a faster than expected rate, which is generally in mid-single digits.

Growth strategy:  GSS has a revenue target of US$ 100 m by FY07, one that has been repeated often enough by the management in the past. The key points of the company’s long-term growth strategy are concentrating on PLM, leveraging relationships with leading OEMs, working with partners and building up the product portfolio. As far as organic growth is concerned, the company is comfortable with a target of US$ 90 m by the specified time frame, with an acquisition contributing the balance US$ 10 m. Considering the current growth momentum and the strategies that GSS’ management is putting into place for the future, we expect the company’s revenues to grow to US$ 82 m by 2007 and US$ 114 m in FY08. This implies a CAGR of 43% during FY05 to FY08.

Change in long-term revenue mix:  Going forward, GSS plans to increase the share of industrial customers in its total revenues. By FY07, the target for this is around 50% to 55% of revenues (39% in FY05), of which the engineering services division (ESD) is expected to contribute 18% to 22%. Products are also expected to increase their contribution to 13% to 16% (9% in FY05). While a greater move towards industrial customers might lead to lower visibility for GSS as there is a systems integrator involved as a middle party, the management has indicated that the company is being increasingly involved in the pre-sales process. This is likely to counter the challenge of low visibility in the future from industrial customers. Also, industrial customers have higher billings than OEMs (61% of revenues) and, to that extent, there is an upside to revenues.

Strengthen relationships with existing partners:  GSS sees greater value in deepening its existing relationships with its partners. The company plans to mine its relationships with its partners effectively by providing end-to-end PLM solutions to its customers. The company also plans to establish two offshore development centres (ODCs) for its industrial customers in FY06. The company has divided its partner accounts into four types and it is concentrating on mining the partners that fall into the “Key accounts” and “Potential key accounts” categories in order to grow its revenues.

Engineering services division (ESD):  GSS has started to focus on the engineering services division and sees strong growth coming from this area. This division recorded revenues of US$ 1.5 m in FY05 and the company has set an internal target of US$ 5 m by FY06. It plans to achieve this through an acquisition during FY06, strengthening partnerships and broadening its service offerings. The company has witnessed an increasing trend of offshoring of engineering services, which are core in nature. Going forward, it expects an increase in this trend as well as offshoring in the PLM market. As a result, engineering services is an area where the company is expecting strong growth.

Products game plan:  GSS has also laid an emphasis on developing its product portfolio, going forward. The key areas where the company sees good growth potential are component technologies, viewing and collaborative solutions, X-PDM applications and CAD-PDM integrations. GSS acquired TekSoft during FY05, which was one of the main reasons as to why the products business showed healthy growth during the year. The company also plans to leverage on its channels in order to cross-sell TekSoft’s products as well as its existing and future products.

To achieve the objective of products contributing between 13% to 16% of revenues by FY07, GSS is looking at 4 products contributing around US$ 3 m each. This includes TekSoft, eDrawings, Feature Recognition (FR) technologies and PDM tools.

Key issues:  GSS believes that recruitment, training and retention of people are some of the key issues that it will face, going forward. Building scale is also another area of focus that the company plans to work on. In order to address these issues, GSS has opened a PLM institute and commenced training of its first batch. Around 200 to 300 people can be trained at a time. GSS expects to add around 800 to 900 people in FY06 and have a total of around 2,700 employees by FY07. Over the medium term, as a result of such aggressive hiring in order to address issues of scale and implementation of robust business, the utilisation rate is expected to come down from the high-80s, which is clearly, quite unsustainable. This will have the effect of putting pressure on the company’s margins.

Dividend policy:  In future years, the board is expected to align the dividend payout ratio in the range of 16% to 20% of consolidated profits, barring any unusual capital expenses.

Key drivers in FY06:  GSS expects an increase in its manpower, recruitment and training costs in FY06. It also expects to be able to leverage on its sales, general and administrative costs (SG&A). Momentum is expected to continue in the products business, given the initiatives GSS plans to take in this regard. However, the company also expects a higher tax implication outside the country, given an expected increase in its onsite revenues, though the effective tax rate is expected to come down from 18% in FY05 to about 16% in FY06. The effective tax rate rose from 10% in FY04 to 18% in FY05 mainly due to one of the company’s units completing 10 years, thus, resulting in a phase-out of tax benefits available under Section 10A of the Income Tax Act, 1961.

Also, the fringe benefits tax (FBT) announced in the Union Budget in February this year is expected to impact profits by around 1% to 2%. As regards 1QFY06, profit growth is expected to be flat, owing to higher employee costs due to revision in salaries in April, higher depreciation due to partial commissioning of its facility in Pune and higher marketing expenses.

We have upgraded our EPS growth estimates for FY06 by 7% and have maintained the estimate for FY07. During the period FY05 to FY08, we expect GSS’ net profits to grow at a CAGR of 49%.

Our view
At the current market price of Rs 600, GSS’ stock trades at a price to earnings multiple of 10.5 times our estimated FY07 earnings. This makes the stock fairly valued from a 2-year perspective. However, considering the growth strategies indicated by the management and our assumptions, we remain positive on the stock from a long-term perspective.

  • Read our updated research report on GSS.

    Company background
    Geometric Software Solutions (GSS) specializes in providing product lifecycle management (PLM) technologies and solutions to the global mechanical design, engineering, manufacturing and industrial markets. The company’s presence in the domain of geometry provides it with a competitive advantage in the form of high entry barriers on account of high-levels of technical skill-set requirements. The company has used the partnership model to grow effectively, where it works with large OEMs like Dassault Systemes, industrial customers and systems integrators like IBM and provides solutions to them through collaboration.

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