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Research meeting extracts: Geometric Software - Views on News from Equitymaster
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Research meeting extracts: Geometric Software
Aug 30, 2004

Background
Geometric Software Solutions (GSS) is a leading player in the product lifecycle management (PLM) space. It provides PLM services and products to the global mechanical design, manufacturing and industrial markets. The company started as a spin-off from the R&D division of Godrej & Boyce in July 1994. Beginning with around 60 people, Geometric currently employs over 800 software professionals in its centres at Mumbai, Bangalore and Pune. The company has a unique business model where it collaborates with OEMs (companies making the PLM software/suite of products) in order to capture business in the niche PLM segment. GSS has maintained strong relationships with three of the big names in the PLM space - Dassault Systemes, MatrixOne and EDS PLM.

PLM is not a strong focus area for other Indian IT companies mainly because of the fact that the market is relatively small (around US$ 14 bn), and revenue potential is not huge unless you want to target end-users. As part of its services, GSS provides software development (75% of FY04 revenues) and implementation (15%). While the company has almost no domestic competition in the PLM software development and product space, it has to face competition from companies like Infosys, Wipro and TCS when it comes to the implementation space. However, GSS has now added engineering services to its portfolio of offerings and this is likely to help it stand out from other PLM solution providers.

Business structure

The delivery structure of GSS’ business is divided into three parts.

  • Joint venture with Dassault Systems – 3D PLM.

    In the remaining parts, the company has differentiated on the basis of who owns the intellectual property rights (IPRs).

  • If the customer owns the IPR, it is pure services

  • Wherever GSS is holding the IPR, which it licenses to its customers, those are products.

    Then there is another division called the engineering services division, and the same is based in Bangalore.

    FY04 in retrospect
    GSS’ had reported strong performance in FY04 with topline and bottomline growing YoY by 26% and 27% respectively. Considering that the PLM market grew by a mere 4% in FY04, the performance of GSS can be termed as strong. The company continued to benefit from strong growth in the projects division (90% of FY04 revenues). However, the products division continued with its display of high levels of volatility and revenues from the segment actually declined by 9% YoY.

    Key impressions from the research meeting
    Addressable market size: Out of the US$ 55 bn global PLM services market, GSS’ management believes that around 25% will be offshored at 50% of the current cost. So, that is around US$ 7 bn (US$ 55 bn * 25% * 50%) market for GSS. As such, the total addressable PLM services market for GSS stands at around US$ 7 bn (FY04 revenues of GSS stood at approximately US$ 23 m).

    Sales: In FY02, GSS’ management had pronounced its aim of reaching a revenue size of US$ 100 m by FY07. The company expects products to be around 15% of US$ 100 m, or US$ 15 m, by FY07. The management believes that it would require around four main products with revenues of around US$ 3 m each and some smaller products with combined sales of US$ 3 m to fulfill this requirement. And to achieve this target, the company is scouting to acquire a PLM products company abroad.

    The company is also looking to acquire an Indian company in the engineering services space to help it reach a targeted revenue figure of around US$ 20 m by FY07. On the employee front, GSS plans to build up a base of around 2,000 people by 2007, which would include 300 additions in Mumbai, 700 in Pune and 200 in Bangalore.

    In our view, at the current momentum, it would be difficult for Geometric to reach that target (considering the required CAGR of 63% between FY04 and FY07), though the company is definitely making serious efforts to close in the gap.

    Margins: GSS’ FY04 operating margins stood at 27.3%, which was lower than 27.7% of FY03. The management is of the belief that operating margins are likely to witness a slower decline going forward. Some of its basic assumptions are:

    • Salary increases will continue to put pressure on margins. However, since most of the recruitment will be at the lower level, salary rises would not have that much of an impact.

    • Since GSS’ go-to-market is through partners, its investments in sales and marketing are unlikely to be very high. The management expects expenditure on this front to go down (as percent of revenues) and this will help GSS get leverage in margins.

    • On the billing rates front, GSS is getting upward revisions from its clients, which is a positive.

    • In its offering mix, this year the company expects that its onsite efforts will grow faster because initial engagements are usually onsite. This will adversely impact margins.

    Considering the above mentioned factors, the management believes margins will be affected in the near term. However, increasing product revenues and offshore services will lead to reduced pressure on margins in the future. As such, we have assumed lower declines in operating margins over the next 3 years (to 25.3% in FY07)

    Conclusion
    Based on our inferences from the research meeting, we have downgraded GSS’ expected FY05 EPS by 3.5%, mainly on account of a fall in other income (due to exchange losses) and higher tax incidence (as projects under one unit became taxable). However, on the basis of strong growth in product and implementation business revenues, combined with reduced pressure of margins, we have upgraded EPS for FY06 and FY07 by 4% and 8% respectively.

    At the current price of Rs 309, GSS is trading at a P/E multiple of 10.9x FY06 expected EPS. As such, we maintain our HOLD on the company with a medium to long-term perspective. Here, we would reiterate that, considering GSS’ small size and the fact that it derives revenues from the highly volatile global manufacturing and engineering industry, investors should not read much into the volatile quarterly growth performances. Rather, as the company grows larger in size and its revenues attain greater visibility and sustainability, a long-term approach will be rewarding. In that sense, Geometric is among our better picks from the sector.

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