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Geometric Software: Investor meet extracts
Sep 5, 2005

At the recently held second Equitymaster Investor meet in Pune, Mr. Shashank Patkar, the Chief Financial Officer (CFO) of Geometric Software Solutions (GSS) gave a brief view about the software industry, Geometric's place in it as a niche player and the future plans and strategy of GSS over the next few years. The Indian software space is demarcated into 4 major types – horizontals (end-to-end service providers, includes players like TCS and Infosys), vertical players (niche players operating in a specific vertical or industry), product companies and captive centres/wholly owned/joint ventures/MNCs. Although Geometric Software (GSS) is present in horizontals, vertical as well as in products, it is categorized as a vertical player with a focus on the niche area of product lifecycle management (PLM).

A little about PLM
All products, like cars, mobile phones, airplanes, even bottles, anything that you can see and touch, are designed and manufactured using PLM technologies and software, also known as computer-aided design/manufacturing/engineering (CAD/CAM/CAE). GSS offers software development services to PLM vendors worldwide and implementation services around PLM technologies.

The PLM market
The PLM market (license revenue) is expected to grow to around US$ 20 bn by 2008. Typically, the services around each dollar of license revenue earned form US$ 9, implying a ratio of 9:1. Thus, the services market is estimated at US$ 180 bn by 2008. As per our estimates, the total addressable market for GSS is currently around US$ 8 bn, expected to grow to US$ 10.7 bn by FY08. Thus, there is tremendous scope for growth.

Engineering community warming up to outsourcing
The engineering community has traditionally been very conservative with regards to outsourcing and typically, functions like financial services and back-office were the first to adopt outsourcing and engineering has been the last to do so. Functions like R&D and product design, which are considerably cheaper to do in India, are now being outsourced to countries like India.

Medium-term strategy
GSS’ strategy is to become a US$ 100 m company by FY07, from about US$ 38 m currently. The company plans to increase the share of its industrial customers in total revenue from 35% currently to about 55% by that time and the share of products is expected to increase to about 13%-16% of revenues from 9% at present. The Engineering Services Division (ESD) is expected to contribute 18% to revenues by that time frame. However, we expect GSS to earn revenues of US$ 81 m by FY07. It must also be noted that GSS plans to achieve this target partly through an acquisition of around US$ 10 m, although there is no clarity as yet as to the possible date of such an acquisition.

Elements of the strategy
The company plans to achieve the said revenue target by concentrating on PLM, their core competency, leveraging its existing relationships with PLM OEMs like Dassault, building up its product portfolio and working with its partners. We believe that this strategy will take GSS in the right direction over the longer term and, given its strong focus on the PLM market and established market position, the company will benefit from the increasing depth of relationships formed with OEMs as well as industrial customers.

The company plans to increase the contribution of products for reasons such as improved margins, thereby improving profitability and countering the impact of rupee appreciation. The products business is not linear in nature, unlike services and so volatility could increase, going forward. However, over the longer term, we believe that this is a good strategy that will help GSS move even higher up the value chain.

Challenges ahead
The major challenges faced by GSS include people. While there may be a fair number of people passing out of engineering colleges every year, getting and retaining good people is not easy and particularly for a niche area like PLM in which GSS operates. Scalability of processes is another challenge. For GSS, which will have to increase its headcount from 1,300 at present, to possibly double in a couple of years’ time, the processes need to be in place to enable this scaling up of resources. We believe that this is a key risk to take into consideration while investing in a company like GSS.

GSS has taken numerous steps to address these issues. It has set up a PLM institute to provide technical training to its staff and is also planning to implement ERP from this year, in order to integrate its systems to enable better decision-making.

Investor-friendly moves
GSS has an employee stock option scheme, which is linked to achievement of certain revenue and profit targets. Thus, only if the company achieves these targets, the employees will get the incentives. Therefore, we believe that the company, through this investor-friendly move, has ensured that its expenses are aligned with its revenues.

Hiring plans
GSS plans to add around 600 to 700 employees in this financial year, taking the total employee base in the region of around 1,800 by the end of FY06.

Hedging policy
The company hedges one year’s revenues. It expects rupee appreciation. From the previous quarter, GSS had adopted a mark-to-market policy of recognizing forex gains, where at the end of every quarter, forex gains or losses are booked.

What to expect?
At the current price of Rs 122, GSS’ stock trades at a price to earnings multiple of around 7.6 times our estimated FY08 earnings. This is at the lower end of the valuation spectrum. Given the company’s strengths in its core area of PLM, strong relationships formed with major PLM OEMs, increased focus on industrial customers and strong potential of the PLM industry, the company appears poised for a period of strong growth ahead. Of course, as always, one must take the risks into account and the key risks for GSS are scalability and employee retention.

During the period FY05 to FY08, we have estimated GSS’ revenues and profits to grow at compounded annual growth rates (CAGR) of 42% and 48% respectively. We had given a ‘BUY’ on the stock in January 2005 at Rs 78 with a target price of Rs 150 in the long-term. We maintain our positive view on the stock.

  • To view the investor meet slide show, click here

  • To download the Geometric Software presentation, click here.

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