Research meeting extracts: i-flex solutions - Views on News from Equitymaster

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Research meeting extracts: i-flex solutions

Sep 13, 2004

i-flex is a focused player in the banking and financial services vertical. The company’s portfolio of offerings comprises products (57% of revenues), like Flexcube, an end-to-end product suite for retail, corporate and investment banking and asset management. Also, the company provides software services (43% of revenues) like application software development and deployment, maintenance and business and IT consulting. In FY04, the company’s flagship product, Flexcube, was ranked as the number one selling wholesale as well as retail back-office banking solution in the world by International Banking Systems (IBS) for the second year in running. In fact, Flexcube has been rated among the top-selling banking solutions for the last five years.

Key impressions from the research meeting
Addressable market size: Total IT spending in the financial services industry is expected to grow from US$ 370 bn in 2002 to US$ 475 bn in 2006, CAGR of 6.4%. Out of this, i-flex’s addressable market of software and external services is expected to grow from US$ 140 bn in 2002 to US$ 186 bn in 2006, CAGR of 7.4%. Sales: From the products perspective, the company is seeing that increasingly larger size banks are adopting standard technologies. The management expects increasing momentum in this space and has mentioned a strong pipeline of banks that want to replace legacy systems in favour of core banking solutions like Flexcube.

On the services side, as technology spending is showing signs of revival, the company is witnessing some spurt in this segment. This is clearly vindicated by the fact that its services revenues had grown by 53% YoY in 1QFY05. The management is also of the belief that the outsourcing debate has created a sort of free publicity for the Indian outsourcing story and this is likely to benefit services growth going forward. Considering all these factors, we maintain our strong sales CAGR for the company at 31.3% for the period between FY04 and FY07.

Margins: The management expects operating margins to stabilise in the services segment at their current levels of 18%. However, the only variable to these margins is if the company has recruitments in advance of the deployment, which may be a temporary phenomenon. Services margins are also likely to be helped by an increase in the offshore contribution (around 30% currently) to total services revenues. As far as product business is concerned, the management expects the rate of spending towards selling and marketing to come down in the future and this might aid the stability in overall margins. We maintain our overall operating margins at 28% for FY05 (28.3% in FY04). However, we foresee margins reduce further to 25.6% by FY07.

Competition: The management believes that Flexcube (the core banking product) is much ahead of its competition and is likely to maintain the strong momentum going forward as well. Flexcube, for instance, scores over its nearest rival ‘T24’ (a product of Swiss company - Temenos) in terms of the overall architecture and scalability features. Flexcube has now also ventured into areas like retail customer differentiation and value based pricing to the retail customer that is the next level of banking and would help the product gain a larger market share going forward. Other big advantages of Flexcube are its lower cost of ownership, higher scalability and better operational efficiencies (lower people required to run the system).

Based on our inferences from the research meeting, we have maintained i-flex’s expected FY05 and FY06 EPS at Rs 30.6 and Rs 37.2 respectively. At the current price of Rs 620, i-flex is trading at a P/E multiple of 16.7x FY06 expected EPS which is near the higher end of the valuation spectrum. However, the company continues to be on the radar of long-term investors (more than 3 years). This is a measure of investors’ belief in a sustained high growth for the company going forward.

At the end of 1QFY05, the company had a tank size (unbilled license fees from the products segment) of US$ 43.7 m and this is specifically indicative of Flexcube’s improving strength in the global market for core banking solutions. However, while the company has suffered on the operating profitability front due to high spending towards sales and marketing initiatives, we believe that investors need to understand it as an investment into the company’s future growth and not a non-productive expense. The very fact that i-flex is steadily expanding its global reach both in the products and services segments speaks volumes of the quality of its offerings. Based on our valuation matrix, the stock is likely to gain 25% from current levels by FY07.

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