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Geometric Software: Does it have an edge? - Views on News from Equitymaster
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Geometric Software: Does it have an edge?
Sep 20, 2007

Amidst all concerns of the impact a possible slowdown in the US and subprime mortgage crisis (partially averted due to rate cut by the Federal Reserve) on the Indian IT companies, we try and analyse how a company like Geometric Software (GSS) will weather this storm. Over the years, the IT industry has matured. If we are to analyse the scenario between the two periods of crisis i.e. 2001-02 and possibly now, then we arrive at the following facts:

  1. In 2001-02, the industry was helping their clients to ‘keep their lights on’ (run the business). These were routine businesses, which are mandatory in nature.

  2. Then the IT companies moved up the value chain and were interacting with organisations where change and technological upgradation was necessary to sustain the business.

  3. Now the companies are working with organisations that are trying to create a niche for themselves.

The first two categories come under the non-discretionary spending where the clients have to spend on IT and without which their survival is at stake. The third category comes under discretionary spending and company can survive without it. Please remember that in times of downturn, discretionary spending is first cut-down.

What’s in store for GSS?
We evaluate whether a company like GSS that already operates in a niche area will be hit in these times. As most of us are aware that GSS is among the rare companies that provide PLM (Product Life cycle Management) services mainly in automobiles and aerospace industry. The company acquired Modern Engineering in November 2006 to focus in engineering design. Currently, GSS derives 53% revenues from PLM services, 40% from engineering design and remaining 7% from products.

We believe that there are three factors that will go in favour for GSS:

  1. Growth in PLM spending: The PLM market grew a little over 10% in CY06 over CY05 and is projected to reach US$ 30 bn by CY11. Currently the market size is US$ 20 bn. This translates to a compounded annual growth of approximately 8.4% (source: CIM). So, there is enormous scope for growth. Though prima facie it looks like a discretionary spend, we believe that under the current business scenario, enterprises will be forced to spend on PLM and extended PLM (which means which integrates PLM with shop floor management) and this could soon evolve to be a non-discretionary expenditure.

  2. Going to direct industrial customers: Till some time back, GSS was deploying projects with their partners. Now the company has changed the strategy and is going to direct industrial customers (DI), which we believe is a welcome shift. This is primarily because it not only enhances revenue visibility but also revenue predictability. Secondly, GSS also plans to increase their billing rates considering the strength they have in the PLM arena. Another factor that will go in favour of GSS is that offshoring at Modern Engineering is currently at 3% and GSS plans to take it to 15% by FY08 and to 65% in FY10. If the company is able to achieve this then it will help it to expand it operating margins, as GSS has given an operating margin target of 18% to 20% by FY10. The company believes that margin expansion will come from engineering space. The real concern is to move work offshore at Modern from current 3% to 15% rather than taking it from 15% to 65% primarily because of two reasons. Firstly, offshoring of engineering services in US is still not in vogue and secondly, there is no domain knowledge of engineering in India.

  3. Move towards extended PLM: The company in its analyst meet in January 2007 stressed upon its shift towards extended PLM. This will certainly give GSS an edge as it has the domain in this field and secondly, extended PLM is a high growth area with high entry barriers. So GSS will retain its dominance in this space in the medium term.

While the company has given a very optimistic outlook for FY10, execution is one area where we are really concerned upon, given its volatile performance in the past. On the positive side, revenues from the Enterprise products division are expected to flow in from FY09 onwards, which will help the company to improve its margins, that are currently under pressure. However, in the medium term, the real test will be to make Modern Engineering a profitable company at the EBITDA level and to successfully bring the work offshore.

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