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Nucleus Software: On a slow growth trajectory - Views on News from Equitymaster
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Nucleus Software: On a slow growth trajectory
Sep 24, 2009

We recently met the management of Nucleus Software Exports, a Noida based smallcap IT company, to understand the business model of the company and discuss the current business environment particularly for small-cap IT companies. Here are the key takeaways from the same. Company background
The major core banking products like Iflex's (now Oracle Financial Services Software) Flexcube, Infosys' Finnacle and TCS' BaNCS do not cater to the retail banking requirements of banks and NBFCs. This is the area that Nucleus Software Exports operates in.

Over 65% of Nucleus' revenue comes from the product business comprising of its flagship products FinnOne, Cash@Will and PowerCard. All these products cater to retail banking functions like customer acquisition, loan management, collection, payment and credit card management. The list of some marquee clients for this business includes banks like SBI, HDFC, ICICI, IDBI, Deutsche etc. in India, Citi and DBS bank in Singapore, Shinsei Bank in Japan and plethora of banks and NBFCs in middle-east and far-east regions.

The company also offers related services. However, the performance of the services segment which contributed 33% of its revenues in FY09 has remained quite volatile. In this pace there are only 2 major clients; Citi Bank in Singapore and Sinshei in Japan. The company does not cross-sell its services to the product customers.

In terms of client geographies, Nucleus generates 49% of its revenues from far-east, 16% from South East Asia, 10% from Middle East and 6.6% from Europe. India is a major market and contributed to 11% of the topline during FY09. The company has nearly no presence in the US market as it considers its product offering still not ready to cater to the complex US market.

Key takeaways from the research meeting

Business environment: The management suggested that the worst impact of the global economic slowdown was seen during the last two quarters and business environment is expected to improve going forward. The company expects the traction to continue in the Middle-East, African and Japanese markets. It will continue to focus on replacement markets (developed markets where financial sector is replacing its old IT infrastructure) of Japan and Europe which have huge IT budgets. Owing to its significant presence in Middle-East, Islamic banking is another major area of interest.

On competition: The major competition comes from Indian vendors like Iflex, 3i Infotech, Polaris and foreign vendors like Misys, London Bridge Software and Fidelity. The management appeared confident of the company's product offering on back of better success rate, domain expertise, scalability and reputation.

On FY09 performance: During FY09, the company's topline stood at around Rs 3.3 bn with a YoY growth of 13.8%. Out of the above, the product business which accounted for 67% of the topline grew by 11.4% YoY. However the profitability of the company received a big blow on account of increased software development and sales and marketing expenses. The operating profit for the company dropped by 32% YoY registering a contraction of 10% in operating margins. Further, impacted by an unfavorable forex movement, the company's net profit declined by 48 % YoY during the last fiscal.

Expansion plans: The company is focusing on adding new functionality to its flagship product i.e. FinnOne suite. The company aims at making FinnOne more compatible with the small financial institutes which have limited IT budgets. Managing the functionality of deposits, wealth management and operating leases in a more structured manner is also an immediate focus area. It has no plans of acquiring technology inorganically. However, it might look for acquisitions in order to gain access to markets which are less penetrated.

Future outlook: Though the management remains cautious about the pace of recovery in the Europe and Japan, it sees a lot of traction coming from India, Middle and Far-East. With a focus on maintaining topline and increasing bottom-line, going forward it expects to clock in a gross margin of around 20%.

Our view: Nucleus software is a dominant player in the niche market of retail loans. With a well-received product portfolio in place, the business model looks impressive. However, this niche appears to be challenged by core banking software providers adding retail banking to their service offerings. Moreover, the client concentration in terms of geographies is a risk. There is also a need to come up with a proper succession plan for the company.

At the current price of Rs 115, the stock is trading at a price to earnings multiple of 9.6 times its trailing 12-months earnings.

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