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3i Infotech: Strong-operating show! - Views on News from Equitymaster
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3i Infotech: Strong-operating show!
Nov 16, 2006

Performance summary
3i Infotech declared its results for the second quarter ended September 2006. The topline registered a sequential growth of 13% for the quarter on the back of strong performance in the product as well as services segment. However, margins expanded at a slower pace due to increase in the cost of revenues by 40 basis points on QoQ basis. Reduction in other income along with increase in interest expenditure has arrested the bottomline growth.

Consolidated financial performance: A snapshot…
(Rs m) 1QFY07 2QFY07 Change 1HFY06 1HFY07 Change
Revenues 1,285 1,450 12.9% 1,858 2,735 47.2%
Expenditure 991 1,109 11.9% 1,492 2,101 40.8%
Operating profit (EBDITA) 293 341 16.2% 366 634 73.3%
Operating profit margin (%) 22.8% 23.5%   19.7% 23.2%  
Other income 48 39 -18.7% 25 86 244.8%
Depreciation 79 90 14.8% 130 169 30.5%
Interest 32 45 39.8% 36 76 115.2%
Profit before tax 230 245 6.2% 226 475 110.2%
Tax 17 13 -22.3% (10) 29.8  
Minority interest - 6   - 6  
Profit after tax/(loss) 214 225 5.5% 236 439 85.6%
Net profit margin (%) 16.6% 15.5%   12.7% 16.0%  
No. of shares (m) 53.2 53.3   52.8 53.3  
Diluted earnings per share (Rs)*         14.6  
P/E ratio (x)*         12.9  

What is the company’s business?
3i Infotech is an IT company focusing mainly on the banking, financial services and insurance (BFSI) vertical. It was incorporated in 1993 as a back-office IT services provider to the ICICI Group and has since metamorphosed into a technology company providing IT services and solutions to over 500 clients in over 30 countries. 3i Infotech earns revenues from products as well as IT services. The company has products for the BFSI space, with a presence in insurance, treasury, asset-liability management, risk management, core banking and investment management. It also has an ERP product suite, providing solutions for the retail, manufacturing, distribution, trading, fashion, and automotive, pharmaceutical and chemical industries. Its main focus in IT services is in the region of enterprise application integration, systems integration, security consulting and e-governance. The company acquired four companies in FY06 with a focus on business intelligence, security consulting, anti-money laundering software, ERP software and a mutual fund product.

What has driven the performance in 2QFY07?
Growth across the segments: 3i infotech registered a growth of 13% on sequential basis during 2QFY07. The major growth driver during the quarter was services segment (up 14% QoQ). Product segment also registered a decent growth of 11% QoQ.

Growth in the ERP segment was 14.2% QoQ, while growth in the BFSI (banking, finance services and Insurance) segment was 10.2% QoQ. Faster growth in ERP segment could be attributed to de-growth witnessed in the previous quarter. In the services segment, the growth rate in the software segment was lower at 7% QoQ compared to 37% growth in the others segment. Revenues mix (including other income) improved, which is apparent from the fact that products constituted 46.9% of the revenues as compared to 45.1% in 2QFY06. Increased share of the products in the revenues tends to have a positive impact on margins, as they enjoy superior margins.

Revenue visibility during the quarter improved, as the order book increased by 9.8% QoQ in the product segment standing at Rs 1,609 m at the end of 2QFY07 (equivalent to 58% of the annualised 2QFY07 revenues from the segment). Order book in the services segment registered a growth of 10% QoQ standing at Rs 1,614 m at the end of the quarter (equivalent to 53% of the 2QFY07 annualised revenues of the segment).

Segment wise performance…
(Rs m) 1QFY07 % of total 2QFY07 % of total Change
Products
Revenues 628 48.9% 699 48.2% 11.3%
Gross profit 330 56.1% 384 65.4% 16.6%
Gross margins 52.5%   55.0%   2.5%
Services
Revenues 657 51.1% 751 58.5% 14.4%
Gross profit 258 43.9% 288 48.9% 11.5%
Gross margins 39.2%   38.3%   -1.0%
Total          
Revenues 1,285   1,450   12.9%
Gross profit 587   672   14.4%
Gross margins 45.7%   46.3%   0.6%

Business mix propelling margins: Margins in the products segment expanded by 250 basis points to touch 55% levels in 2QFY07, while margins in services declined marginally to 38%. The overall margin expansion can be attributed to improvement in the business mix of the company, reflecting the increase share of product in the revenue mix of the company. Selling, general and administrative (SG&A) expenses were stable in 2QFY07 (22.8% of the sales). Staff cost though decline as a percentage of sales during the quarter on a sequential basis, the same has risen significantly (870 basis points YoY), thus limiting margin expansion.

Other income, interest shakes bottomline: During 2QFY07, other income declined 19% QoQ while the interest expenditure increased by 40% QoQ. This restricted the strong operating performance to transpose itself at the bottomline level. However, lower tax outgo helped matters at the bottomline level.

Performance over the recent past…
Particulars 1QFY06 2QFY06 3QFY06 4QFY06 1QFY07 2QFY07
Sales growth (%, QoQ) 10.0 11.9 15.0 7.1 7.1 12.9
Operating margins (%) 13.4 20.5 20.9 21.3 22.8 23.5
Profits growth (%, QoQ) 21.0 11.7 22.0 7.6 21.9 5.5

3i on acquisition spree…

Continuing with its strategy to grow via the inorganic route, 3i Infotech acquired two more companies to enlarge the product and service offerings of the company. It recently acquired a 51% stake in Professional Access and E-enable. Professional Access is a profitable company with revenue of about US$ 24 m and has net profit margins of 10%. 3i Infotech would pay US$ 12 m for the 51% stake in the company. Thus, the acquisition is roughly at a multiple of 1 times its revenue, which looks reasonable. 3i Infotech had earlier acquired stake in Datacons, 51% stake in BPO player (Delta Services) and 100% stake in UK based software products company, Rhyme Systems.

Impact of acquisitions…

Combined revenues from the all the acqusitions made would be Rs 3,000 m (48% of the revenues guidance for the 3i Infotech). 3i Infotech expects to increase its revenues as much as 45% to 50% from these acquisitions from the current levels. These acquisitions seem to be consistent with the management’s mission to balance the revenues stream from products and services.

Funding of the professional access will be done from the FCCB proceeds (foreign currency convertible bond), while the funding of E-enable will be done from internal accruals. The company recently raised Euro 15 million through the FCCB route with an embedded conversion option at a price of 190 per share upto March 2010.

Inorganic growth – The rationale…

Inorganic growth fills the void in current product offerings, reduces time to market substantially and enables cross selling of the key products. In order to wider its product offerings and to improve is business mix, the acquisitive strategies of the company is going to continue for the times to come. Also, acquiring product companies not only strengthens the product offerings but also paves the way to capture the service needs of customer, as clients will also be offered services post product offerings. Acquisition will also help 3i Infotech to cross-sell the products across the geographies. Management has shown intent to take some of the offerings of the Rhyme Systems to US and other geographies.

What to expect?
At the current price of Rs 188, 3i InfoTech’s stock is trading at a price to earnings multiple of 13 times its trailing 12-month earnings. 3i Infotech plans to expand its offerings and geographical presence in the future. In the insurance space, the company has made inroads into the US markets and sees significant replacement opportunity in the form of small clients (1,500 to 2,000). In the banking space, the company plans to target the emerging markets and markets where first wave of automation has already taken place.

The company has upgraded its earlier revenues guidance of Rs 6,200 to 6,400 m for FY07. But the management has also revised its earnings guidance upwards to Rs 16 to Rs 17 per share (excluding the recent acquisitions). We maintain a positive view on the stock from a long-term perspective.

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