One of the very few Indian software companies that have outperformed the benchmark Sensex over the period beginning January 2003 till date is i-flex, the owner of the world’s largest selling core banking product in FY03 – Flexcube. While the Sensex has returned Rs 169 for Rs 100 invested in the beginning of the year, the gains on i-flex have been greater at Rs 198 (or 98%). These returns are not only a factor of the overall market rally but also because of the factors internal to i-flex and the performance that it has been showing over this period.
Returns are calculated on Rs 100 invested on Dec 31 2002
At the core of i-flex’s rapid growth is Flexcube, ranked by International Banking Systems as the largest selling banking software in the world in FY03. Due to its mission-critical nature, Flexcube, apart from placing i-flex at the higher end of the value chain, commands higher margins than the software services business. Since contribution from this product as a percentage of revenues has increased over the years, operating margins are declining at a slower rate when compared to its peers. This is because of the fact that after a product becomes successful in the market, and there is less incremental expenditure on selling and marketing of the product, the revenues earned from it directly flow down to the bottomline.
One positive factor favouring the high growth potential for i-flex is its recent entry into the US markets where it was earlier restricted an entry (until FY01) due to a regulation. Recently, the company has won a few contracts in North America (US and Canada) and this has taken its share of revenues from this region to over 40%. However, the company has done well to de-risk revenues from a single region as can be seen by its penetration into over 100 countries. Out of this, Flexcube has clients in around 74 countries. Over that, the visibility of Flexcube’s revenues can be gauged from the fact the tank size of unbilled license-fee (an indicator of contracts that have been entered into but still remain to be implemented) stands at around US$ 36 m (around 45% of the company’s FY03 product revenues).
Apart from the growth in product business, the service business has also been a key contributor to the growth in i-flex’s revenues. With a CAGR of around 36%, the services business acts as an incubator for the company that helps it to develop new technology and acts as a window for new opportunities.
At the current price of Rs 869, the stock trades at a P/E multiple of 29.6x our FY04E earnings. Apart from the success of its product, Flexcube, another reason why i-flex commands a premium is due to its ability to successfully manage the products’ lifecycle.
i-flex seems to be moving in the right direction of growth as seen by its strides in the US and other global markets. As the global banking and financial industry undergoes the phase of consolidation and adherence to ever-changing regulations, there is a need for banks to continuously upgrade systems. This will benefit i-flex. While valuations might seem a bit stretched for a risky business involving products, the niche that i-flex has been able to carve out through its offerings puts the company in a favourable position to outperform its peers in the long term.
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