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i-flex: Past performance, future promise…

Feb 14, 2005

In the entire gamut of the Indian software space, there is one company that has brought much-needed recognition to the 'Made in India' brand through its world-class product portfolio. The company is i-flex Solutions, which provides comprehensive IT solutions to the Banking, Financial Services and Insurance (BFSI) vertical. It is mainly a products company (61% of revenues in FY04), with services making up the balance. The company's flagship product, Flexcube, is an end-to-end product suite for retail, corporate and investment banking and asset management. In 2003, International Banking Systems (IBS) ranked it as the number one selling wholesale as well as retail banking back-office solution in the world for the second year running. In this article, we take a look at the company's past performance and see where it is headed going forward.

As a matter of fact, the global financial services industry spends more on technology than any other industry worldwide. According to i-flex's annual report, total IT spending in the global financial services industry is expected to grow from US$ 370 bn in 2002 to US$ 475 bn by 2006. Of this, the target market for i-flex is estimated to grow from US$ 140 bn in 2002 to US$ 186 bn by 2006.

i-flex's business model…

i-flex has classified its revenues into two major business segments – products (comprising of product licenses and related activities) and services (comprising IT solutions and consulting services). The product portfolio comprises of Flexcube (around 97% of product revenues), Reveleus and Daybreak. This business enjoys higher margins, since it is less people-intensive, requires a high level of expertise to create, and is often used in mission-critical functions of the client, enabling it to cut costs, streamline its systems and processes, reduce its time-to-market, and compete effectively in its industry. Revenues from products flow straight to the bottomline after recovering costs associated with producing them, branding and marketing them.

The services business, on the other hand, is highly people-intensive, and therefore, the salaries component of the costs is high. Apart from this, over 60% of i-flex's services revenues come from onsite services, where margins are lower. Thus, the end result is that i-flex's services business margins are lower than those of its peers in the industry. The management has indicated in the past that the services business serves as an 'incubator' for the development of new technologies, and helps in cross-selling opportunities to clients.

Segment-wise performance
(Rs m)FY01FY02ChangeFY03ChangeFY04Change
Products
Net Sales1729252946.3%385552.4%479424.4%
Operating profit (EBDITA)848114835.4%185061.1%208112.5%
EBDITA margin (%)49.0%45.4% 48.0% 43.4% 
Services
Net Sales1511166910.5%228637.0%308535.0%
Operating profit (EBDITA)568464-18.3%448-3.4%55022.8%
EBDITA margin (%)37.6%27.8% 19.6% 17.8% 

The consolidated performance…

As can be seen from the table below, while revenue growth has been robust over the years, profit growth has not kept pace. This could be attributed to the pressure on margins on account of increasing expenditure, particularly employee costs, which form an important part of any software company's total expenses. During FY01 to FY04, revenues have risen by over 35% CAGR, but profits have risen by just 21% CAGR. On the other hand, employee costs from FY02 to FY04 have risen at a CAGR of 40%. There has also been a fair amount of earnings volatility for the company. This is typical of a product company like i-flex, whose revenues are highly dependent on the “tank size” (unbilled license fees), time taken for implementation of orders, and receipt of milestone payments. Thus, it is possible that in a particular quarter, there may not be any major implementation and fees received, and hence the quarter may show a poor performance, while in the next quarter, a major implementation may take place, and may result in big profits.

i-flex: Over the years…
(Rs m)FY01FY02ChangeFY03ChangeFY04Change9mFY05
Net sales 3,241 4,195 29.4% 6,141 46.4% 7,881 28.3% 7,799
Operating profit (EBDITA) 1,183 1,387 17.2% 2,003 44.5% 2,227 11.2% 1,733
EBDITA margin (%)36.5%33.1% 32.6% 28.3% 22.2%
Profit after tax/(loss) 1,014 1,153 13.7% 1,709 48.2% 1,788 4.6% 1,286
Net profit margin (%)31.3%27.5% 27.8% 22.7% 16.5%
No. of shares (m)31.933.3 73.6 76.9 76.8
Diluted earnings per share (Rs)*13.215.0 22.3 23.3 22.3
(* annualised)        

Conclusion

At the current market price of around Rs 635, the stock trades at 28.5 times annualised 9mFY05 earnings. This is clearly at the higher end of the spectrum. Given the company's growth opportunities, and the fact that it is well positioned to take advantage of them, the risk-return ratio, although skewed towards risk in the short term, does favour investors with a 3-year time horizon.

i-flex, as mentioned above, is a market leader in developing IT solutions for banks and financial institutions. The industry in which it operates is growing at a fast clip, and there is an increasing need for banks, financial institutions, investment banks and asset managers to become more competitive, cost-conscious, respond quickly to market changes, and have a quick time-to-market for their products and services. This clearly underscores the point that they will need to make more investments in technology, and upgrade their legacy systems in order to survive. This only bodes well for i-flex.

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