Persistent Systems Ltd : BUY

Guidance In-Line; Watch for Playout of OPM Levers

Revenue traction remains robust led by strong growth in focus areas. Buoyancy in demand is reflected in: 1) pace/ quality of client addns (22 new clients in Q4/ 36 in Q3; active client base now includes +40 clients with annual rev run rate > USD 1 bn), 2) inv in S&M team, & 3) gross hiring target of ~2,300 (~36% of current employee base) which would include ~1,000 freshers. Persistent reported Rev of ~Rs 213 cr (~9% QoQ & ~24% YoY), EBITDA of Rs 38.1 cr (~11% QoQ & ~1% YoY) & PAT of Rs 33.1 cr (~9% QoQ & ~17% YoY) in Q4FY11.

Key highlights

ü  Sales: Led by growth in volumes (~8% QoQ) and IP sales. Pricing rose ~1.1% QoQ for offshore; declined 2.6% QoQ for onsite.

ü  EBITDA: (a) 10% salary hikes effective 1 Jan’11 and (b) Rs 2.4 cr provision for bad debts as a conservative provision, impacted EBITDA. Decline in attrition rate (190 bps QoQ) was a positive.

ü  PAT: Forex gain of ~Rs 2.9 cr helped PAT performance.

Valuation

Revenue guidance good; margin mgmt critical for a better EPS: Upsides exist in the FY12E topline guidance of USD 220 mn (+29% YoY of which organic biz is 25%) given: 1) strong traction in R&D by ISVs* given higher discretionary spend, 2) robust demand in the focus areas (to contribute ~43-45% to FY12E topline vs. ~42% in Q4), 3) ambitious plans to raise IP-led revs to ~20% of the topline over the next 3-5 years vs. ~10% in Q4 & 4) growth in new biz – Sell-with biz (partnership with existing clients to offer integrated solns) & TCG (which leverages its domain expertise in focus areas to offer consulting svcs). However, margin mgmt is critical to offset margin headwinds from salary hikes & high attrition rates in the industry. For a +ve YoY EPS growth in FY12E, it would have to leverage on existing op. levers in: 1) employee pyramid, 2) utilization rates 3) pricing & 4) growth of IP-led revs, to offset the impact of 30% effective tax rate which would consume most of the growth in operating profit.

Est./Valuations: F12E EPS marginally revised downwards by ~1.7% to incorporate higher S&M investment. Our TP of 511 implies an upside of 30%. Maintain BUY rating.