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MOSL: PERSISTENT SYSTEMS (Buy)-Growth trends remain challenging-Focus on new management and changed strategy

Persistent Systems: Growth trends remain challenging; Focus on new management and changed strategy

(PSYS IN, Mkt Cap USD0.7b, CMP INR639, TP INR800, 25% Upside, Buy)

• Revenue performance soft as expected: In FY19, PSYS faced challenges in its top client, which impacted its Services and IP revenue. Consequently, revenue growth was tepid at 2.2% YoY, while EBITDA/PAT increased 38%/12% YoY in the year. Amidst the earnings softness, the uptick in payout to 92% (including INR2.25b buyback) was to some extent comforting. In 4QFY19, revenue declined by 2.1% QoQ to USD118m (our estimate: USD117m). IP revenue (22% of the top line) was down 15% QoQ owing to seasonality and a weak performance from IBM’s CE/CLM segment (more than 40% contribution to IP). Revenue from Services increased 2.3% QoQ (our estimate: +1.6%). Adjusted PAT (at 28% ETR) was INR933m (+2% QoQ and 26.5% YoY), well above our estimate of INR726m mainly due to the margin beat.
• Profitability above expectations despite a drag from IP: EBITDA margin appears to have bottomed out, expanding 230bp YoY to 17.8% (adjusted) in FY19 after two years of downtrend. 4QFY19 EBITDA margin shrank 230bp QoQ to 17.4% (adjusted for IL&FS provisioning) driven by a dip in IP revenue, but was ahead of our estimate of 15.7% due to better pricing in linear services and write-back of bonus incentives. We expect the expansion in the gross margin to fully compensate for PSYS’ increased budget on selling & marketing, keeping the margins similar to FY19 levels.
• Expect changes to strategy post overhaul of top personnel: PSYS sees a greater role in ‘sell-with’ partnerships, where it can own some categories of its clients’ products and drive value-added sales. More such strategic endeavors will be crystalized by the company in a month’s time under the new CEO Chris O'Connor and Technology President Sandeep Kalra. The focus will be to accelerate revenue growth via [1] monetizing and optimizing IP assets, [2] forging partnerships with more platforms, apart from those of top clients and [3] deploying cash for a few acquisitions.