An underappreciated digital story
Persistent Systems (PSYS) reported strong execution in Q4FY20 where Technology Services Unit (TSU), which comprises 74% of revenues, witnessed a USD revenue growth of 3.8% QoQ, which was on top of 6.3% QoQ growth in Q3FY20. EBITDA margins increased 40bps QoQ despite a 24.5% QoQ decline in IP revenues. Though fundamentals in H1FY21 will likely be impacted on account of Covid-19, as they will for all companies within our coverage, PSYS can likely fare better as 1) their exposure to stressed verticals like Travel, Retail and O&G is minimal, and 2) given absence of meaningful legacy in their portfolio with key focus being on digital technologies with strong domain specific context (e.g., Salesforce expertise in healthcare, Pega in Banking etc.,). Strong digital positioning was reflected in strong deal intake in Q4FY20 as well, with the intake being highest in the past few quarters. With the stock trading at ~9x FY22 EV/FCF, we retain our high conviction BUY rating on the stock with target price of Rs750.
* Strong services execution across Enterprise and ISV. Technology Services Unit (TSU) revenues increased by 3.8% QoQ in Q4FY20 with digital revenues increasing faster at 7% QoQ. Services revenues increased across ISV and Enterprise end markets with QoQ growth in USD revenues being 5% and 3.6% within ISV and Enterprise segments respectively. Large deal intake (multi-million dollar, multi-year deals) was strong within TSU and at multi quarter highs. Qualified pipeline, which has been curated over the past few quarters, remains strong across large clients, PE partners and advisory channels. Services revenues were broadly stable at the largest client and within the Alliances segment (QoQ revenue decline of 12.3% and 18.4% QoQ respectively) with weakness within them primarily driven by the IP segment.
* IP weak as expected. IP revenues excluding Accelerite declined by 32% QoQ to $15.5mn, with the weakness driven primarily on account of 1) delay in license sales closures given the impact of Covid-19 in the month of March, and 2) typical weak Q4 seasonality. Accelerite revenues increased by 11.8% QoQ to $5.2mn as the products are now sold as integrated offerings within the services construct and not as standalone offerings. IP revenues can potentially decline again in Q1FY21 though the magnitude of declines should be limited post that given higher proportion of support and maintenance revenues, which have an annuity characteristic.
* Margins managed well despite weak IP license revenues. EBITDA margin increased by 40bps QoQ to 13.8% despite material weakness in IP license revenues which tend to have a flow through impact on profitability with INR depreciation being a tailwind of 50bps. Profitability declined as expected in the Alliances segment (segment margin of 24.8% vs 28.3% in Q3FY20) though that was offset through increases in Services business (segment margin up 190bps QoQ to 39.5%) and Accelerite (segment margin up 710bps QoQ to 53.2%). Senior management has taken a pay cut of 20-25% to lead from the front on cost containment initiatives with multiple other initiatives taken to defend profitability as well.
* Maintain Strong BUY rating. Though management remains cautiously optimistic on the demand environment while seeing some challenges on the services side with smaller clients, prudence warrants modeling a mid-single digit revenue decline in Q1FY21 especially as IP revenues may remain under duress if lockdown restrictions get extended in some form or the other across geographies. With the stock trading at 9.2x FY22 EV/FCF on conservative estimates, we maintain our BUY rating with a target price of Rs750.
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