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Lower than expected revenues lead to significant margin miss

Intellect Design Arena  reported  revenues of Rs  5,275 mn which was  ?6%/?8% lower than our/consensus estimates. Intellect attributed lower than expected revenues to one?offs of $6mn. Overall pipeline continued to be healthy at Rs 65,280 mn while the company had 14 deal wins over Q2FY23. EBITDA declined to Rs 840mn (?28% q?o?q, ? 29% y?o?y) at an EBITDA margin of 15.9% which was lower due to the revenue one?offs which would have otherwise flowed to EBITDA. The company expects to continue to invest  in  developing  its  platforms  business  despite  weakening  macros.  We  expect volatility  in  macro  and  increased  R&E  spending  to  impact  revenue/margins  in  the  medium  term  while  we  remain  constructive  on  the  long?term  revenue  growth  prospects of the company. We revise our revenue forecasts for FY23/24 by ?2%/?3%  and reduce our EBITDA estimates by 320 bps/460 bps. We value the company at 20x  H1FY25 EPS and a target price of Rs 557 with an ADD rating.

Revenue growth below estimates due to one?offs

Deal pipeline remains strong  Revenues were  Rs  5275mn  (?1.5%  q?o?q,  +16.7%  y?o?y),  ?6%/?8%  lower  than  our/consensus  estimates.  The  company  attributed  this  to  one?offs  of  approximately  $6mn (Rs 500 mn), where $3.1 mn was license revenue from deals which were closed but not contracted while $2.9mn was from 2 deals with a 2 year ARR which could not be accounted for upfront. Deal pipeline was Rs 65,280 mn (+5% q?o?q, +36% y?o?y).

EBITDA margins significantly lower than estimates as company continues to invest in platform development 

EBITDA declined  to Rs 840mn  (?28% q?o?q,  ?29% y?o?y) at an EBITDA margin of 15.6%  which was lower than the company’s guided range of 22?25%. Decline in EBITDA was due  to the revenue one?offs which would have flowed to EBITDA without significant costs. The  company  expects  EBITDA  margins  to  be  20%+  for  FY23  despite  the  slippage  in Q2FY23  margins.  Given  the  volatility  across  Europe  and  investments  in  platform development EBITDA margins could stay compressed for longer than estimated.

Transition  to  platform/SaaS  in  a  volatile  macro  environment  could  weigh  in  on revenue/margins in the medium term

Intellect is continuing to invest as it transitions to a SaaS based platform business and  the company’s R&D expenditure increased to Rs425 mn  (+50% y?o?y, +7% q?o?q). The  company  noted  some  delays  in  deal  closures  and  a  volatile  macro?economic  environment and  feels  that growth over 1?2 years could be challenging. Slowdown in  license/SaaS based deals could also result in margin pressure as the high?margin nature  of the SaaS business compensates for the lower margin implementation revenues.

Valuation: We  value  Intellect  Design  at  20xH1FY25  EPS  and  revise  our  target  price downwards to Rs 557

We  revise  our  revenue  forecasts  for  FY23/24  by  ?2%/?3%  and  reduce  our  EBITDA  estimates by 320 bps/460 bps. We note that Intellect’s products continue to be ranked highly among industry benchmark rankings and we continue to be positive on the long? term growth story in the company’s banking products despite near term challenges. We revise our rating to ADD and our target price to Rs 557.

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