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Positive on new strategy and leadership

We attended ZENT’s analyst meet on Day 2 of the RPG conference, where the management reiterated its GTM strategy and highlighted key investment areas for the company. Here are the key highlights from the meet:

* ZENT reiterated its GTM strategy under the new leadership of Mr. Ajay Bhutoria. It reiterated its focus on five strategic growth opportunities (SGOs) to better target the enterprise market. ZENT expects its capabilities under Experience Services (c10% of revenue) to fuel business in Advanced Engineering Services, Data Engineering, Analytics, and Infra Services. Application Services will remain a focus area, given it’s the largest volume generator in the business.

* To increase the traction in its GTM strategy and drive better revenue growth, it has identified four key areas of investments: 1] sales, 2] partnerships, 3] talent, and [4] M&A.

* It plans to use its historical high profitability (4QFY21 EBITDA margin of 19.9%) and cash balance (of c$160m in 4QFY21) to fuel investment in sales and for inorganic acquisitions to add capabilities and target clients.

* We remain positive on the strategy devised under the new leadership and expect the same to deliver results in the next two years. We expect ZENT to deliver 12.5% CAGR over FY21-23E as against a combined 11% decline in revenue from FY19-21.

Five key strategies to leverage the strong market environment

* The company has been focusing on unbundling its current services into five key segments: 1] Experience Services – Spearheaded through earlier acquired entities – Foolproof and Indigo Slate; 2] Advanced Engineering Services – to tap downstream demand; 3] Data Engineering – leverage AI/ML; 4] Application Services, and 5] Digital Foundation Services – experience led infra services.

* While these are not the new businesses, a different packaging of the same will help in targeting the right client for right services, instead of a nonsystematic sales structure.

* ZENT believes this change will be fully implemented in the next 4-8 weeks.

Investments in sales and talent to keep margin rangebound

* The company has been investing in building up its sales strength on two fronts: 1] increasing/restructuring the sales team, and 2] enriching the sales process. It is also hiring/restructuring several business heads and bringing in senior delivery personnel.

* The management said there is an acute shortage of relevant talent in the market. To manage the same, it has enhanced its onboarding engine by expanding its recruiting team and invested in better training of freshers. It has also invested in the recruitment process to onboard laterals and on-site talent (East Europe).

* ZENT believes the above two factors, along with the partial comeback of travel expenses, will impact margin. However, sustained offshoring and better pyramid structure should keep EBITDA margin at high-teen levels.

Capital allocation skewed towards M&A, payout to remain low

* The company will use its over USD160m cash balance majorly for acquisitions. It has identified three parameters for the same: 1] capability enhancement, 2] increased access to skills, and 3] access to market.

* ZENT will keep its payout at 20-25%, one of the lowest in the industry, to use the cash to fuel growth.

Valuation and view

* ZENT’s current valuation at 15x FY23E EPS is the lowest in our midcap coverage and is at a 44% discount to the median valuations of peers.

* We expect revenue growth to rebound from 2HFY22E as the new leadership (Mr. Ajay Bhutoria took over in Jan’21), refreshed strategy, and reinvestment of margin gains in sales starts to pay off. With a likely return to double-digit growth in FY23E (we estimate 18% YoY) on a good FY22E exit and recovery in key accounts, we see potential for a significant stock re-rating as valuations catch up with its peer group.

* We see higher downside protection in the share price at current levels as 21% of ZENT’s m-cap is in cash v/s only 8% for its midcap IT Services peers.

* We maintain our Buy rating on the stock in the likelihood of a recovery in growth and attractive valuations. Our TP implies 17x FY23E EPS.

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