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Improving Outlook

Polaris Software Lab is likely to benefit from growing IT spending in financial services…

Polaris Software Lab is a mid-cap player in the information technology (IT) services and information technology-enabled services (ITES) . It operates in two segments: banking and financial services, and emerging verticals. It offers comprehensive solutions in areas such as core banking, corporate banking, wealth and asset management, and insurance. The company owns a large set of intellectual properties in the form of a comprehensive product suite called Intellect Global Universal Banking (GUB) 10.0. Intellect is the first pure play service oriented architecture (SOA) based application suite for retail, corporate, investment banking and insurance.

Sectoral Outlook Improving
Demand recovery continues: Indian IT services companies have exhibited good sequential quarterly growth rates during the nine months ended December 2010 (9MFY11), reflecting an improvement in demand that had begun recovering from the second half of 2009. The key areas that have contributed to demand are financial services, manufacturing, retail, energy and utilities. Indian IT services companies derive about 65-70 per cent of their revenues from these sectors. Revenue growth for Indian IT services companies is expected to rise much higher as they continue to increase their market share.
Cost pressures likely: The pricing environment was stable in 2010. However, employee expenses increased, on account of strong hiring along with salary hikes and promotions. Increase in employee expenses has a direct impact on the EBIDTA margins of IT services companies. Furthermore, for the contracts coming up for renewal, increasing competition may lead to price pressures. If the current growth momentum is maintained, Fitch believes that Indian IT services companies will be able to maintain their EBIDTA margins despite increased competitive pressures and supply-side constraints arising from wage inflation and employee attrition.
Liquidity profile comfortable: The liquidity profiles of Indian IT services companies has been comfortable with positive cash flows from operations, minimal to low levels of balance sheet debt, and high cash and investment surpluses.

Strengths
Global expertise: Polaris Software has hands-on experience in implementing financial technology solutions in both mature and emerging markets. It has expertise especially in domains such as banking, financial services and insurance.
Tapping diverse markets: Intellect, which is their product business, addresses deep domain business challenges with globally competitive technology solutions. Intellect Global Universal Banking is a comprehensive product suite comprising nine key platforms: Intellect universal banking, Intellect retail banking, Intellect wealth, Intellect cards, Intellect portals, Intellect cash and liquidity, Intellect risk and treasury, Intellect trade finance, Intellect brokerage. The Intellect suite gives Polaris the opportunity to tap markets in as many as 60 countries around the world.
Good numbers: The company’s sales have grown at a five-year compounded annual growth rate (CAGR) of 11 per cent. Its profit after tax and earnings per share have registered a CAGR of 20 per cent and 19 per cent respectively over this period.
In Q3FY11 Polaris reported stronger-than-expected results. It posted a year-on-year (y-o-y) sales growth of 24.30 per cent and profit after tax growth of 18.79 per cent. According to a report from Prabhudas Lilladher, the strong demand for Intellect and growing IT spend by banking, financial services and insurance (BFSI) will continue to drive the company’s growth.
Cash rich: Polaris is a zero-debt company with cash reserves of over Rs500 crore.

Growth Opportunities
Acquisitions: In FY09-10, as part of its inorganic growth strategy, the company acquired Laser Soft Infosystems in the Indian banking space. This acquisition gave it access to 40 accounts in India for cross-selling Intellect products.
During the year, the company also signed a definitive agreement with Indigo TX Software and Software as a Service (SaaS) for providing software solutions in the stock broking segment.
Strong demand: According to the company’s management, the demand outlook of the services business is strong and it expects q-o-q growth in high single digits. Moreover, the deal pipeline for the Intellect business has been strong and sales have picked up. Opportunities for licence sales: The emerging economies in Asia Pacific, Latin America, Eastern Europe and Africa offer substantial opportunities for licence sales by Polaris.
Four growth levers: The company has identified four growth levers: Intellect (product) expansion, strategic accounts expansion, country expansion and growth in the insurance sector.
In Q3FY11, the company bagged 17 new deals in the product business.

Peer Group
The company competes both in product/ platform and services space. In the banking space Intellect Global Universal Banking 10.0 competes with players such as Oracle, SAP, Temenos (T-24) and Infosys (Finacle). It also competes with a few regional solution providers in different geographies.
In the services space, the company competes with players such as IBM, Cap Gemini and Cognizant, and with Indian outsourcing vendors such as TCS, Infosys, Wipro and HCL.

Concerns
Like all IT companies, the company’s earnings are exposed to currency fluctuations or exchange-rate risk.
In a growing demand scenario, ineffective hiring and talent utilisation have the potential to impact margins. Increase in wage expectations and talent movement pose minor risks to their business operations.
In Q3FY11, the company’s margins were hit by rupee appreciation and increased hiring. The EBITDA margin stood at 13.1 per cent, down 250 basis points (bps) q-o-q and 310 bps y-o-y.
Concentration risk: The company focuses mainly on the banking and financial services segment. This is a cause for concern as it creates concentration risk.

Valuations
The stock is currently trading at a price-to-earnings (P/E) ratio of 11.62 times (as on April 19, 2011). This is significantly below its five-year median P/E of 13.04. Based on the five-year CAGR in earnings per share (March-ending) of 19 per cent, the stock currently trades at a price-earnings to growth (PEG) ratio of 0.6 times.
You may accumulate this stock at the current levels but should take into account the concentration risk that comes with it.