Multibagger: 3i Infotech

3i Infotech
Cluster: MultiBagger
Recommendation: Buy
Price target: Rs79
Current market price: Rs45

Price target revised to Rs79

Result highlights

• 3i Infotech’s top line grew by 28.4% quarter on quarter (qoq) to Rs601.6 crore in Q2FY2009. The Regulus’ acquisition contributed 18.1% to the sequential growth in the top line and the organic revenues rose by 8.7% during the quarter.
• The operating profit margin (OPM) contracted 101 basis points to 20.8% sequentially in Q2FY2009 on account of unfavourable sales mix (higher revenue contribution from low-margin Regulus acquisition). Consequently, the operating profit went up by 22.5% qoq to Rs124.9 crore during the quarter.
• The net income was up 16.5% sequentially to Rs68.4 crore in Q2FY2009, slightly above our expectation of Rs66.6 crore. The net income was lower than the operating profit growth on account of higher interest and depreciation expenses.
• In terms of outlook, 3i Infotech has upgraded its revenue guidance and the fully diluted earnings per share (EPS) on account of Regulus’ acquisition and better than expected organic growth. The company has raised it revenue guidance to Rs2,200-2,300 crore from the previous Rs1,700 crore and has also raised the fully diluted EPS (including foreign currency convertible bonds [FCCBs]) to Rs14-Rs14.5 from the previous guidance of Rs13-13.5.
• The order book grew by 49.6% to Rs1,372.8 crore during the quarter. The order book includes Regulus’ order book of Rs300 crore. Adjusting for the same, the company’s order book grew by 16.9% to Rs1,072.8 crore in Q2FY2009. Though the strong order book provides visibility for FY2010, the uncertain demand environment from the financial meltdown in the USA and the anticipated slowdown in the Europe has put a question mark on FY2011 earning growth.
• On FCCB front, 3i Infotech did not provide for any foreign exchange (forex) loss or gain on outstanding FCCBs. The management has highlighted that the company has made investment in US Dollar, Euro and Pound Sterling from the proceeds of FCCBs, which provides natural hedge against FCCB borrowing. Moreover, the management has mentioned that there is no call option to the bondholder (ie the bondholder cannot redeem the debt before maturity) and there is no reset clause for the exercise price. However, we believe the redemption of FCCBs on maturity would increase the company’s leverage ratios significantly and is likely to remain an overhang on the stock.
• We have already incorporated the acquisition of Regulus in our estimates. Though the company has a strong order book, we have built conservatism in our estimates to reflect the uncertain demand environment. We have incorporated around 10% organic growth and incremental revenues from the acquisitions’ full-year impact in our FY2010 estimates. Consequently, we have revised downward our FY2009 earnings estimate by 1.1% and FY2010 earnings estimate by 10.2%.
• Given 3i infotech’s exposure in the banking, financial services and insurance (BFSI) vertical and the concern over the conversion of FCCBs, the sentiments toward the counter are expected to be weak in near term. However, the same is already reflected in 3i Infotech’s stock price. Considering the strong order book and the Regulus acquisition ensuring an earning growth of 27% during the period FY2008-FY2010, the stock is currently trading at attractive valuation of 3.1x FY2009 and 2.8x FY2010 earning estimates. In fact, the current valuation is the lowest since 3i Infotech’s listing in April 2005. Hence, we maintain our Buy recommendation on the stock with a revised price target of Rs79. We have also lowered our target price/earnings multiple to 5x to reflect the uncertainty on the demand environment in the BFSI vertical and the concern over the conversion of the FCCBs.