NIIT Technologies Ltd - Chola Wealth Direct

NIIT Technologies Ltd Sector: IT/ Small cap Re-initiating Coverage

26 October 2012

Sensex 18,625

Nifty 5,664

Price: INR 278

Target Price: INR 295

OUTPERFORMER

Background: NIIT Technologies has got a strong prowess in application development & maintenance, system integration and enterprise solutions including managed services and BPO. As on September 2012, NIIT Technologies headcount stood at 7,617 people catering to clients across insurance, financial services, travel, transportation & logistics, manufacturing, retail and healthcare. Its marquee client list includes British Airways, Saber, Changi Airport, ING Group, Amlin, AXA, SEI, Deutsche Bahn, Holcim and Thrivent 52 Week High/Low

INR 324.9/164

Bloomberg code

NITEC IN

Reuters code

NITT.BO

Issued Equity (shares in mn) Mkt. Cap in mn Mkt. Cap in mn USD

60.08 INR 16,720 $ 312.2

Avg. Daily Vol. (‘000)

220.6

Avg. Daily Vol. (mn)

INR 61.3/$ 1.2

Order book gives revenue visibility… NIIT Technologies opening order book (executable in next 12 months) has grown at a CAGR of 21% from US$76 mn in FY07 to US$243 mn in FY13. Historically, the ratio between the company revenue to opening balance of order book was in the range of 1.9X ~ 2.6X (average of 2.1X for the period between FY07 – FY12). In 2QFY13, NIIT Tech has obtained a fresh order intake of US$93 mn, which includes US$20 mn deal from Morris to be executed over the next four years. The company has added 3 clients this quarter (1 in the US and 2 in the EMEA region). Our revenue estimates for FY13 is lower than the historical range (i.e. 1.6X of FY13 opening balance of order book) in the midst of uncertain global economic condition.

Revenue to grow at a CAGR of 23% between FY12-14...

Shareholding

Sep11

Jun 12

Sep12

Promoters(%)

39.24

38.85

FII (%)

23.71

22.56

31.37 Strong order book, higher domestic business, recovery in GIS & NITL and revenue flow from new deal i.e. 27.09 Morris Communication gives thrust to our revenue assumption.

DII (%)

12.34

14.09

17.24

Others (%) Pledge (% of promoter holding)

24.71

24.50

24.30

0.00

0.00

0.00

1M

3M

12M

NIIT Tech

-5.27

-5.40

19.65

Sensex

0.34

11.35

8.72

Performance%

350

160

300

140 120

250

100

200

80 150

60

100

40

50

20

Oct-12

Sep-12

Jul-12

Aug-12

Jun-12

Apr-12

May-12

Mar-12

Jan-12

NIIT Tech

Feb-12

Dec-11

Oct-11

0 Nov-11

0

Relative Sensex (RHS)

Sathyanarayanan M +91-44-30007361 [email protected]

We expect NIIT Technologies revenue to grow at a CAGR of 23% between FY12 – FY14 to INR 23,955 mn.

Domestic business to support revenue during global uncertainties… Amongst tier II players, NIIT Technologies has got one of the highest exposures to Indian and Asian markets with 11.8% and 13.4% of revenues in FY12. Revenues from these geographies grew faster than the companies average (CAGR of 16.4%) at a CAGR of 18.2% and 19.1% from FY05 to FY12.

Outlook & Valuation We expect NIIT Technologies to report an EPS of INR 31.3 and INR 36.5 for FY12E and FY13E. At the CMP of INR 278 the stock trades at 7.4X and 6.6X to the FY13E and FY14E earnings respectively. We have arrived at a target price of INR 295 is based on 7x FY14E EPS (PEG of 0.55). We recommend NIIT Technologies as an “Outperformer” rating with a potential upside of ~6% from current levels.

Risk: Challenging macro economic situation, slowdown in IT spending, adverse cross currency movement, and INR appreciation.

Valuation Summary Y/E March ( INRmn) Revenue EBIDTA PAT EPS EPS growth (%) FCF / Share PE P/ BV EV / EBIDTA EV / Sales Dividend Yield (%) ROCE (%) ROE (%) Net Debt / Equity

1

FY11

FY12

FY13E

FY14E

12,323 2,404 1,822 30.9 44.26% 4.2 9.0 2.2 6.4 1.3 2.77% 34.66% 26.93% -0.14

15,764 2,684 1,973 33.2 8.29% 8.1 8.4 1.8 5.5 0.9 2.97% 31.75% 23.57% -0.19

20,644 3,570 2,252 37.6 14.13% 19.3 7.4 1.5 4.0 0.7 3.14% 34.95% 22.32% -0.21

23,955 4,052 2,531 42.2 12.41% 23.8 6.6 1.3 3.3 0.6 3.32% 33.68% 21.26% -0.24

Industry overview: In the current scenario, the global economies are under a lot of stress as developed markets witness subdued growth while emerging economies face slowing growth. According to International Monetary Fund (IMF), advanced economies are projected to grow 1.3% this year & 1.5% in 2013 while emerging economies will expand 5.3% this year & 5.6% in 2012. The IMF has also cut its growth projections for India to 4.9% this year and chopped its 2013 forecast to 6.0% from 6.5%. The IMF has also warned that the global outlook could dim further if policymakers in Europe delay in resolving the region’s debt crisis. According to a recent update by Gartner, a global IT research and advisory firm, worldwide IT spending outlook has been revised from 2.5% to 3% to reach US$3.6 trillion in 2012. The growth outlook has slightly been revised upwards amidst the presence of global economic problems; euro zone crisis, weaker U.S recovery and a slowdown in China. Worldwide IT services spending is forecast to reach US$864 billion in 2012, reflecting a 2.3% increase from 2011

Chart 2: Worldwide IT spending forecast

80

8.0%

60

7.5%

40

7.0%

20

6.5%

0

6.0% FY08 Exports

FY09

FY10

FY11

Domestic

3750

IT Spending in USD bn

Revenues in USD bn

Chart 1: Indian IT-BPO revenue forecast

2881

2764

2678

3000

7.5% 6.5%

2250 1500

8.5%

5.5% 845

864

905

4.5%

750

3.5%

0

2.5% 2011

FY12E

IT Services

% of GDP

2012 Others

2013 Growth (%)

Source: Gartner

Source: NASSCOM

IT sector in India has demonstrated stupendous performance and has grown at 30% CAGR in the last 10 years. According to NASSCOM Strategic Review, FY2012 is considered as a milestone year for IT-BPO sector as aggregate revenues is expected to cross USD 100 billion. As a proportion of national GDP, the sector revenues have grown from 1.2% in FY1998 to an estimated 7.5% in FY2012. The industry’s share of total Indian exports increased from less than 4% in FY1998 to ~25% in FY2012. While the global macroeconomic scenario remained uncertain, the industry exhibited resilience and was able to sustain its growth rate as global spending on technology continues to grow and the global IT off shoring market is expected to grow much faster.

Export revenue is expected to reach US$69.1 billion in FY2012 & account for ~68% of the IT-BPO revenue while domestic revenues are projected to reach US$31.7bn & account for 32% of the total revenues. US continued to drive exports growth while Europe has gone through a tough period in the last couple of years. However it was APAC region that exhibited the fastest growth at ~18%. In the service verticals, BFSI is set to increase its share in exports revenue to 41% while share of telecom is projected to decrease to 19% due to slowdown in telecom investments in US &UK. However, energy and utilities followed by healthcare remains the fastest growing verticals. NASSCOM has indicated that export revenues from IT services are expected to grow between 11 and 14% in US dollar terms while the domestic market is expected to grow by 13-16% in rupee terms for FY13.

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The Indian IT industry consists of a large number of players who derive a majority of revenue through exports. Cost leadership has been the competitive edge of the Indian software sector over the last few years. However, in the recent years, MNCs have started to replicate the Indian outsourcing model by setting up bases in the country and providing services at an affordable cost on par with Indian software vendors. The Porter’s five forces framework for IT industry is presented below.

Chart 3: Porters Five Force Model:

Source: CSEC Research

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Company Profile: NIIT Technologies was spun off from NIIT Ltd. It has got a strong prowess in application development & maintenance, system integration and enterprise solutions including managed services and BPO. As on September 2012, NIIT Technologies headcount stood at 7,617 people catering to clients across insurance, financial services, travel, transportation & logistics, manufacturing, retail and healthcare. Its marquee client list includes British Airways, Saber, Changi Airport, ING Group, Amlin, AXA, SEI, Deutsche Bahn, Holcim and Thrivent. Business Model NIIT Technologies through its business model “Focus and Differentiate” has created a niche for itself, by focusing on selected industry segments i.e. insurance, financial services and travel, transportation & logistics (TTL), which contributes 75% of the company’s revenue in 2QFY13. It has delivered superior customer centricity which is evident from a long standing relationship with marquee clients such as British Airways with whom NIIT Technologies has been associated for 15 years, with SATS for 10 years and with Sabre for 8 years. NIIT Technologies is has been ranked no. 1 in Datamonitor’s Black Book of Outsourcing for the last three years (2008, 2009 & 2010) for customer service in the Travel segment and ranked No. 3 globally among all IT outsourcers. Chart 4: Revenue by Industry Vertical

Others 14%

BFSI 33%

Government 5% Manufacturing & Retail 6%

Transport 42% Source: Company, CSEC Research

BFSI contributes 33% of companies revenue in 2QFY13 and most of it is through the insurance vertical (~61%) and rest from banking and financial services (BFS) which contributes equally. Among BFS it caters to risk & compliance, investment management, community / cooperative retail bank. Its Marquee clients in BFSI include ING, SEI, NN, Amlin, Thrivent and AXA.

4

Chart 5: Banking & financial services Vertical…

Chart 6: Insurance Vertical…

11% 19%

29%

41% 40%

60%

Risk & Compliance

Asset Management

Others

Source: Company, CSEC Research

Reinsurance

Life

P&C


Travel, Transportation and Logistics (TTL) vertical contributes 42% of NIIT Technologies revenue in 2QFY13, which comprises of large carriers (35%), airports (18%), travel distribution (24%) and surface transportation (23%). It caters 50+clients and has a long standing relationship with clients such as British Airways (15 years), Sabre (8 years), Virgin Group (6 years) and Deutsche Bahn (5 years) Manufacturing & Retail contributes 6% of company’s revenue whereas other sectors (incl. Government) contribute 19% of the revenue. It offers turnkey projects for defense, paramilitary and power sector. It also offers GIS services.

Revenues by Geographies

NIIT Technologies generates 3/4

th

of its revenue from America (38%) and Europe (39%) with revenues from America

growing at a CAGR of 17.3% during the period FY05-12, while the revenues from Europe grew at CAGR of 14,4%. Asia Pacific and India which contributes 13% and 10% of its revenue grew at CAGR of 19.1% and 18.2% during the same period.

Chart 7: Revenue from Geographies…

Chart 8: Asia Pacific (incl. India) revenue contribution…

50% 40% 30% 20% 10% 0%

India 10% APGC 13%

Americas 38%

Europe 39%



Its combined exposure in Asia-Pacific and India is one of the best amongst its tier II peers; this provides relative comfort during this uncertain global macroeconomic condition.

5

Service Offering:

Application Development & Maintenance: NIIT Technologies offers custom software development, application management, business intelligence, system migration and modernization. It also specializes in functional & regression testing, system testing and full lifecycle testing.

Package Implementation: It offers ERP implementation of SAP and Geographic Information System (GIS) based solution around ESRI technology.

It offers Geographic Information System (GIS) to clients worldwide. Domestically it has partnered with ESRI Inc, USA (global leader in GIS) through a JV to form a company called NIIT GIS Ltd, in which NIIT Technologies Ltd hold 88.9% and remaining share held by ESRI Inc. In FY12 GIS revenue stood at INR 975 mn i.e. 6.2% of NIIT Technologies revenue share. GIS is a seasonal business with 1Q being the lowest, 2Q and 3Q moderate quarters and 4Q is the strongest quarter.

Non Linear strategy: NIIT Technologies has transformed from a generic services provider to a specialized domain focused player. Its next phase of transformation involves increasing the revenue share from non-linear activity by evolving new service offering (managed services, platform based solution and cloud services) that provide higher value to its clients and higher margin to the company. NIIT Technologies’ non-linear revenue contribution in 2QFY13 stood at 21% (i.e. managed services contributing 11% and platform based solutions contributing 10% of revenue) which the highest amongst its Indian peers.

Managed Services: Company manages IT infrastructure and application as completely administered services to their clients which include Holcim.

Platform Based Solutions: NIIT Technologies offer platform based solutions which contributes 10% of its revenues. It offer solutions based on its own platform or through partnership.

6

Chart 9: Platform based solutions offered by NIITT


Cloud Services: NIIT Technologies provides cloud services such as Software-as-a-Service (SaaS), Platform-asa-Service (PaaS) and through its partnership with Hitachi, Thailand it also offers Infrastructure-as-a-Service (IaaS) where Hitachi owns the cloud and NIIT Technologies manages the cloud.

Cloud computing is a new revolution that enables applications to be hosted in an Internet-accessible virtual environment and supplies the necessary hardware, software, network, and storage capacities on demand in a secure and reliable manner. According to NASSCOM, the global cloud market is projected to grow at 33% CAGR to reach US$680bn by 2020, while the Indian cloud market is expected to reach US$16bn in the same period. While cloud will create and utilize some of the existing service line for IT and BPO companies, it also opens up a whole new opportunity to play along the cloud services. A report by consulting firm Zinnov Management Consulting estimates that the cloud computing market will grow from USD 400 million (currently) to USD 4.5 billion by 2015. A recent Microsoft-IDC study says that cloud computing will generate over 2 million jobs in India by 2015.Globally, SaaS is expected to contribute US$244bn by 2020 and IaaS the second largest segment is expected to reach around US$143bn by 2020.

7

Investment Rationale Superior margin profile combined with low relative volatility in earnings… Earnings volatility is one the principal concern faced by midcap IT companies and NIIT Technologies has got a superior margin profile with relatively low volatility in margins. During the Period FY07-FY12, its operating margin was in the range of 18.9% ~22.6% with relative volatility 7%. Operating Margin Company

FY07

FY08

FY09

FY10

FY11

FY12

Volatility

Relative volatility

NIIT Tech.

22.6

20.8

18.9

19.7

20.4

19.1

1.4

7%

Persistent Sys

25.8

27.5

16.5

26.2

24.8

25.8

4.0

16%

Infotech Enterprises Mindtree

22.2

21.4

16.8

26.7

17.4

18.5

3.7

18%

19.9

20.8

10.9

24.9

13.4

17.3

5.1

29%

Hexaware*

18.6

14.3

9.2

16.8

11.6

23.1

5.0

32%

4.7

7.8

13.2

17.6

17.6

18.7

5.9

44%

Infinite Comp

Source: CSEC Research,* CY

Superior margin profile and low volatility in earnings are attributed to higher non-linear revenue share and its specialized focus (verticals) yielding pricing power.

Increasing non linear revenues to aid margin… Currently 21% (2QFY13) of revenues are derived from non-linear revenue source (IP assets & managed services), which typically has higher margin compared to the linear revenue source. The IP assets business showed weakness in the current quarter owing to traction in ROOM solutions and was down 11.3% q-o-q while managed services experienced a moderate decline (2.4%). NIIT tech won a $20mn deal from Morris this quarter while 4-5 deals are expected to be finalized soon, which is expected to ramp up non linear revenue going forward. Chart 10: Non-linearity to improve margin


8

Morris Deal:

Through the deal with Morris Communication, NIIT Technologies has forayed into the media space in the form of a JV (NIIT Media Technologies). Morris Communication will hold 40% (will move its assets and 100 consultants to JV Company) and NIIT Technologies will have a 60% share for which it will invest US$3.2mn. JV will have a revenue commitment of US$85mn from Morris Communication for 5 years to offer managed services (Integrated IT and BPO services). Though, the Morris deal may not contribute any margins in FY12, going forward higher offshoring from Morris likely to yield positive margins.

In 2QFY13, NIIT Media Technologies reported revenues of INR264 mn (~US$5mn). Learning curve benefits of the JV will help in winning more such deals in the media space, moreover, Morris Communication has offices across the US, UK, France and Asia, which will act as a near shore centers.

Eurostar deal:

In Q1FY12, company signed a large deal with Eurostar to provide managed services. NIIT Technologies will create the infrastructure and charge on a utility basis. NIIT Technologies is likely to invest £3mn (US$4.68mn) on infrastructure.

Though the domestic businesses (Government business) mount pressure on margins, we believe increase in non linear revenue will provide a cushion to margin.

9

Order book gives revenue visibility… NIIT Technologies opening order book (executable in next 12 months) has grown at a CAGR of 21% from US$76 mn in FY07 to US$243 mn in FY13. Historically, the ratio between the company revenue to opening balance of order book was in the range of 1.9X ~ 2.6X (average of 2.1X for the period between FY07 – FY12). In 2QFY13, NIIT Tech has obtained a fresh order intake of US93 mn, which includes US$20 mn deal from Morris to be executed over the next four years. The company has added 3 clients this quarter (1 in the US and 2 in the EMEA region). Our revenue estimates for FY13 is lower than the historical range (i.e. 1.6X of FY13 opening balance of order book) in the midst of uncertain global economic condition. Chart 11: Strong order book with good execution capability

600 500

US$ mn

3.0

2.6

2.0 2.3

2.0

1.9

400

2.0 330

300 200

273 232

212

76

103

113

FY07

FY08

199

100 0

2.5

1.9

FY09

Op. order book

1.0

194 97 FY10

Revenue

1.5

147

169

0.5 0.0

FY11

FY12

Revenue / OB


At the end of 2QFY13, NIIT Technologies’ order book (executable in next 12 months) grew to a record high of US$253 mn, thus indicating strong revenue visibility in the near term. Three significant clients were added in 2QFY13, one each in Travel & Transportation, BFSI & Others.

Domestic business to support revenue during global uncertainties…

Amongst tier II players, NIIT Technologies has got one of the highest exposures to Indian and Asian markets with 11.8% and 13.4% of revenues in FY12. Revenues from these geographies grew faster than the companies average (CAGR of 16.4%) at a CAGR of 18.2% and 19.1% from FY05 to FY12.

Domestic business gives comfort amidst global uncertainties. After successfully completing the INR 2,290 mn worth Border Security Force (BSF) deal (won in Q4FY10), NIIT Technologies has won large deals from the Indian Government under Crime and Criminal Tracking Network & Systems (CCTNS) program to implement in four states. The deal was won under stiff competition from both domestic and international players.

10

Revenue - INR mn

2,500

18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%

2,000 1,500 1,000 500 0

Revenue Share

Chart 12: Strong domestic business

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 India

APAC

India %

APAC %


CCTNS program is one of the 27 mission mode projects under the INR 230,000 mn national e-governance plan. The CCTNS deal likely to have higher hardware component (approximately 65% ~75% of the deal). NIIT Technologies has won orders worth INR 3,470mn to implement CCTNS in four states (Tamil Nadu, Jharkhand, Uttar Pradesh and Odisha). Tamil Nadu CCTNS considered as a model project by National Crime Records Bureau.

Inorganic growth – an integral element of growth strategy NIIT Technologies has pursued acquisition and collaboration as integral part of its growth strategy. Through this strategy it forayed into new geographies, emerging technologies, strengthening its technical capabilities and expanding its customer base.

In 2002 NIIT Technologies acquired AD Solutions AG (ADS), a German IT company headquartered in Germany with subsidiaries in Austria and Switzerland. This acquisition facilitated NIIT Technologies to expand its foothold in Germany, Switzerland and Austria. It also helped the company to build a strategic relationship with Deutsche Bahn (German Railways).

In May 2006, NIIT Technologies acquired a major shareholding in Room Solutions, through which it got access to the Lloyds insurance market. NIIT Technologies has turned around operations of Room Solutions. In 2QFY07 operating margins were 4%, through synergy and process integration operating margin have improved substantially to 19% in 2QFY13. In 2QFY13, the revenues from Room Solution stood at INR 366mn.

11

Revenue (INR mn)

Chart 13: Revenue from Room Solutions 450 400 350 300 250 200 150 100 50 0

Room Solutions


In FY11, NIIT Technologies foray into healthcare business in US, by acquiring an electronic health records and referral management platform called “Preferr” (Patient Referral System) enables collaboration between all providers namely physicians, hospitals, diagnostic facilities and laboratories.

In August 2011, NIIT Technologies acquired Spain based Proyecta Sistemas with revenue of about US$10 mn (Travel accounts for 68% of revenue, 23% from BFSI and 9% from others) with EBIDTA margin of 10%. Through this acquisition it got access to marquee clients such as Iberia, Solimat and Pullmantur in the travel space and Merrill Lynch, Santander and BBVA in BFSI space. Moreover through this acquisition will facilitate a foray into other Spanish speaking countries in Latin America. It would also use Proyecta as a near shore center and providing technology backend from India. Joint Venture: NIIT Technologies has been partnering with ESRI Inc, USA, when it began reselling and supporting ARCInfo software. In 1996, the collaboration evolved into a strategic relationship to form a JV to provide GIS in India. This collaboration has enabled NIIT Technologies to access ESRI Inc’s, know how on GIS services. In FY12, NIIT Technologies GIS revenue stood at INR 975 mn i.e. 6.2% of company’s revenue.

Chart 14: Revenue from GIS

Revenue (INR mn)

350 300 250 200 150

GIS

100 50 0


12

Financials Revenue to grow at a CAGR of 23% between FY12-14... We expect NIIT Technologies revenue to grow at a CAGR of 23% between FY12 – FY14 to INR 23,955 mn. Strong order book, higher domestic business, recovery in GIS & NITL and revenue flow from new deal i.e. Morris Communication gives thrust to our revenue assumption.

Chart 15: Revenue to grow at a CAGR of 23% between FY12-14 34.9%

30,000

31.0% 27.9%

INR mn

25,000

16.0%

30%

20,000 15,000

4.1%

40%

20%

-6.8%

10%

10,000

0%

5,000 0

-10% FY09

FY10

FY11

FY12

Revenue

FY13E

FY14E

Growth %


Going forward margins to be under pressure…

We expect NIIT Technologies margins to come under pressure due to low margin from hardware component of Crime and Criminal Tracking Network Systems (CCTNS) deal, investment in SG&A and margin pressure from new deal wins, pricing pressure and lower profitability in GIS, Proyecta & ROOM solutions. The CCTNS segment posted revenues of INR 240mn and the management expects revenue potential of ~INR 1,200mn in FY13

Chart 16: Margin Drivers


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However, higher non-linear revenues (stronger revenue share from GIS business), rupee depreciation, higher off shoring from the Morris deal and a broadening employee pyramid will act as levers to improve margin. Currently the proposition of employees with