The Hindu Business Line : 3i Infotech: Invest at Rs 100

Investors seeking to diversify their IT portfolio will find 3i Infotech suitable as it is a products-cum-services play in the BFSI (banking, financial services and insurance) segment, with a strategic focus on the domestic markets. Investing at Rs 100 is preferable, as investors will remain eligible to participate in the offer even if the final offer price is fixed at a lower level in the bidding process.

3i Infotech will be raising Rs 180-Rs 200 crore through this offer and it will increase to Rs 230 crore, if the green-shoe option is exercised. One of the principal objectives of this offer is to redeem the preference shares of Rs 150 crore issued to ICICI Bank and repay part of its short-term and long-term loans of Rs 94 crore out of an outstanding loan portfolio of Rs 140 crore.

As the cost of servicing debt and preference shares of the company works out to Rs 20 crore for 2004-05, once the offer proceeds are used to reduce this obligation by over Rs 15 crore, it will comfortably double post-tax earnings.

As the company is competitively positioned to take advantage of the growing demand for BFSI, e-governance and ERP product solutions in the domestic market and also broad-base its revenue stream through its presence in overseas geographies, its earnings momentum is likely to be strong in 2005-06. A 20-25 per cent growth in earnings from core operations, the effect of significantly lower interest cost and preference dividend would lead an EPS of Rs 7.5-8 for FY-06. This will be a sharp rise from an annualised EPS of Rs 3.7 for FY-05.

At the offer price of Rs 100, the price-earnings multiple works out to 13 times 2005-06 earnings, leaving room for capital appreciation. While investing in this offer, investors will have to keep the following positive factors and risks in mind.

Positive triggers

Product focus: Nearly 43 per cent of revenues for the nine months ended December 31, 2004 was contributed by software products (see table).

As product revenues derived principally from licence fees and implementation enjoy higher margins, the company's bottomline has the potential to grow faster than its software service focussed peers.

The positioning of the company in products/solutions is in three areas: Banking, insurance and enterprise solutions. The remaining revenues come from software services, which include IT-enabled and infrastructure services.

Strategic focus on Indian markets: There are three focus areas identified by 3i Infotech. First, the insurance market. It is implementing its product solution for Oriental Insurance, a large non-life insurance provider at its 300 branches.

This will serve as a good reference point to bag orders from other players. Second, in banking products, it aims to exploit niche areas such as treasury for growth.

Finally, in enterprise solutions, it plans to focus on three vertical markets: Pharma, automotive and chemicals for growth. Outside this, it is also establishing its presence in the field of e-governance, expected to be a growth area in the future.

ICICI Bank, one of the promoters, remains its largest customer in India.

The Indian markets contributed about 45 per cent of the total revenues of Rs 201 crore for the nine months period ending December 31, 2004.

ICICI Bank accounted for nearly 60 per cent of the revenues from India. Overall, ICICI Bank remained its top client accounting for 27 per cent of revenues (See Table).

Improvement in margins: The gross margins of the company have improved by six percentage points to 42.9 per cent in the first nine months of 2004-05 compared to the previous year. If the product business gets stronger, there is scope for improvement in these margins.

Similarly, the selling, general and administrative (SG&A) expenses fell by 3 percentage points to 27 per cent in the first nine months of this year. As this is likely to remain at these levels on an expanding revenue base, the operating margins at 16.3 per cent is expected to improve.

Risks and concerns

Perils in products space: Typically, the sales cycle (from the start to the closure of a product deal) for products is much longer than services.

In addition, as the economy is at a take-off point, the growth rates for products (banking and enterprise solutions) in the domestic market is difficult to assess.

As the record of the company is still unproven in the products space, the possibility of fluctuations in revenue and earnings cannot be ruled out.

Competition in services: In the services business, especially in the US, the company is expected to face competitive pressure from established Indian and multinational vendors such as TCS, Infosys, Wipro or Accenture. Its focus on BFSI will help, but scale disadvantages can result in revenue growth lower than the industry.

Standalone valuations: It is tempting to conclude that the company's valuation is attractive relative to mid-tier service companies, which are trading at a PEM of 15 times annualised EPS.

But since 3i Infotech is a product-cum-services play focussed on the domestic markets, its valuation may be dictated purely by market forces, subject largely to growth and earnings performance.

Background

Shares on offer: 2 crore equity shares of Rs 10 each, with 35 per cent reserved for retail investors. The offer constitutes 39.2 per cent of the fully diluted post-issue equity.

The post-offer equity will be Rs 51 crore.

The shareholding of ICICI Strategic Investments will decline from 63 per cent to 38 per cent and ICICI Bank from 29.5 per cent to 17.9 per cent.

The book-built IPO opens on March 30 and closes on April 4. The stock is to be listed at NSE and BSE.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Trends in mutual fund flows — Is shift to equities sustainable?

Commodity stocks: Hedging a possible dollar fall

NTPC: Better to stick to one's knitting

Reliance MF declares bonus and dividends

ABN Amro Equity Fund: Hold

PruICICI Tax Plan: Invest in small lots

Equity funds to supplement pension

Coromandel Fertilisers: Buy