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Krishnan Thiagarajan

Solid show from products and services.

INVESTORS can consider retaining their exposure in the i-flex solutions stock at the current price levels. The stock trades at a price-earnings multiple of 21.5 times its diluted per share earnings of Rs 30.2 for 2004-05.

Following a robust fourth quarter performance, the stock has run-up by about 10 per cent since the announcement. From these levels, however, the scope for capital appreciation will be moderate relative to the volatility associated with a product-based stock.

In this backdrop, investors sitting on gains of over 25 per cent (our last recommendation was a "Buy" in May 2004 when the stock was trading at about Rs 500) can consider booking profits on part of their exposure on every uptrend in the stock.

Positive variables

As one of the few successful product-based companies in the banking space, our "Hold" recommendation in i-flex is predicated on three variables that are proving to be favourable:

Additions to order-book: There was a robust addition to the order-book by i-flex in the fourth quarter ended March 31, 2005. Based on a product tank size (which represents licence fee contracted but not yet billed) of $50 million for the latest quarter, the additions to order-book at $24 million are significantly higher than an average of $10-12 million over the last three quarters. This sharp increase is bound to help add to the company's revenues and bottomline in the coming quarters.

This addition is also encouraging as it has grown despite zero licence fees accruing from Citigroup, as i-flex had completed the 50-country implementation and roll-out for this client this year.

Unlike in the past, the product tank includes a broader portfolio — Flexcube — its flagship product, and Daybreak Lending suite, added to its products portfolio through the acquisition of Super Solutions in December 2003.

Average licence fee up: The average licence fee per deal at end-2004-05 was $ 1.3 million compared to $0.9 million at the end of the previous year.

Just as the tank size reflects the product sales momentum in terms of order wins, average deal size reflects the size of each relationship with the client. The increase in the average deal size is significant as it reinforces the capability of i-flex to handle large size deals in the banking space. This also reflects that the company's strategy of stepping up sales and marketing spends through strategic alliances, select acquisitions and investments is working well.

In 2004-05, the company had made about six such product investments (such as IPR acquisition from SRA Systems/Trivium Technologies, investment in Equinox/Login SA, apart from a couple of marketing partnerships) involving a cash outflow of $11 million.

Thumping show by services: For the full year, the services business grew 69 per cent and in the fourth quarter, it soared 13 per cent on a sequential (quarter-on-quarter) basis. The services business accounts for 46 per cent of i-flex's total revenues.

With a higher proportion of revenues coming from offshore, the operating margins improved by nearly three percentage points to 21 per cent for the year 2004-05.

Given the volatile nature of the products business, services can provide greater stability to the revenue stream in the coming years. Moreover, the orders recently bagged by Reveleus, a division focussed on business intelligence, Basel - II and money laundering frameworks, promises to be a good start for the future.

Challenging elements

Despite several variables working in its favour, the i-flex management will have to contend with two challenging elements:

Competitive intensity: The competition in the banking products scene from the likes of Temenos, Misys and FiServ is only getting more intense.

As the overall growth in the products space is likely to be in single-digits in the near term, there is a greater possibility of entrenched players eating into each other's market share, rather than widening the overall market. Though the likes of i-flex and Temenos may stand to gain in a competitive scenario, relatively, Temenos will prove to be a stiff competitor in every banking product deal that matters.

This is an inference that can clearly be drawn from two variables disclosed by Temenos in its year-end performance. One, the median deal size of Temenos is $2.6 million in December 2004, higher than $2.2 million from the previous year. Two, it has also claimed that is has started competing more effectively in 2004 than it did a year ago, winning more than 4 out of every 5 opportunities that they engage in.

Breakthrough in advanced markets: Almost 50 per cent of the revenues of i-flex in the fourth quarter came from Asia Pacific, West Asia and Africa and Latin American markets. While the revenue flow from Europe is encouraging for i-flex, with a couple of high profile wins in the past year or so, North America is proving to be a difficult market to penetrate. Since expanding the presence into these two advanced markets is crucial for long-term revenue and margin growth, the company's investments in terms of selling and marketing will continue to remain fairly high in the coming years.

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