The Hindu Business Line : Polaris Sofware Lab: Buy

Polaris has undergone a painful restructuring into a products-cum-services player. Two quarters of strong performance and good order pipeline are encouraging.

Mr Arup Gupta, President and COO, and Mr Arun Jain, Chairman and CEO.Architecting a turnaround.

Investors with a penchant for risk can consider taking exposure in the Polaris Software Lab stock with a one/two-year perspective. Two straight quarters of robust financial performance with a sharp jump in operating margins, good pipeline of business across Tier I/II global banks, and reduced dependence on Citigroup, its largest client, lend confidence to the stock.

At the same time, the company remains exposed to risks arising from heightened competition in the banking products space, product acceptance, efficacy of its cross-selling capabilities across the banking and financial services space and execution issues on large projects. At the current price levels, the stock trades at a price-earnings multiple of 14 times its likely per-share earnings for 2006-07 on a conservative basis.

PAINFUL RESTRUCTURING

Since its merger with Orbitech in 2003, Polaris has passed through a troubled phase in restructuring its overall business model.

Its transition from a pure software services player to a hybrid model focussed on product-cum-services catering to the banking, financial services and insurance (BFSI) industry has been a slow process, with the first signs of turnaround evident in its financial performance and order pipeline.

In terms of structural changes to the business model, Polaris has created six sub-verticals within the BFSI space, which are: Retail banking and credit cards; consumer finance and mortgages; insurance; capital market and wealth; corporate banking and cash; and enterprise solutions and mainframe.

Around this, Polaris has created three distinct growth engines, as spelt out in the 2005-06 Annual Report:

Intellect product (its core suite)-led services, in which it has secured business wins from clients in the UK, West Asia, Latin America, Australia and Nordic region.

This is likely to be a high-margin business as it is IP-led playing to the strengths of its core products suite.

Domain-led services, which will be used to secure business from Wall Street Banks such as JP Morgan Chase or Bear Stearns. Generally, projects or solutions that are bagged on the strength of vertical expertise typically enjoy a reasonably high margin.

The senior management of Polaris has indicated that for 2005-06, 10 per cent each of the revenues can be categorised as intellect-led and domain-led services. As these two services start contributing more to revenues in the coming years, the operating margins and bottomline will expand significantly.

Application Maintenance services are typically the low-margin business, which are likely to come under greater pressure.

IMPROVED FINANCIALS

For the first half of 2006-07, Polaris' financial performance has turned out to be quite impressive. Not only did the company log two successive quarters of double-digit sequential revenue growth, its operating profit margins have also perked up. At 15.5 per cent in the first quarter-ended June 30 and 17.9 per cent in the second quarter-ended September 30, the operating profit margins were three and five percentage points higher than the same period in the previous year.

This is encouraging, as it creates the prospect of pushing up margins to 20 per cent in the coming quarters. As the Asia-Pacific region contributes over 30 per cent of its revenues, margins are lower. With rising contribution from Europe and the US, the overall margin picture may start moving northwards. For instance, in the latest quarter, the onsite billing rate per hour in Asia-Pacific was $41.5 compared to $68.3 across Europe and the US.

ORDER PIPELINE

The company's efforts in strengthening its sales and marketing organisation over the past year are beginning to pay off. As of September 30, the company has 53 large global banks as its customers, comprising 15 AAA accounts (with revenues of $ 10 million or more), 14 AA ($5 million to $ 10 million) and 24 A ($ 1 million to five million).

These suggest the good client mining potential from these customer accounts. In the latest quarter, the company added 14 clients, including three global banks. Recently, the company inaugurated a specialty centre for technology solutions for the investment banking industry called `Capital' in Hyderabad. Seven out of the top 10 investment banks are the customers of Polaris serviced through this centre.

The contribution from Citigroup as its single largest client has been coming down steadily. In the latest quarter, Citigroup contributed 48.7 per cent of revenues, down from 51.7 per cent in the first quarter and 57.7 per cent in the corresponding previous period.

The contribution from the high-margin intellect-led business has also been going up. It contributed 16.65 per cent of overall revenues in the second quarter, up from 14.9 per cent in the previous quarter.

The robust order-book creates scope for this contribution to increase steadily in the coming quarters, with an improvement in its overall margins.

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