R Systems: Buy

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The relatively nascent growth of the outsourced product development, good client relationships and expertise across verticals are encouraging.

Krishnan Thiagarajan

Promising market for OPD
Robust quarterly performance
Acquisitions to add pep

Investors can consider taking exposure in the R Systems International stock with a one/two-year perspective.

As the stock has run-up by about 10 per cent recently, investors can use any declines linked to the broad market to step up exposure. The stock trades at a price-earnings multiple of 13 times the expected per share earnings for calendar 2006.

Compared to the initial offer price of Rs 250, the stock trades at a 30 per cent discount. We had recommended that investors subscribe to the IPO in March, and we continue to remain bullish on the prospects for the company's core business of outsourced product development (OPD). The relatively nascent growth of the OPD space, good client relationships, vertical expertise spanning banking/manufacturing and robust second-quarter performance lend strength to the stock.

The principal risks are the likely slowdown in the US economy, impacting IT spends in the OPD arena and higher volatility in financial performance owing to project relationships.

With greater willingness among Fortune 1000 companies to offshore their product portfolio, the OPD market has taken off in a big way. As offshoring continues to offer compelling cost and time-to-market advantage, several established and start-up companies in the US are capitalising on this potential. Using its proprietary pSuite execution framework and iPLM services that confer these advantages, R Systems has been able to build some established client relationships in this space. Though competition in the OPD space is stiff, the company's visibility through these relationships is fairly high.

The company recently acquired the US-based WebConverse Inc., a technical support company with a special focus on the mobile applications market. The consideration payable on the acquisition works out to $10.7 million (inclusive of earn-outs). The company reported revenues of $5.1 million in calendar 2005.

To derisk its portfolio of offerings to some extent, R Systems had forayed into the banking domain by acquiring Indus Software in 2002 , and in manufacturing/logistics through a buyout of ECnet in 2004. Through Indus Software, the company offers solutions for the retail lending market and ECnet focusses on supply chain management solutions for manufacturing clients. GE is one of the key clients for the company's banking suite, apart from ABN Amro and Standard Chartered.

Financial s

On a consolidated basis, for the second quarter-ended June, R Systems reported revenues of Rs 49.5 crore, up 26 per cent over the corresponding previous period. Post-tax earnings nearly doubled over this period and, even after excluding `other income', have grown by over 70 per cent. With better control over operating expenses, the company has expanded its operating margins by nearly three percentage points to 13.6 per cent.

With higher utilisation levels and greater offshoring, R Systems will be able to steadily increase its operating margins.

(This article was published in the Business Line print edition dated August 27, 2006)
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