Leadership in financial technology – that’s the stated vision of Chennai-based Polaris Software Lab’s long term plan. For sure, it’s a tall order for a company that rakes in about $300 million (Rs 1,400 crore) in annual revenues. But with over 90 per cent of its revenues from the financial services sector and Citibank as its largest customer – and investor – that goal is not as improbable as it first seems. Their expertise in the technology used in banking and financial services can be leveraged to increase their global presence, say experts.

To provide a further boost, the company also plans to use its Rs 446 crore cash chest to make strategic acquisitions when required.

All these sound well and good for the long term, but what of the short term? How is the company faring in the current downturn? Not too bad actually, with recovery seemingly at hand

A re-alignment in costs and business operations has allowed the company to post an improved performance

. A re-alignment in costs and business operations allowed the company to post an improved performance in recent quarters. Now that things seem to be improving on the technology spending front, analysts are predicting an improvement in earnings growth, which could lead to a re-rating of the stock.

The big freeze on IT spending has thawed a little as the global financial sector slowly gets back on its feet. The number of deals from financial services companies is starting to gain momentum and Indian IT firms are starting to see an increased proportion of spending on offshore IT services. After the Indian IT giants, it’s now the turn of the mid-caps to benefit from the deal flow.

Polaris is a highly leveraged play on the recovery in the banking and financial services segment, with more than 90 per cent of revenues coming from offering products and services in retail banking, credit cards, insurance, risk management and investment banking.

Coping with downturns

About 79 per cent of Polaris’ revenues come from services stemming from its financial products

The company is focusing on four areas for growth – new regions, new products, expanding existing accounts and the insurance business

. Products (the Intellect suite) contribute about 18 per cent of revenues and while its business process operations (Optimus) bring in about 3 per cent. Overall, the BFSI (banking, financial services and insurance) segment generates revenues of over $60 million (Rs 300 crore) each quarter, in line with the revenues from the banking and financial services for other diversified mid-caps such as Patni (about Rs 300 crore) and Mphasis (Rs 450 crore).

Analysts say that Polaris has been able to develop an integrated model of financial technology which includes services, products and consulting capabilities, helping it differentiate itself from mid-cap peers. Despite the sharp cut in discretionary tech spending in the past year and vendor consolidation, Polaris managed to win new projects from both existing and new customers such as HSBC and RBS. Operations from these new clients are expected to scale up gradually over the next 12 months. In the September-ending quarter, Polaris won about 12 new deals across countries. Business from Citibank, its largest customer accounting for 40 per cent of revenues, grew by 6 per cent from the previous quarter, after posting declines for two straight quarters.

Importantly, while most IT companies have actively pursued the diversification route to grow their businesses, Polaris has chosen to remain a niche player in banking and financial services. “The technology bite size of banks is very high and they spend billions of dollars on technology,” explains R Srikanth, executive vice president and chief financial officer of Polaris. “Given that our revenues are in millions, the global opportunities are still immense.”

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On solid ground

Recovery in tech spending is expected to drive earnings growth going forward

in Rs cr	2008	2009	2010e	2011e
Net sales	1,099	1,378	1,345	1,486
Change (%)	6.5	25.3	-2.4	10.5
Ebitda	118	235	234	271
Change (%)	-26.7	98.1	-0.2	15.6
PAT	73	131	147	201
Change (%)	-27.6	78.5	11	27.1
EPS (Rs)	7.4	13.2	14.8	20.4
BV (Rs)	66.6	78.3	88.5	106
ROE (%)	11.6	18.3	17.8	21
PE @ Rs 167	22.5	12.6	11.3	8.2

Source: Bloomberg, JP Morgan

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In its pursuit of revenues, the company plans to improve its presence in emerging economies such as Vietnam, Egypt and Chile. The recent acquisition of banking software products company Laser Soft Infosystems is a step in that direction. Laser Soft has been valued at Rs 52 crore, which works out to about 7.5 times estimated earnings for the current fiscal year. Polaris will pay Rs 35 crore upfront for the deal, while the balance will be paid over two years, depending on the Laser Soft’s performance. “Laser Soft products will not only enhance our core banking offerings but also help establish ourselves in both the domestic market and emerging markets,” says Srikanth. The company will gain around 50 customers through the acquisition, domestic and overseas (mainly in the Middle East). Laser Soft’s operating profit margin is about 20 per cent, slightly better than Polaris’ 17 per cent, one of the reasons why Polaris expects the acquisition to be EPS (earnings per share) accretive.

Focus, focus, focus

According to the management, the company will focus on four areas for growth – new regions, new products, expanding existing accounts and the insurance business. (Around this time last year, Polaris took over American firm SEEC Inc, a company dealing in insurance products, gaining 23 marquee clients from the insurance industry. SEEC’s products have been spruced up and the company hopes to replicate its success with banking clients in the insurance sector too.)

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On a tight leash

A leaner cost structure will help strengthen margins in the coming quarters

Source: Company, JP Morgan estimates

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Maximum efficiency

Realignment of resources have kept utilisation rates at an all-time high

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On a high

The stock has more than tripled in the past one year thanks to improving prospects

Source: Bloomberg

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The company, which counts almost all the global banking heavyweights among its clients, is looking to actively mine its exhaustive list. “We have 200 accounts and we are looking at how effectively we can mine the large customer accounts we have” says Srikanth. It is also hoping to ramp up its products business, in which it has made substantial investments in the past few years. “We would like to grow our products business to 30 per cent of our global revenues in the next three years,” he adds.

The products business enjoys a higher operating margin of 23 per cent while its services business reports a 17 per cent margin, so a higher contribution from the products business will lift overall margins. A JP Morgan report notes that with Polaris’ pricing power in the products business, margins could expand by 150-200 basis points in the next 1-2 years.

In the September-ended quarter, revenues were up by 4 per cent in rupee terms, driven by a 6 per cent growth in Citibank revenues and a 4.5 per cent growth in revenues from its top 5 clients (ex-Citi) from the previous quarter. However, one-time visa costs of Rs 3.7 core and a one per cent appreciation in the rupee against the dollar brought down operating margins by 110 basis points. Excluding these costs, margins remained flat. Hedging losses were lower at Rs 8.5 crore (from Rs 15.5 crore in 1QFY10). Net profit increased 11 per cent to Rs 35.2 crore from the previous quarter.

Analysts say a weak rupee, steady cuts in employee numbers and heavy cost cuts in other areas have helped Polaris retain operating margins despite poor revenue growth in the past four quarters. Even utilization rates have improved to 80 per cent from around 70 per cent in FY2008. The company admits that there is little room to push this rate higher; in fact, they could settle at slightly lower levels in coming quarters.

While optimising costs had been the priority so far, the management says it is now time to go after revenues. “During the downturn, we focused on internal efficiencies and customer delivery,” says Srikanth. “But now it’s time to exploit the market opportunities.”

Picture gets brighter

The consensus analyst estimates suggest the gradual recovery in global banking and financial services will lead to increased IT spending and translate into better business prospects for Polaris. Analysts at JP Morgan expect revenues to rise by an average 13 per cent in FY10-12; with forex losses being completely written off by March 2010, earnings are forecast to climb at an even higher 26 per cent.

Nevertheless, there are some concerns. One of them has been the recent stake sale by its largest investor Citigroup. In four trading sessions since September 24, the international financial group offloaded around 39 lakh shares at Rs 150 levels, bringing down its holding to 39 per cent from 43 per cent. Experts reckon the share sale was driven more by Citigroup’s decision to divest a portion of its non-core investments and not because of any worries over Polaris’ operations.

In fact, Polaris is putting a positive spin on this development and says that Ctigroup’s action paves the way for new investors to buy into the company. “The stake sale allows a new set of investors to participate in the growth of the company and the investor diversification will definitely help increase the comfort levels of our non-Citi clients,” says Srikanth. In any case, Citigroup and Arun Jain (Polaris’ founder-promoter) have an agreement not to sell their respective stakes to a competitor.

In terms of stock valuation, the cash value per share of Rs 45 offers strong support (at the end of June, Polaris boasted a net cash position of Rs 446 crore).

At Rs 167, the stock trades at 11.3 times FY10 earnings and 8.2 times FY11 earnings. Given the cash in its coffers, a brighter business outlook and estimated growth in earnings over the next few years, the stock looks attractive at current levels.