ORACLE FINANCIAL SERVICES Witnessing initial signs of demand pick up

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1 VISIT NOTE ORACLE FINANCIAL SERVICES Witnessing initial signs of demand pick up India Equity Research IT We recently met the management of Oracle Financial Services (OFSS) for business update and understanding the strategy going forward. OFSS is a leading software provider to BFS clients. FLEXCUBE, its flagship core banking product, has been among the top 2 selling banking software products. Key takeaways a) It is witnessing initial signs of demand pickup for its products improved pipeline and sales activity, b) margins remain key focus in services business (revenue decline may continue) but margins to be stable, and c) Q4 will continue to be seasonally strong. BFSI focused product led business model OFSS, with its strong product portfolio and marquee parentage, is poised to benefit from the revival in CBS replacement demand. While spending in FY12 on new licenses has been modest, management has indicated pockets of opportunities and improved deal pipeline particularly in North America and Asia. We believe the muted growth over FY09 11 has been due to two reasons: a) overall pressure on IT spent in the BFSI vertical and b) discretionary nature of spend that OFSS caters to. Margin a clear focus in services business Within services i.e. IT and BPO (30% of revenues), OFSS has been consciously reducing focus on the low margin segments including implementation. Reasons being: One, its parent (Oracle) lays significant importance to high margin business and second, the company intends to leave all low margin (~15%) work for partners who aid product sales. Its current revenue portfolio on services side is USD175mn. Despite this smaller scale, EBITDA margins at 27 28% are comparable to tier 1 vendors. Outlook and valuations: Performance to improve; Not Rated Success in the US through large core banking deal win could offer OFSS the next leg of growth, rendering it strong referencing capability. Further, we expect the company to remain immune to pricing pressure given its higher focus on products and strong parentage. At CMP of INR2585, the stock is trading at P/E of 20.5x and 18.7x FY12E and FY13E, consensus earnings, respectively. We believe delisting premium is partly getting build into the share price given Oracle s ownership of 80.4% and the minimum 25% public shareholding criterion leading to the belief that Oracle may chose to delist. Financials Year to March FY08 FY09 FY10 FY11 Revenues (INR mn) 23,812 29,278 28,741 29,970 Rev. growth (%) (1.8) 4.3 EBITDA (INR mn) 4,686 7,757 10,282 11,220 Net profit (INR mn) 4,173 7,419 7,739 11,110 Diluted EPS (INR) EPS growth (%) (1.4) 43.5 Diluted P/E (x) EV/EBITDA (x) Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. EDELWEISS RATING Absolute Rating Edelweiss Securities Limited NOT RATED MARKET DATA (R: ORCL.BO, B: OFSS IN) CMP : INR 2,585 Target Price : NA 52 week range (INR) : 2,729 / 1,699 Share in issue (mn) : 83.9 M cap (INR bn/usd mn) : 229 / 4,570 Avg. Daily Vol.BSE/NSE( 000) : 70.8 SHARE HOLDING PATTERN (%) FIIs 2.7% MFs, FIs & Banks 5.1% * Promoters pledged shares (% of share in issue) RELATIVE PERFORMANCE (%) Sensex Stock : NIL Stock Over Sensex 1 month (2.7) (3.4) (0.7) 3 months months (8.9) Kunal Sangoi kunal.sangoi@edelcap.com Sandip Agarwal sandip.agarwal@edelcap.com Omkar Hadkar omkar.hadkar@edelcap.com March 28, 2012 Others 11.8% Promoters* 80.4%

2 IT BFSI focused product led business model OFSS, with its strong product portfolio and marquee parentage, is poised to benefit from the revival in CBS replacement demand. While the spending in FY12 on new licenses has been modest, management highlighted that pockets of opportunities are present and deal pipeline has improved particularly in North America and Asia. We note that the market opportunity for the CBS remains very large due to its highest share within the BFSI IT spend pie (~13 15%). OFSS strategy increasingly has been focused to grow its products business post its acquisition by Oracle. Its product revenues have posted CAGR of 21% over FY06 11 (42% over FY06 08) and product revenue contribution has increased to ~70%. We believe the muted growth over FY09 11 has been due to two reasons: a) overall pressure on IT spent in BFSI vertical, and b) discretionary nature of spend that OFSS caters to. Green field automation and replacements are key drivers for its products business. Table 1: Segment wise revenue break up Revenues (USDmn) FY06 FY07 FY08 FY09 FY10 FY11 YTDFY12 Product Revenues Growth (%) Service Revenues Growth (%) (3.4) (13.7) 5.2 (14.9) BPO revenues Growth (%) (10.1) 6.6 Total Growth (3.3) 8.4 (2.5) Source: Company, Edelweiss research Note: FY12 growth based on annualized numbers Chart 1: Geo wise revenue contribution in products and service business (Q3FY12) Latin Products America & Carribean 2% Europe 21% US 25% Asia Pacific 21% Europe 12% Services Latin America & Carribean 1% Asia Pacific 33% Middle East & Africa 19% Middle East & Africa 4% US 62% Source: Company, Edelweiss research 2 Edelweiss Securities Limited

3 Solid product portfolio Oracle Financial Services OFSS product portfolio comprises its flagship FLEXCUBE a core banking product suite, REVELEUS an analytics and information management suite, and MANTAS a risk management and anti money laundering solution. Flexcube is an end to end core banking product suite for consumer, corporate, investment, mobile and internet banking, consumer lending, asset management and investor servicing including payments. Clients can implement it in an integrated system or as discrete modules incorporated into their existing systems. Chart 2: LTM product revenues of third party core banking software vendors (USDmn) OFSS Temenos TCS Infosys Source: Companies, Edelweiss research Margins a clear focus in services business Within IT services (30% of revenues), OFSS has been consciously reducing focus on the lowmargin segments including implementation. Reasons being: One, its parent (Oracle) lays significant importance to high margin business and second, the company intends to leave all low margin (~15%) work for partners who aid product sales. Its current revenue portfolio on services side is USD175mn (and declining). Despite this smaller scale, EBITDA margins at 27 28% are comparable to tier 1 vendors. Its IT services business caters to BFSI space and supports the entire application lifecycleincludes end to end consulting (in areas such as business transformation, risk and compliance, process improvement and IT architecture), application and technology services. It also offers BPO services (2% of revenues) for the banking, capital markets, and asset management domains. 3 Edelweiss Securities Limited

4 IT Chart 3: EBITDA margins for services business (nos. based on TTM performance) Q1FY09 Q2FY09 Q3FY09 Q4FY09 (%) Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11 Q1FY12 Q2FY12 Q3FY12 Source: Company, Edelweiss research Outlook and valuations OFSS is purely a play on rising spend in the BFSI vertical, especially in emerging market. In developed markets, its success rate has been limited; hence, it has been investing its sales efforts aggressively in the US since Success in the US could offer OFSS the next leg of growth, rendering it strong referencing capability. Further, we expect the company to remain immune to pricing pressure given its higher focus on products and strong parentage. At CMP of INR2590, the stock is trading at P/E of 20.5x and 18.7x FY12E and FY13E, earnings, respectively. This is higher than valuations of tier 1 IT services players that are trading at P/E of 17x FY13. We believe delisting premium is getting build into the share price. Oracle owns 80.4% in OFSS and will have to decide on the minimum 25% public shareholding criterion that is leading to the belief that Oracle may chose to delist. Currently, OFSS has INR37.6bn cash and equivalents in hand (i.e. INR 448/share) as at Dec Edelweiss Securities Limited

5 Company Description Oracle Financial Services OFSS (erstwhile i flex Solutions), a subsidiary of Oracle Corporation, is among the leader in software product space in the banking and financial services space. FLEXCUBE is OFSS flagship core banking product and has been among the top 2 selling banking software products in 4 out of the last 5 years (Source: IBS, a financial technology market research firm). The company s product suite comprises FLEXCUBE, Daybreak, Mantas and Reveleus, which are trademarks of OFSS and are registered in several countries. It is a leading player in the core banking space with over 500 bank customers. The company s past twelve month revenues stood at INR 31.5bn (USD 672 mn). 5 Edelweiss Securities Limited

6 IT Financial Statements Income statement (INR mn) Year to March FY08 FY09 FY10 FY11 9MFY12 Revenues 23,812 29,278 28,741 29,970 22,842 Cost of revenues 13,047 14,492 13,087 13,294 11,281 Gross profit 10,765 14,786 15,654 16,676 11,560 S&M expenses 2,703 3,426 2,354 2,734 1,994 G&A expenses 3,377 3,603 3,018 2,721 1,940 Total SG&A expenses 6,080 7,030 5,372 5,456 3,934 EBITDA 4,686 7,757 10,282 11,220 10,168 Depreciation & amortization EBIT 3,980 7,199 9,794 10,812 9,833 Other income 640 1,498 (856) 1,668 3,732 Share of loss/(profit) in subsidiary 5 (26) Profit before tax 4,614 8,723 8,937 12,480 13,565 Tax ,199 1,370 3,171 Core profit 4,173 7,887 7,739 11,110 10,394 Extraordinary income/(loss) 0 (469) 0 0 (693) Profit after tax 4,173 7,419 7,739 11,110 9,701 Net profit after minority interest 4,173 7,419 7,739 11,110 9,701 Shares outstanding (mn) EPS (INR) basic Diluted shares (mn) EPS (INR) diluted CEPS (INR) Common size metrics as % of revenues Year to March FY08 FY09 FY10 FY11 9MFY12 Cost of revenues Gross margin G&A expenses S&M expenses SG&A expenses EBITDA margin EBIT margin Net profit margins Growth metrics (%) Year to March FY08 FY09 FY10 FY11 FY12* Revenues (1.8) EBITDA (9.4) EBIT (14.1) Net profit (1.9) 43.6 (14.1) EPS (1.4) 43.5 (14.1) Note: FY12 growth based on annualized numbers 6 Edelweiss Securities Limited

7 Oracle Financial Services Balance sheet (INR mn) As on 31st March FY07 FY08 FY09 FY10 FY11 Equity share capital Reserves 22,163 27,352 34,630 42,485 53,638 Total shareholders funds 22,580 27,771 35,049 42,904 54,057 Minority interest Sources of funds 22,580 27,778 35,068 42,904 54,057 Goodwill and other intangible asset 4,394 6,339 6,041 6,087 6,087 Net fixed assets 4,302 3,488 3,664 3,581 3,899 Investments Deferred tax asset Cash & bank balances 7,172 8,966 15,490 22,046 29,023 Debtors 8,644 9,487 10,064 9,001 11,754 Loans and advances 2,039 5,387 6,527 7,834 9,765 Total current assets 17,856 23,839 32,081 38,881 50,543 Sundry creditors Provisions ,063 1,484 Other liabilities 6,166 5,220 5,854 4,883 5,600 Total current liabilities 6,686 6,173 7,054 6,054 7,236 Working capital 11,170 17,666 25,027 32,827 43,307 Application of funds 22,580 27,778 35,068 42,904 54,057 Book value per share (BV) (INR) Free cash flow Year to March FY07 FY08 FY09 FY10 FY11 Net profit 2,768 4,173 7,419 7,739 11,110 Add : Non cash charges Depreciation Others (213) 3,730 (772) 155 (1,719) Gross cash flow 3,388 8,608 7,205 8,382 9,800 Less:Changes in working capital 1,742 4, ,244 3,502 Operating cash flow 1,646 3,906 6,368 7,138 6,297 Less: Capex 4,302 (4,302) Free cash flow (2,656) 8,208 6,368 7,138 6,297 Cash flow statement Year to March FY07 FY08 FY09 FY10 FY11 Cash flow from operations 3,474 3,802 6,610 7,548 8,580 Cash for working capital (1,828) 104 (243) (410) (2,283) Operating cashflow (A) 1,646 3,906 6,368 7,138 6,297 Net purchase of fixed assets (6,750) (2,086) (762) (466) (672) Net purchase of investments 32 (1,986) (4,076) (4,156) (9,424) Investments cashflow (B) (6,718) (4,072) (4,838) (4,622) (10,096) Proceeds from issue of equity 6, Proceeds from LTB/STB (11) (19) (20) (12) (12) Financing cash flow (C) 6, (9) Exchange rate differences (D) (68) (640) 232 Change in cash (A+B+C) + (D) 1,266 (134) 1,795 1,942 (3,536) 7 Edelweiss Securities Limited

8 IT Ratios Year to March FY07 FY08 FY09 FY10 FY11 ROAE (%) ROACE (%) Debtors (days) Payable (days) Cash conversion cycle Current ratio Fixed assets turnover (x) Total asset turnover(x) Equity turnover(x) Valuation parameters 9.2 Year to March FY07 FY08 FY09 FY10 FY11 Diluted EPS (INR) Y o Y growth (%) (1.4) 43.5 CEPS (INR) Diluted P/E (x) Price/BV(x) EV/Revenues (x) EV/EBITDA (x) EV/EBITDA (x)+1 yr forward Edelweiss Securities Limited

9 Oracle Financial Services Edelweiss Securities Limited, Edelweiss House, off C.S.T. 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