Sonata Software (SONSOF) 147

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1 Company Update Rating matrix Rating : Buy Target : 2 Target Period : 12 months Potential Upside : 36% What s changed? Target Changed from 17 to 2 EPS FY16E Unchanged EPS FY17E Introduced at 16.5 Rating Unchanged Quarterly performance FY16 FY15 YoY (%) FY15 QoQ (%) Revenue EBITDA (1.6) EBITDA (%) bps bps PAT Key financials Crore FY14 FY15E FY16E FY17E Net Sales 1,566 1,682 1,887 1,919 EBITDA Net Profit EPS ( ) Valuation summary FY14 FY15E FY16E FY17E P/E Target P/E EV / EBITDA P/BV RoNW (%) RoCE (%) Stock data Particular Amount Market Capitalization ( Crore) 1,545.4 Total Debt (Mar-15) ( Crore) 5.7 Cash and Investments (Mar-15) ( Crore) EV ( Crore) 1, week H/L 183 / 73 Equity capital 15.1 Face value 1. Price performance 1M 3M 6M 12M Sonata Accelya Kale MPS (1.7) (9.2) (3.) Mastek Research Analysts Abhishek Shindadkar abhishek.shindadkar@icicisecurities.com Hardik Varma hardik.varma@icicisecurities.com Bumpy, in an otherwise smooth ride August 1, 215 Sonata Software (SONSOF) 147 Sonata Software reported weak FY16 earnings despite being optically better. Revenue growth was primarily led by the domestic business while international revenue growth moderated. Reported revenues grew 22% QoQ to crore led by 36.2% QoQ growth in the domestic business while international grew 2% QoQ Adjusted EBITDA margins declined 317 bps QoQ to 8.7% led by 317 bps decline in services margins to 18.7%. Reported PAT grew 9.7% QoQ to 38.2 crore, led by f/x gains and income tax refund Growth moderation in services business may be near term concern During the quarter, Sonata reported 22% QoQ revenue growth led by rebound in domestic revenues (36.2% QoQ, 12.5% YoY growth) while international (services) revenues were flat QoQ in US$ terms ($25.9 million) while those in rupees grew 2%. Sharp growth deterioration compared to 4.8% CQGR during FY14-FY16, which the management attributed to client specific issues, could persist in FY16E. Overall, the management expects ~1% organic growth in FY16E led by deals ramp-ups in H2. Consequently, we moderate our FY16E growth assumption to 1% (vs. 19% earlier) and $18 million. The domestic business could remain volatile inter-quarter and grow ~1% in FY16E, in our belief, led by rising cloud adoption and new service offerings. Note, the management continues to prioritise profitability (and RoCE) targets over growth in the domestic business. Structural change in business mix to aid margins Adjusted for f/x gains, other income and income tax refund, EBITDA margins declined 317 bps QoQ to 8.7% as international services margins declined 32 bps QoQ to 18.7% led by higher onsite effort and S&M investments. The management indicated that services margins could range in this narrow band as investments in technology, S&M, and people could offset operational tailwinds while domestic margins could improve led by better product mix and solutions offering. Consequently, we expect flat YoY margins (1%) in FY16E. Acquisitions to aid digital portfolio Sonata Software acquired 1% stake in US-based Halosys, an enterprise mobility enablement technology company, for $5 million. The acquisition entails an upfront payment of $2 million with $3 million earn-outs payable over the next three years. Last year, the company had acquired 6% stake in US-based Rezopia (with revenues of $1.5 million) for an enterprise value of $2.4 million. Rezopia provides cloud based PAAS travel IT solutions platforms to large and small travel companies. Currently, Rezopia a FY16 annualised revenues are at $3.1 million. Sonata s digital offerings (business intelligence, e-commerce, mobility, cloud, Rezopia) now contribute 25% to overall revenues vs. 19% in FY15 and could aid company average going ahead. Healthy balance sheet, reasonable valuations dictate BUY We expect Sonata to report revenue, PAT CAGR of 7%, 14% during FY15-17E (average 1.8% EBITDA margin), respectively, vs. 4%, 11% growth reported during FY1-15 (7.8%), led by client mining, deal wins and improving business mix. We introduce FY17E estimates and now value Sonata at 2, i.e. 12x FY17E EPS of 16.5 (translates to 3x Mcap/sales for services business) given improving fundamentals, healthy cash balance ( 22 crore) and high dividend payout (~5%). ICICI Securities Ltd Retail Equity Research

2 Variance analysis FY16 FY15 YoY (%) FY15 QoQ (%) Comments Revenue Revenue growth was led by domestic business while services business grew a modest 2% QoQ Employee expenses Purchase of stock-in trade Gross Margin Gross margin (%) bps bps SG&A expenses EBITDA EBITDA Margin (%) bps bps Depreciation & amortisation EBIT EBIT Margin (%) bps bps Other income (less interest) PBT Tax paid PAT Margins declined 317 bps QoQ led by rising contribution of lower margin domestic business and 32 bps QoQ decline in service margins Key Metrics International IT services (Revenue- crores) International IT services (EBITDA - %) bps bps Domestic products (Revenue- crores) Domestic products (EBITDA - %) bps bps Change in estimates FY16E FY17E ( Crore) Old New % Change Old New % Change Comments Revenue 1,859 1, NA 1,919 NA Management commentary indicates FY16E revenue growth could moderate to 1% in constant currency EBITDA NA 221 NA EBITDA Margin (%) bps NA 11.5 NA PAT NA 173 NA EPS ( ) NA 16.5 NA Assumptions Current Earlier FY14 FY15 FY16E FY17E FY16E FY17E International IT services (Reven NA International IT services (EBITD NA Domestic products (Revenue- 1,85 1,93 1,2 1,15 1,2 NA Domestic products (EBITDA - % NA ICICI Securities Ltd Retail Equity Research Page 2

3 Company Analysis Growth moderation in services business may be near term concern During the quarter, Sonata reported 22% QoQ revenue growth led by rebound in domestic revenues (36.2% QoQ, 12.5% YoY growth) while international (services) revenues were flat QoQ in US$ terms ($25.9 million) while those in rupees grew 2%. Sharp growth deterioration, compared to 4.8% CQGR during FY14-FY16, which the management attributed to client specific issues, could persist in FY16E. Overall, the management expects ~1% organic growth in FY16E led by deals ramp-ups in H2. Consequently, we moderate our FY16E growth assumption to 1% (vs. 19% earlier) and $18 million. The domestic business could remain volatile inter-quarter and grow ~1% in FY16E, in our belief, led by rising cloud adoption and new service offerings. Note, the management continues to prioritise profitability (and RoCE) targets over growth in the domestic business. Exhibit 1: Rupee revenue may grow at 12.6% CAGR during FY15-17E crore FY1 FY11 FY12 FY13 FY14 FY15E FY16E FY17E % International IT services Growth, YoY Exhibit 2: Domestic business may remain volatile inter-quarter and grow ~1% in FY16E crore FY1 FY11 FY12 FY13 % FY14 FY15E FY16E FY17E Domestic products Growth, YoY ICICI Securities Ltd Retail Equity Research Page 3

4 Operating metric highlights Geographically, RoW led growth (7.1% QoQ) during the quarter; Europe was flat after a strong while weakness in the US persisted for second consecutive quarter (-1.9%, -2.1% in FY16 and FY15, respectively). From a vertical perspective, retail + CPG led growth (6.7%) while travel and transport declined 3% QoQ after reporting robust growth in (14%) and (14.3%). Outsourced product development declined 2.9% QoQ after declining 4.6% QoQ in FY15. Dynamics AX led growth (15.4%) among services, IMS (11.1%), testing (5.6%) followed while ADM (- 1.3%) was a laggard. Top 1 customer revenues were stable QoQ (72% of revenues) while clients contributing $1million+ increased by one to 2. The company added two new clients during the quarter vs. 21 each added during FY15 and FY14. Exhibit 3: Top 1 client revenues were stable sequentially $ million FY11 FY12 FY13 FY14 FY15E % Top 1 revenues ($ million) Top 1 revenues (%) Exhibit 4: Revenue contribution across verticals % FY14 FY14 FY14 FY15 FY15 FY15 FY15 FY16 OPD Travel Retail & CPG Others Structural change in business mix to aid margins Adjusted for f/x gains, other income and income tax refund, EBITDA margins declined 317 bps QoQ to 8.7% as international services margins declined 32 bps QoQ to 18.7% led by higher onsite effort and S&M investments. The management indicated that services margins could range in this narrow band as investments in technology, S&M and people could offset operational tailwinds while domestic margins could improve led by better product mix and solutions offering. Consequently, we expect flat YoY margins (1%) in FY16E. ICICI Securities Ltd Retail Equity Research Page 4

5 Exhibit 5: Tapering margin profile in international business may impact overall profitability in FY16E FY1 FY11 FY12 FY13 FY14 FY15E FY16E FY17E IT Services(%) Company average Domestic business ICICI Securities Ltd Retail Equity Research Page 5

6 Outlook and Valuation Sonata reported 22% QoQ revenue growth led by a rebound in domestic revenues (36.2% QoQ, 12.5% YoY growth) while international (services) revenues were flat QoQ in US$ terms ($25.9 million) while those in rupees grew a modest 2%. Sharp growth deterioration, compared to 4.8% CQGR during FY14-FY16, which the management attributed to client specific issues, could persist in FY16E. Overall, the management expects ~1% organic growth in FY16E led by deals ramp-ups in H2. We expect Sonata to report revenue, PAT CAGR of 7%, 14% during FY15-17E (average 1.8% EBITDA margin), respectively, vs. 4%, 11% growth reported during FY1-15 (7.8%), led by client mining, deal wins and improving business mix. We introduce FY17E estimates and now value Sonata at 2, i.e. 12x FY17E EPS of 16.5 (translates to 3x Mcap/sales for services business) given improving fundamentals, healthy cash balance ( 22 crore) and high dividend payout (~5%) Exhibit 6: One year forward PE Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Price Exhibit 7: Valuations Sales Growth EPS Growth PE EV/EBITDA RoNW RoCE ( cr) (%) ( ) (%) (x) (x) (%) (%) FY14 1, (377.2) FY15E 1, FY16E 1, FY17E 1, ICICI Securities Ltd Retail Equity Research Page 6

7 Company snapshot 25 2 Target Price Jan-1 Mar-1 May-1 Jul-1 Sep-1 Nov-1 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Source: Bloomberg, Company, ICICIdirect.com Research Key events Date Event Sep-1 Media reports suggest CDC software could acquire 45% stake in Sonata. The company denies reports Mar-11 Sonata launches "MilEdge" for the global car rental industry Nov-11 Reports disappointing FY12 results Feb-12 Company's CEO Sanjay Viswanathan quits and is succeeded by company veteran and current CEO, Mr. Srikar Reddy May-12 Sonata reports losses in FY12 as EBITDA margins shrink to ~3% vs. ~1% in FY11 led by poor performance in TUI Jul-12 Sonata strengthens its focus on cloud offerings Jul-12 Sonata announces setting up of offshore development centre for US based Coalfire Systems Inc to aid Coalfire's Navis platform development Feb-13 Sonata launches Center of Excellence for Oracle Exalytics to offer business analytics services to its clients Apr-13 Sonata partners with Sage to extend the latter's ERP product lines on Microsoft's Azure cloud platform May-13 Focus on business restructuring leads to sequential EBITDA margin improvement during FY13 (~6%) vs. ~3% reported in FY12 Jan-14 International IT services grew 7.9% QoQ in US$ terms while EBITDA margins reported sharp improvement of 77 bps to 22.1% Jul-14 Sonata acquires 6% stake in US-based Rezopia for EV of $2.4 million. Nov-14 Sonata reports yet another healthy quarter led by international services business Top 1 Shareholders Rank Name Latest Filing Date % O/S Position (m) Change (m) 1 Pace Industries Pvt Ltd. 31-Mar Pace Services, Ltd. 31-Dec Global Solutions Pvt. Ltd. 31-Mar DSP BlackRock Investment Managers Pvt. Ltd. 3-Apr HSBC Global Asset Management (India) Private Limited 31-Mar ICICI Prudential Asset Management Co. Ltd. 3-Apr Norges Bank Investment Management (NBIM) 31-Mar AKM Systems Pvt. Ltd. 31-Mar Thadani (Renuka Vijay & Vijay Kumar) 31-Mar Infrastructure Leasing & Financial Services, Ltd. 31-Mar Source: Reuters, ICICIdirect.com Research Shareholding Pattern (in %) Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Promoter FII DII Others Recent Activity Buys Sells Investor name Value Shares Investor name Value Shares Pace Industries Pvt Ltd m 23.5m Sundaram Asset Management Company Limited -.15m -.25m AKM Systems Pvt. Ltd..6m.1m BlackRock Asset Management North Asia Limited -.14m -.2m Raghavan (G).3m.9m Norges Bank Investment Management (NBIM) -.6m -.1m DSP BlackRock Investment Managers Pvt. Ltd. -.5m -.9m SBI Funds Management Pvt. Ltd. -.5m -.6m Source: Reuters, ICICIdirect.com Research ICICI Securities Ltd Retail Equity Research Page 7

8 Financial summary Profit and loss statement Crore ( crores) FY14 FY15E FY16E FY17E Total Revenues 1,566 1,682 1,887 1,919 Growth (%) Total Operating Expenditure 1,462 1,514 1,697 1,698 EBITDA Growth (%) Depreciation & Amortization Other Income Interest costs PBT before Exceptional Items Growth (%) NM Tax PAT before Exceptional Items Exeptional items PAT before MI Minority Int & Pft. from associates PAT Growth (%) NM EPS EPS (Growth %) NM Cash flow statement Crore ( crores) FY14 FY15E FY16E FY17E Net profit before Tax Depreciation & Amortization WC changes 2 (72) 1 (5) Other non cash adju. (31) (12) (23) (27) Income taxes paid 36 (27) (6) (69) CF from operations Capital expenditure (3) (6) (2) (2) Δ in investments (37) (14) (5) (5) Other investing cash flow CF from investing Activities (25) (11) (43) (4) Issue of equity Δ in debt funds (11) Dividends paid (28) (67) (76) (89) Other financing cash flow (2) (3) (4) (4) CF from Financial Activities (41) (51) (8) (93) Δ in cash and cash bank balance Effect of exchange rate changes (1) (1) - - Opening cash Other cash adjustments Closing cash Balance sheet Crore ( crores) FY14 FY15E FY16E FY17E Equity Reserves & Surplus Networth Minority Interest LT liabilties & provisions Source of funds Net fixed assets Goodwill Long term loans and advances Other non current assets Loans and advances Inventories Current Investments Debtors Cash & Cash equivalents Other current assets Current liabilities Provisions Net current assets Application of funds Key ratios (Year-end March) FY14 FY15E FY16E FY17E Per share data ( ) EPS-diluted Cash per share BV DPS Operating Ratios (%) EBITDA Margin Adjusted PBT Margin Adjusted PAT Margin Return Ratios (%) RoNW RoCE RoIC Valuation Ratios (x) P/E EV / EBITDA Price to Book Value EV/Total Revenues MCap/Total Revenues Turnover Ratios Debtor days Creditors days Solvency Ratios Total Debt / Equity..1.. Current Ratio Quick Ratio Debt / EBITDA ICICI Securities Ltd Retail Equity Research Page 8

9 ICICIdirect.com coverage universe (IT) CMP M Cap EPS ( ) P/E (x) EV/EBITDA (x) RoCE (%) RoE (%) Sector / Company ( ) TP( ) Rating ( Cr) FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E Cyient (INFENT) Hold 6, Eclerx (ECLSER) 1,596 1,4 Sell 4, Firstsource (FIRSOU) Buy 2, HCL Tech* (HCLTEC) 936 1,1 Buy 131, Infosys (INFTEC) 1,86 1,3 Buy 249, KPIT Tech (KPISYS) Hold 2, Mindtree (MINCON) 1,354 1,2 Hold 11, NIIT Technologies (NIITEC) Hold 2, Persistent (PSYS) Hold 5, TCS (TCS) 2,572 3, Buy 53, Tech Mahindra (TECMAH) Buy 51, Wipro (WIPRO) Buy 139, * June year end, ICICI Securities Ltd Retail Equity Research Page 9

10 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/2% for large caps/midcaps, respectively, with high conviction; Buy: >1%/15% for large caps/midcaps, respectively; Hold: Up to +/-1%; Sell: -1% or more; Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai 4 93 research@icicidirect.com ICICI Securities Ltd Retail Equity Research Page 1

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