Zylog Systems IPO - Invest at cut-off

Zylog Systems, promoted by first generation entrepreneurs Sudarshan Venkatraman and Ramanujam Sesharathnam, is a global services provider delivering technology driven business solutions. The major focus is application development and integration including web application, web services, application integration, business Intelligence, data warehousing and mobile and wireless applications; enterprise infrastructure management and quality assurance & testing. The company also has a few products -- Z*Connect and Z*Prism -- in the telecom space, insured vehicle accident recovery system and claims management systems in the insurance space; RTGS PayManager, VISTEM and WAP Page in the banking, financial services and insurance (BFSI) space.

Over the last four years, Zylog Systems has made five acquisitions. The company operates through two global development centres in Chennai. It has overseas branches set up across the US. The US headquarter is located in New Jersey. Subsidiaries have also been set up in Singapore and United Kingdom. But 98% of the revenue is derived from clients located in the US. About 81.50% revenue comes from services performed onsite, up from 80.73% in the year ending March 2006 (FY 2006).

End March 2007, ZSL had 133 consultants and 835 permanent employees with 635 technical staff and 127 support staff. The attrition rate of the software professionals was 21.9% per annum in FY 2007.

The number of clients increased to 259 clients in FY 2007, from 196 in FY 2006. The million-dollar clients increased to 16 in FY 2007, from six in FY 2006. Repeat business constituted 88.9% of revenue in FY 2007, up from 70.7% in FY 2006. Top client contributed 3.84% (2.60% in FY 2006) of revenue, top 5 clients 15.44% (10.79%), top 10 clients 25.67% (18.27%) and million-dollar clients 34.31% (12.56%).

In industry verticals, BFSI contributed 34.12% in FY 2007 (39.94% in FY 2006), telecom 20.96% (20.96%), retail 8.20% (5.27%), manufacturing 7.32% (12.20%), pharma/healthcare 7.83% (5.33%) and others 20.53% (16.30%).

In service verticals, consulting contributed 22.65% in FY 2007 (36% in FY 2006), development 44.95% (34.60%), maintenance 6.57% (7.70%), package implementation 13.43% (8.80%), testing 3.60% (5.20%), application support 3.78% (4.70%), network support 1% (1.10%) and others 4.02% (1.90%).

The net proceeds of the issue along with preferential allotment of Rs 43.88 crore and term loan of Rs 13.15 crore will be utilised for setting up Offshore Development Centres (ODCs) in Chennai, acquisitions/strategic investments and meeting working capital needs.

Strengths

• Over the last four years, operating revenue grew at a CAGR of 58.5% and net profit at a CAGR of 76.7%. This is a consistently good performance.

• Operating profit margin (OPM) is at 17-18% level, in line with its onsite focus. Going forward, offshoring will increase leading to improvement in margin due to the setting up of ODCs.

• Acquisitions will expand clients and geographic presence, enabling cross-selling of services and solutions.

• Unlike other medium-sized IT companies, not dependent on handful of customers. In FY 2007, 95% of the revenue was from Top 145 clients, with Top 10 clients contributing 25.70%. Also, repeat business accounted for 88.90%, up from 70.7% in FY 2006.

Weaknesses

• Onsite-focused companies are more prone to visa-related issues and anti-outsourcing rhetoric.

• OPM has been continuously falling every year, from 29.9% in FY 2003 to 17.1% in FY 2007.

Valuation and Recommendation

The IPO is priced between a band of Rs.330-350. At the upper band, the company is priced at 10.5x its FY07 diluted EPS of Rs.33.36 and at 7.25x its FY08E EPS which looks quite cheap as compared to its peers. The FY08 EPS is arrived at a conservative sales growth of 50% and net profit growth estimate of 45% against 79% net profit CAGR from FY05 to FY07. We believe the company has a potential to give solid listing gains. We strongly recommend our investors to Subscribe to the issue.

Reference:- www.capitalmarket.com

ANURAG DUJARI
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