Table of Contents

Premia Research
NSE

Table of Contents Page No.

Sectoral Overview 2-8

Turbulence in the rear view mirror; Digital to be growth driver 3

Green shoots are visible 4

IMS to be driven by Next-Gen Infrastructure Outsourcing 5

ER&D to outpace overall industry growth 6

Infosys 10-14

HCL Technologies 15-19

Persistent Systems 20-23

Disclaimer 24

1|Page
 Indian IT – Re-rating on the cards
Premia Research

Infosys– BUY The Indian IT sector is poised to perform well over FY18-20E on the
CMP Target Upside back of improving global macro environment. Revamp in IT budgets
1,188 1,379 16.1%
for BFSI and increasing adoption of digital technologies by
Enterprises, indicate strong momentum for the overall IT sector. The
HCL Tech – BUY
depreciating trend of Rupee will comfort the margins of the IT
CMP Target Upside companies. Other areas of opportunities include next-gen
1,088 1,309 20.3% Infrastructure Outsourcing Services (ISO) and Engineering &
Persistent Systems – BUY Research Development (ER&D) services that will spur growth for
CMP Target Upside companies with exposure to above segments. Moreover, TCS’ result
747 966 29.3% beat, solid digital growth and positive guidance provides
Prices as on 23/04/2018 confirmation that the skies are clear for the Indian IT space. Better
times and higher FCF distribution by companies would drive rerating
of the sector.

April 24, 2018 Traction in digital to fuel IT services growth

As per NASSCOM, the digital revenues of the overall IT exports have
Analyst–Milan Desai grown at 50.8% CAGR over FY16-18, driving overall export CAGR of
research@iifl.com
8%. Industry estimates suggest that digital component (exports)
would grow at 27-30% in FY19E aiding 7-9% growth for the overall
sector. ISG data provides proof that deal activity in Americas is on the
up and pricing pressures have bottomed out. ISG global level data is
indicating that incremental spends are moving towards digital and
outlook for the industry is brighter vs. FY18.
Shift towards cloud would aid next-gen ISOs
Owing to adoption of hybrid cloud, management of hybrid cloud and
higher focus on workplace services would mean that companies with
value proposition and broad reach would perform well and benefit
from higher growth in Infrastructure-as-a-Service (IaaS, growing at a
robust pace).
ER&D services to benefit from increasing presence of GICs
ER&D services have been in demand on account of rising spends on
IoT and need for customized products. The growing role of Captive
centers in ER&D services and emergence of India as a hotspot for
setting up of captives would result in third party engineering service
providers benefitting from the growing trend of co-sourcing.

We prefer (1) Infosys – stability returning, focus on growing digital

capabilities and unwarranted discount to TCS (value at 18.0x FY20E
EPS), (2) HCL Tech – favorable growth profile vs. peers, IP
partnerships (value at 17x FY20E EPS), (3) Persistent Systems – to
ride momentum in digital, valuations attractive post correction
(value the stock at 17.0x FY20E).
2|Page
 Indian IT – Re-rating on the cards
Premia Research

Turbulence in the rear view mirror; Digital to be growth driver

Diversion of budgetary spends towards
newer technologies are driving overall IT
growth
Indian IT sector is expected to perform well over FY19E-20E, as the IT
spends of corporations are looking up. This is owing to (1) improved
global macro environment and (2) digital becoming mainstream.
Moreover, Rupee in a depreciating trend augurs well for the IT sector.
As per NASSCOM, the Indian IT industry added USD13bn in FY18 to
reach USD167bn revenues, up 8.1% yoy. Of the USD13bn incremental
revenue, USD10bn came from exports, of which, USD9mn was digital.
Further, digital component grew at 56.3% yoy to reach USD25bn in
FY18, increasing its share from 10% in overall exports in FY16 to ~20%
in FY18E. This suggest that ex-digital, the IT exports grew by mere
CAGR of 2% over FY16-18E.

This underperformance of non-digital/traditional services was on

account of slowdown in global economy (mainly North America) and
shift in budget allocations towards emerging technologies. Traditional
business models have been disrupted by emergence of tech savy
companies and as a result, the traditional service spends have been
diverted towards digital in order to become agile enterprises.
Exhibit 1: Digital to drive overall IT-exports growth
200
16
15
150 14 29
13 26
24 32
22 25
100 11 16

50 97 100 101 104

0
FY16 FY17 FY18E FY19E

Exports (Ex-Digital) Exports (Digital) Domestic Hardware

Source: NASSCOM, Industry Reports, IIFL research

Going forward, based on NASSCOM and industry estimates, and

assuming the trend continues (NASCCOM said that digital is growing
1.5x faster than global digital growth rate), we expect digital to grow
~28% yoy in FY19E to reach USD32bn size and thus drive overall
Indian IT exports growth of ~8% yoy in FY19E.

3|Page
 Indian IT – Re-rating on the cards
Premia Research

Green shoots are visible

The performance of the Indian IT sector is heavily influenced by IT
spends by the BFSI vertical (~50% of revenue) especially in the North
America (~60% of revenues). As per Information Services Group (ISG)
data, CY18 has started on a positive note with ~11% yoy growth in
annual contract value (ACV) to USD12.2bn in Q4FY18. Traditional
sourcing, however has declined by 6% yoy to USD6.3bn (on 14% yoy
decline in BPO), while As-a-Service grew by impressive 40% yoy to
USD5.9bn, in-line with trend of increasing spends towards digital.
Exhibit 2: Increasing Global ACV points at improving sentiment
30.0 26.6
24.2 24.6
25.0

20.0 18.8
(USD BN)

15.0 14.2
10.6
10.0 6.6 7.5 6.6 6.8 6.3
5.9 5.8 6.0 5.7 5.9 6.1 6.2
5.0
2.2 2.8 2.8 2.8 2.8 3.2 4.0 4.1 3.8 4.4 4.7 5.9
0.0 FY16

FY17

FY18
Q1FY18
Q1FY16

Q2FY16

Q3FY16

Q4FY16

Q1FY17

Q2FY17

Q3FY17

Q4FY17

Q2FY18

Q3FY18

Q4FY18
Traditional sourcing As-a-Service
Source: ISG, IIFL research

Things are improving in American market as Amongst regions, Americas showed strength with combined ACV up
sourcing volumes reached an all-time high 32% yoy to USD6.9bn. Both traditional sourcing and As-a-Service
and pricing pressures are seen easing grew by impressive 31% yoy and 32% yoy respectively. As per ISG
commentary, things are improving in American market as sourcing
volumes reached an all-time high and easing pricing pressure aided
27% yoy increase in IT sourcing.
Exhibit 3: Traction in American ACV points at brighter outlook
14.0 13.0
12.0 11.2
10.5 10.3
10.0
8.3
(USD Bn)

8.0
6.4
6.0
3.6 3.3 3.7
4.0 2.9 2.4 2.9 2.9 2.8 2.4 2.6 2.8 2.5
2.0 2.6 3.2
1.3 1.7 1.7 1.7 1.7 1.9 2.3 2.4 2.1 2.4
0.0
FY17
FY16

FY18
Q2FY16

Q1FY17

Q4FY18
Q1FY16

Q3FY16

Q4FY16

Q2FY17

Q3FY17

Q4FY17

Q1FY18

Q2FY18

Q3FY18

Traditional sourcing As-a-Service

Source: ISG, IIFL research

4|Page
 Indian IT – Re-rating on the cards
Premia Research

The outsourcing advisory firm added that on TTM basis, sourcing

All of the IT majors have indicated that they
would be looking at ~30% of the revenue in
the near future
from financial services vertical (global) was up 20% yoy whereas,
Healthcare, up 31% yoy, was the fastest growing vertical for sourcing
on TTM basis. We believe that bottoming out of pricing pressure in US,
and increasing TCV in US for Traditional services indicates a positive
environment for Indian IT Services companies in the near future.
Industrialization of digital to aid IT majors
As per above trends and industry articles, digital deal sizes are already
moving up from the initial stages. Accenture’s commentary and TCS
signing its first USD50mn+ deal in digital in 3QFY18 provide evidence
of growing deal sizes. We believe that as enterprises move from trial
stage to full scale implementation stage, the flow of deals would
move towards larger companies like TCS, Wipro and Infosys amongst
others. All of the IT majors have indicated that they would be looking
at ~30% of the revenue in the near future. Hence, we believe that
Industrialization of digital would benefit larger companies.
IMS to be driven by Next-Gen Infrastructure Outsourcing
As per Dun & Bradstreet Research, the share of IMS (Infrastructure
Management Services or IS outsourcing), in total IT services exports
has increased from 17.8% in FY13 to about 24% in FY17. The growth
has been at ~18% CAGR over the same period vs. ~9% of the overall
industry (exports). This has been on account of robust growth in
Infrastructure-as-a-Service on increasing preference for cloud
technologies. Although this has caused deceleration in growth rates
for traditional IMS on the said account, our interaction with company
management suggests that the penetration of IS outsourcing is still
low and as per industry reports, it is not at the levels of other
services.

We expect challenges for data center revenues in IMS to continue

and believe that end user computing (workplace services), network
and security services still provide opportunities in the IMS space. This
is because the focus is expected to shift to improving productivity and
making organizations agile. In the near term, we expect growth rates
to remain at 10-12%, higher than that of overall industry guidance of
7-9%. Our interaction with IT personnel suggests that although cloud
migration is picking up, hybrid cloud (mix of on premises, private
cloud and third party) is the most sensible option for the companies
from business stand point. As per Forrester Research, companies with
successful blend of data center and workplace services along with
differentiating value proposition will position themselves to

5|Page
 Indian IT – Re-rating on the cards
Premia Research

successfully deliver next-gen infrastructure outsourcing services. HCL

Tech and Wipro are leaders as per the Forrester in terms of next-
generation infrastructure outsourcing. HCL Tech scores higher on
value proposition criterion.

ER&D to outpace overall Industry growth

ER&D segment has grown at 13% CAGR
over 2011-16
As per NASSCOM, at 16% of India’s IT-BPM market, Engineering
Research & Development (ER&D) segment has been and continues to
be the fastest growing segment. The segment has grown at 13%
CAGR over 2011-16. ER&D services, comprising of product
engineering services and process engineering services, pertains to
high-end engineering services for improving a product or managing
services.

As per LT Technology Services’ (LTTS) RHP, product engineering

services address product development life cycle for companies, which
produce discrete products through services in areas of mechanical
engineering, embedded systems and software product engineering.
Majority of the services outsourced today are product engineering
services and there are very few third party India based ER&D services
providers for process engineering services.

Exhibit 4: Global ER&D industry service lines

Mechanical/Electrical - External housing, Inner
frame, Industrial Design, Styling, Surfacing,
Ergonomics, Solid Modelling, Drafting, Structural
analysis etc.

Embedded Systems - Embedded hardware &

Product software, Semiconductor, Processor, RTOS, OS-
Engineering ware, Codec, Communication protocol,
Application software etc.

Global ER&D Software Engineering - Graphical user interface,

Services mobile applications, application program
Industry interface, software product/platforms for
ISV/Technology Companies

Plant Engineering - Plant Design, Instrumentation

and Control engineering, Civil/Structural
engineering, Process and Instrumentation
Process diagram (P&ID), FEED engineering
Engineering
Manufacturing Engineering - Tooling and factory
equipment design, Jigs & Fixture Design, PCB
Manufacturing, Should Costing etc.
Source: Zinnov

6|Page
 Indian IT – Re-rating on the cards
Premia Research

As per Zinnov (product engineering market research), the ER&D

services is provided by a combination of in-house ER&D teams, global
(offshore) in-house centers (GICs or Captives) and offshore third-
party engineering service providers. R&D spends on product
development by global top 500 R&D spenders across geographies
stood at USD621bn in 2016. Companies part of this group include
Amazon, Alphabet, Volkwagen, Roche, Samsung among others.

The total addressable size for captives and third-party engineering

services outsourcing (3P-ESO) partners for product engineering stood
at USD232bn of which USD85bn has been addressed so far. Lower
penetration of outsourced work suggests that there is significant
opportunity available for participants on the 3P-ESO side. The share
of captives stands at USD34bn (40%) and that of 3P-ESO at USD51bn
(60%). Going forward, overall growth in R&D spends will be driven by
rising spends behind IoT and need for unique and customized
products to adhere to changing trends. This, in-turn will drive the
growth for outsourcing of ER&D services with software expected to
be the fasted growing segment. The USD232bn addressable market is
expected to grow to USD302bn by 2021E implying 5% CAGR over
2016-21E.
Exhibit 5: Total addressable size for captives and 3P-ESO vendors
350
300
250
USD Bn

200
150
100
50
0
2016 2021
Mechanical 78 83
Embedded 93 107
Software 61 112

Software Embedded Mechanical

Source: Zinnov

7|Page
 Indian IT – Re-rating on the cards
Premia Research

India as Global ER&D hotspot to boost 3P-ESO revenues

Further to the Zinnov report, India is among the top destinations for
offshore in-house R&D centres, with share of USD13.4bn of total
USD34bn. Also, it is key market (third largest) in terms 3P-ESO with
share of USD8.9bn of USD51bn. China is also key market in terms of
offshore in-house R&D centers with ER&D spend share of USD10.2bn.
This suggests that Asia is the preferred location for ER&D activity.
Within India, in-house R&D centers are expected to post CAGR of
13.7% to reach USD22.4bn in 2020E from USD13.4bn in 2016 while
3P-ESO is expected to grow at 14.1% CAGR and reach USD15.1bn in
2020E from USD8.9bn in 2016.
Exhibit 6: Total addressable size for captives and 3P-ESO
25

20

15
USD Bn

10

-
2015 2016 2020

Captives 3P-ESO
Source: Zinnov

As per NASSCOM article, there is a trend of large corporates adopting

in-sourcing and setting up R&D centers in India. Hence, the GICs are
As GICs move up the value chain, they expected to play critical role in parent organization retaining its
are expected to become customers to
3P-ESO partners and require competitive edge and provide niche skills from earlier operations as
integration of operations with GICs cost arbitrage centers. As these GICs move up the value chain, they
are expected to become customers to 3P-ESO partners and require
integration of operations with GICs. This presents greater opportunity
for 3P-ESO players.
HCL Tech is the largest company in ER&D space in terms of revenue
while LTTS is the largest pure play ER&D services company in India.
Cyient derives ~63% of its revenue from ER&D services.

8|Page
 Indian IT – Re-rating on the cards
Premia Research

Exhibit 7: Prominent companies as per Zinnov Zones

Verticals Large Cap IT Mid Cap IT
Overall HCL Tech, Wipro, TCS LTTS, Cyient
Mechanical Engineering – TCS, Tech Mahindra, HCL
Cyient, LTTS
(Overall) Tech
Embedded Systems
Wipro, HCL Tech, TCS LTTS, Mindtree
(Overall)
Persistent Systems,
Software - Enterprise Wipro, TCS
Mindtree
Persistent Systems,
Software - Consumer HCL Tech, Infosys, Wipro
Mindtree
Automotive TCS, Wipro, HCL Tech KPIT, LTTS
HCL Tech, Tech Mahindra,
- Industrial LTTS
TCS
Tech Mahindra, HCL Tech,
- Transport Cyient, LTTS
TCS
Semiconductor Wipro, HCL Tech, TCS L&T TS, Mindtree
Tata Elxsi, LTTS,
Consumer Electronics HCL Tech, TCS, Wipro
Mindtree
Telecom & Networking Wipro, HCL Tech, TCS LTTS, Mindtree
Source: Zinnov

We believe that IT firms which are capable of scaling up focus on

newer technologies will better offset the pricing pressures seen in
traditional services going forward. We prefer Infosys in the large cap
IT space vs. TCS on account of unjustified discount to the latter. We
also like HCL Tech on account of higher mix of IMS revenues and
presence in the higher growth ER&D segment. We like Persistent
because it is transitioning from an outsourced product development
(OPD) company to investing and building offering around Data,
Digital and IoT.
Exhibit 8: MF ownership of IT is below average level of 9.5%

20.0
15.6
15.0 9.5

10.0
5.0 8.0 7.0

-
Jul/12

Jul/17
Jun/10

Jun/15
Nov/10
Apr/11

Feb/12

May/13

Nov/15
Apr/16
Sep/16
Jan/10

Sep/11

Dec/12

Mar/14

Jan/15
Aug/14

Feb/17

Dec/17
Oct/13

MFS IT ownership Avg. Since 2010

Source: Ace MF

9|Page
 Infosys Ltd
Premia Research CMP: `1,188; 1-year Target: `1,379

Infosys, India’s second largest IT company, would benefit from

Sector IT
stable operating environment and reap benefits from its
Recommendation BUY investments in digital capabilities. It trades at unjustified discount of
Upside 16.1% ~23% to TCS despite growth deltas expected to converge between
the two in FY20E on investments behind digital and efforts to boost
Stock Data
deal wins. Attractive valuations and USD2bn to be returned to
Sensex 34,451
shareholders in FY19 provides attractive risk-reward. We build
52 Week h/l (`) 1,221/860
revenue and adj. PAT CAGR of 9.9% and 5.6% respectively over
Market cap (`Cr) 2,59,409 FY18-20E. We recommend BUY with target of `1,379 (18x FY20E EPS).
BSE code 500209 Stability returns: Infosys had lost ground to its peers because of
NSE code INFY disruption stemming from management/promoter issues. We believe
FV (`) 5.0 that with right hire in place, the focus has now turned to execution.
Div yield (%) 3.7 Mr. Parekh has credible record and can turn the focus on deal wins.
Digital is ~25% of its portfolio and investments in building digital
Shareholding Pattern capabilities and sales team expansion are main revenue drivers
Strategy refresh to boost revenues: Infosys has mapped out four
Sep-17 Dec-17 Mar-18
areas of focus as part of its Navigating your next strategy which
Promoters 12.8 12.9 12.9
covers scaling up digital revenues, focusing on customers, reskilling of
DII+FII 72.9 73.4 74.2
employees and increasing local presence. This is largely the reason
Individuals 14.3 13.7 12.9 behind 100bps lower guidance for FY19E but we believe that higher
Source: www.bseindia.com
digital services component, having better gross margins and rupee
Share Price Trend
tailwinds would aid margin recovery by FY20E.
Sound business, discount to TCS: Despite having similar growth
Infosys Ltd Sensex
profile as TCS in FY18, Infosys’ discount to TCS reached ~23%. TCS
1180
36300 would outperform in revenue growth terms vs. Infosys in FY19 on
1140 35300 deal ramp ups, but we expect Infosys to catch up by FY20E, as its sales
1100 34300
1060 33300 and investments behind digital and sales team expansion would result
1020
980
32300 in deal wins. Moreover, strong cash generation would be paid out via
31300
940
30300
special dividend and a potential buy-back. We believe that Infosys can
900
860 29300 grow successfully under new leadership and is a preferred pick in large
Apr-17 Aug-17 Dec-17 Apr-18 cap IT space that would benefit from commercialization of digital theme.
Prices as on 23/04/2018
Financial Summary
Consolidated `cr FY17 FY18 FY19E FY20E
Revenue 68,484 70,522 76,884 85,237
Growth (%) yoy 9.7 3.0 9.0 10.9
EBIT% 24.7 24.3 23.5 23.8
Adj. PAT 14,353 15,011 15,071 16,731
Growth (%) yoy 6.4 4.6 0.4 11.0
P/E (x) 18.1 17.3 17.2 15.5
ROE % 22.0 22.4 23.0 24.2
ROIC % 58.5 56.8 49.0 53.1
Source: Company, IIFL Research

10 | P a g e
 Infosys Ltd
Premia Research

Balance Sheet Snapshot

` Cr FY17 FY18 FY19E FY20E
Share Holders Funds 68,982 64,923 66,393 72,051
Total Liabilities -180 -420 -420 -420
Sources of Funds 68,802 64,503 65,973 71,631
Fixed Assets 12,492 12,390 12,750 13,036
Other Assets 22,987 20,581 20,581 20,581
Net Current Assets 33,323 31,532 32,641 38,014
Application of Funds 68,802 64,503 65,973 71,631
Source: Company, IIFL Research

Company Background
Infosys is India’s second largest and a leading provider of consulting,
technology, outsourcing and next generation services. Application
Infosys is India’s second largest and a development & maintenance (31.1% of revenue, as on Q4FY18) and
leading provider of consulting, Consulting, Package Implementation & Others (32%) are its main
technology, outsourcing and next service lines. BFSI forms the largest vertical (33%) followed by
generation services
Manufacturing (21.9%). North America (59.4%) and Europe (24.8%)
are the largest contributors in terms of geography. It had 2,04,1017
employees as on Q3FY18.

Exhibit 1: Revenue by service line as on Q4FY18

Products and Others, 3.1%
Platforms, 5.3% Application
Development &
PES, 4.0%
Maintenance,
BPM, 5.4% 31.1%

IMS, 9.3%

Testing Services,
9.8% Consulting,
Package
Implementation
& Others, 32.0%
Source: Company, IIFL Research

11 | P a g e
 Infosys Ltd
Premia Research

Exhibit 2: Revenue by verticals – Q4FY18

Others, 6.0%
Communication
and Services, Banking &
10.8% financial services,
26.2%
Energy & Utilities,
5.9%
Life Sciences &
Healthcare, 6.6%
Insurance, 6.8%
Transport &
Logistics, 2.5% Manufacturing,
21.9%
Retail & CPG,
13.3%

Source: Company, IIFL Research

Exhibit 3: N. America & Europe are largest contributors – Q4FY18

India, 2.8% ROW,

13.0%

Europe, 24.8% North America,

59.4%

Source: Company, IIFL Research

Exhibit 4: Employee count has increased to over 2 lakhs in FY18

250,000
204,107
200,000

150,000

100,000

50,000

-
FY13 FY14 FY15 FY16 FY17 FY18

Source: Company, IIFL Research

12 | P a g e

Premia Research
Digital is expected to be the next
growth driver for overall Indian IT
exports as per NASSCOM
13 | P a g e
Infosys Ltd
“Navigating your next” and focus on deal wins
Infosys has mapped out four areas of focus as part of its “Navigating
your next” strategy. This would entail (1) Scale up of digital, (2)
energizing client’s core via automation and AI, (3) reskilling employ on
technologies and (4) increased localization of talent. The
management has indicated that it would invest in areas of digital
where it feels it is underinvested and will be expanding its sales team,
especially in Europe, to accelerate deal wins. The management is
positive on the BFSI recovery in FY19 with regional banks and US and
European financial institutions increasing their IT spends. We believe
that Mr. Parikh would step up the focus and target higher deal wins.
Although above steps would exert pressure on margins, we believe
that higher gross margins of digital services would aid in margin
defence.
Digital capabilities to support growth
Digital contribution to Infosys’ overall top-line is at 25.5% as on FY18.
Digital is expected to be the next growth driver for overall Indian IT
exports as per NASSCOM. Infosys is already witnessing favorable
demand for digital services and investments behind expanding its
portfolio of next-gen offerings, which are aiding growth, while
traditional services face pricing pressure. We also believe that as the
deal sizes grow, clients would be more inclined to opt for larger
services firms like Infosys for scaled rolled out.
Exhibit 5: Indian IT Services digital revenues need scale up
Digital Revenue (%)
60.0 ~ 55.0
50.0
40.0
30.0 25.5 25.0 + 23.8
20.0
10.0
-
Accenture Infosys Wipro TCS
Source: Bloomberg, Company, IIFL Research
 Infosys Ltd
Premia Research

Strong balance sheet, steep discount

Infosys has huge cash reserves (~`20,000cr, FY18) and strong cash
generation, which would ensure that the dividend payouts would
continue despite 5% buy-back conducted in FY18. The management
mentioned that apart from current policy of returning 70% of FCF, it
has identified USD2bn to be paid to shareholders in FY19. This would
be via special dividend of Rs10 amounting to USD400mn, while the
rest would be decided at the later date. We believe that this will be
likely via a buy-back route.

Finally, we believe that with cloud of uncertainty now passing by and

We believe that with cloud of
uncertainty now passing by and right
hire in place, we expect the company to
focus on execution and gain some lost
ground
right hire in place, we expect the company to focus on execution and
gain some lost ground. Infosys’ discount vs. TCS has widened in recent
time, which we feel is unwarranted. Hence, we expect the gap to
converge. Hence we value Infosys at 18x FY20E EPS on higher
dividend payment and higher chances of buy-backs.

Exhibit 6: Infosys discount to TCS should shrink going ahead

10.0 Infosys Disc to TCS (3Yr)

-
(%)

(10.0)

(20.0)

(30.0)

Nov/17
Jul/15

Jul/16

Jul/17
May/15

Nov/15

May/16

Nov/16

May/17
Mar/15

Sep/15

Jan/16
Mar/16

Sep/16

Jan/17
Mar/17

Sep/17

Jan/18
Mar/18
Infosys Disc to TCS 3 Yr Average Disc

Source: Company, IIFL Research

14 | P a g e
 HCL Technologies Ltd
Premia Research CMP: `1,088; 1-year Target: `1,309

HCL Tech (HCLT), India’s fourth largest IT services company is poised

Sector IT to perform well on account of expected recovery in its main service
Recommendation BUY line, IMS. It is the largest third party engineering services partner in
Upside 20.3% India by revenues, which bodes well for the company. This is
because, both these service lines are characterized as
Stock Data underpenetrated, which would enhance the overall growth rates. Its
Sensex 34,451 strategy to invest in IPs is another growth driver for the company.
52 Week h/l (`) 1,108/796 We expect HCLT to post revenue and PAT CAGR of 10.4% and 10.5%
Market cap (`Cr) 1,51,476 respectively over FY18-20E. We recommend BUY with target price of
BSE code 532281
`1,309 (17x FY20E EPS).
NSE code HCLTECH Recovery in IMS to aid revenue growth: The organic growth for
FV (`) 2
HCLT has paused in recent quarters due to sluggish state of IMS
(Infrastructure Management Service). The service line has been in
Div yield (%) 2.3
frozen state owing to slower decision making in US geography. The
management is confident that things should look up and believes that
Shareholding Pattern
overall penetration level is still low. The growth rates are expected to
Sep-17 Dec-17 Mar-18
be better than overall industry, which bodes well for HCLT.
Promoters 60.1 60.2 60.2 Largest ER&D services outsourcing partner can help growth:
DII+FII 35.2 36.1 36.3 HCLT, is the largest ER&D services outsourcing player in India. Owing
Individuals 4.7 3.7 3.5 to India’s positioning of place to set up R&D center, scope of work
Source: www.bseindia.com carried out by captives is expected to increase, which in turn should
benefit off-shore outsourcing partners like HCLT. HCL figures in most
Share Price Trend
of Zinnov’s zones, which speaks volumes about its offerings and
HCL Technologies Ltd. scalability. We believe that this horizontal can become the next IMS
Sensex
1080 36300 like growth driver for the company.
1040 35300 IP partnerships a step in right direction: HCLT has been active in
1000 34300
960 33300
signing IP deals with total investments of ~USD1.2bn till date. This is
920 32300 expected to stabilise revenue and margin profile of the company as
880 31300
840 30300
the revenue stream is sticky in nature and better than company level
800 29300 margins. HCLT has a wide user base for these products and can be
Apr-17 Aug-17 Dec-17 Apr-18
easily cross sell, thus enhancing the revenues.
Financial Summary
Prices as on 23/04/2018
Consolidated `cr. FY17 FY18E FY19E FY20E
Revenue 46,723 50,758 56,815 61,894
Growth (%) yoy 14.2 8.6 11.9 8.9
EBIT% 20.3 19.9 20.2 20.4
PAT 8,456 8,779 9,773 10,723
Growth (%) yoy 15.0 3.8 11.3 9.7
P/E (x) 17.9 17.3 15.5 14.1
ROE % 28.0 25.4 25.3 24.4
ROIC % 70.1 57.9 58.2 61.7
Source: Company, IIFL Research

15 | P a g e
 HCL Technologies Ltd
Premia Research

Balance Sheet Snapshot

` Cr FY17 FY18E FY19E FY20E
Share Holders Funds 32,950 36,119 41,194 46,763
Total Liabilities 1,082 1,082 1,082 1,082
Sources of Funds 34,032 37,201 42,276 47,845
Fixed Assets 9,154 11,761 12,106 12,327
Other Assets 22,987 20,581 20,581 20,581
Net Current Assets 1,891 4,859 9,590 14,937
Application of Funds 34,032 37,201 42,276 47,845
Source: Company, IIFL Research

Company Background
HCL Technologies (HCL) is a leading global IT services company. HCL
focuses on providing an integrated portfolio of services underlined by
its Mode 1–2–3 growth strategy. Mode 1 encompasses the core
services in the areas of Applications, Infrastructure, BPO and
Engineering & R&D services, leveraging DRYiCETM Autonomics to
transform clients' business and IT landscape, making them 'lean' and
'agile'. Mode 2 focuses on experience–centric and outcome–oriented
integrated offerings of Digital & Analytics, IoT WoRKS™, Cloud Native
Services and Cybersecurity & GRC services to drive business outcomes
and enable enterprise digitalization. Mode 3 strategy is ecosystem–
driven, creating innovative IP–partnerships to build products and
platforms business.
Exhibit 1: IS and ER&D form ~60% of revenues (LTM Mix)
Engineering and
R&D Services,
22.1%

Application
Business Services, Services,
3.7% 36.1%

Infrastructure
Services, 38.1%

Source: Company, IIFL Research

16 | P a g e
 HCL Technologies Ltd
Premia Research

Exhibit 2: Revenue by verticals (LTM Mix)

Retail & CPG, Telecommunicati
9.4% ons, Media,
Public Services,
Publishing &
10.9% Others, 0.1% Entertainment,
7.9%
Lifesciences & Financial
Healthcare, Services,
11.7% 24.7%
Manufacturing,
35.4%

Source: Company, IIFL Research

Exhibit 3: Americas accounts for bulk of the revenue (LTM Mix)

RoW,
8.9%

Europe, 28.2%
Americas,
62.8%

Source: Company, IIFL Research

Favorable growth metrics v/s peers

HCL’s IMS division grew at revenue
CAGR of 23.2% over FY12-17
HCL Technology’s growth has largely been fueled by its strategy to
capitalize on the higher growth in the IMS service line. On adjusted
financial year basis, its IMS division grew at revenue CAGR of 23.2%
over FY12-17. While the overall USD revenues for the company grew
at CAGR of 11.6%. At the same time the contribution of IMS surged
from ~24% in FY12 to 40% in FY17, suggesting that the growth was
largely driven by IMS. However, ER&D revenue contribution remained
constant during the same period but grew at CAGR of 11.8% during
the same period.

17 | P a g e
 HCL Technologies Ltd
Premia Research

Exhibit 4: IMS drove majority of growth in the past

60

40

20

-20
FY13 FY14 FY15 FY16 FY17

Application Services (%) Infrastructure Services (%)

Business Services (%) Engineering and R&D Services(%)

Source: Company, IIFL Research

Although, IMS growth has been erratic and on a slowing trajectory in

the past few years, it still is the main growth driver for the company.
The growth has been impacted owing to shift towards cloud, which
has impacted the data center revenues. We believe that, as
Infrastructure, as a Service continues to grow, the focus of businesses
will movetowards work place services (end user computing, to
improve productivity levels). We project the service revenues for the
company to grow at CAGR of 10.5% over FY18E-20E on the back of
improving decision making in US and owing to its strong position in
Next-Gen Infrastructure Outsourcing space.

We expect ER&D services to post
revenue CAGR of 11.2% over FY18E-20E
owing to its strong capabilities in ER&D
services
HCL Tech is the largest listed ER&D service company in India by
revenue and figures in most of the Zinnov’s zones for Product
Engineering services. This augurs well for the company as ER&D
service, the next fastest growing horizontal would benefit from the
favorable environment for the ER&D space. We expect ER&D services
to post revenue CAGR of 11.2% over FY18E-20E owing to its strong
capabilities in ER&D services.
Exhibit 5: India is the largest listed ER&D service provider
1,400 1,303

1,200

1,000 861
USD Mn

800

600 484
388
400

200

-
Infosys Wipro TCS HCL Tech Cyient LTTS Tata Elxsi
Source: Company, IIFL Research
18 | P a g e
 HCL Technologies Ltd
Premia Research

IP partnerships are a step in the right direction

HCL Tech had invested US$310mn in its IP partnership portfolio,
thereby taking its overall IP investment to date to US$1.15bn. The
growth in the ER&D services (IP partnership revenues are reported
here) can be attributed to synergies from its IP-partnerships to some
extent. HCL Tech acquires IPs from leading companies like IBM. These
licensing agreements depend on the expected life of the IP. HCL,
builds upon the existing IP using its product engineering capabilities
to somewhat extend the life of the IP. These present an excellent
cross selling opportunity for HCLT, which has a diverse client base.
The management has suggested that there is thorough evaluation
with respect to technology risk and are fairly confident of the strategy
citing sticky revenue stream and higher than company level margins.

19 | P a g e
 Persistent Systems
Premia Research CMP: `747 1-year Target: `966

We believe that the recent correction in Persistent Systems’ stock

Sector IT price provides an excellent entry point to capture the expected
Recommendation BUY improvement in overall performance. Persistent’s digital business
Upside 29.3% (~22% of revenue) is expected to drive the growth for the company,
while it transitions from offshore product development to
partnerships (IBM alliance) and IP-led offerings (Accelerite). We
Stock Data
expect Persistent to post revenue and PAT CAGR of 13.4% and
Sensex 34,451
19.5% over FY18-20E, respectively. We recommend BUY with target
52 Week h/l (`) 878 / 561
price of `966 (17x FY20E EPS).
Market cap (`Cr) 5,974 Favorable change in business mix: Persistent’s ISV business
BSE code 533179 accounted for ~60% of the business in FY14. It recognized the trend of
NSE code PERSISTENT spends moving from ISV to digital and Enterprise early and has
FV (`) 10 focused on digital and IoT segments. Its non ISV business has grown
Div yield (%) 1.2
substantially and as a result the contribution of ISV business has
declined to 38.5% in Q3FY18 and non-ISV business have managed to
build significant base. Persistent stands to benefit from favorable
Shareholding Pattern
business mix with large chunk of revenue growing at a faster clip.
Sep-17 Dec-17 Mar-18
Digital to drive revenue growth: Digital accounts for 22% of overall
Promoters 30.7 30.6 30.5 revenue and is its main growth driver. It is focusing on platform based
DII+FII 37.4 38.5 40.6 solution for financial services and healthcare verticals, as the clients
Individuals 31.9 30.9 28.9 are undergoing transformation. Its platform based partnership, which
Source: www.bseindia.com account for ~75% of digital revenues has mainly aided growth. We
believe that higher focus on select verticals and its partnership-led
Share Price Trend strategy should drive digital revenue CAGR of 31.5%.
Persistent Systems Ltd IoT businesses to recover in FY19E: The stock has corrected by
Sensex ~11% after the company issued profit warning for Q4FY18E owing to
870 36300
830 35300 decline in IP revenues. However, the company is expected to recover
790 34300 its lost revenue over the next few quarters, which should assist its
750 33300
710
32300
overall growth rates. Margins are expected to decline, however, the
670
630 31300 company has completed a major co-development phase with IBM (for
590 30300 IoT) which would aid margins going forward.
550 29300
Apr-17 Aug-17 Dec-17 Apr-18 Financial Summary
Prices as on 23/04/2018 Consolidated `cr FY17 FY18E FY19E FY20E
Revenue 2,878 3,026 3,455 3,891
Growth (%) yoy 24.5 5.1 14.2 12.6
EBIT% 11.0 10.5 11.5 12.4
PAT 301 318 383 455
Growth (%) yoy 1.4 5.6 20.4 18.5
P/E (x) 17.9 16.9 14.0 11.8
ROE % 17.0 15.9 17.3 18.2
ROCE % 27.3 20.2 20.0 22.2
Source: Company, IIFL Research
20 | P a g e
 Persistent Systems
Premia Research
Balance Sheet Snapshot
` Cr FY17 FY18E FY19E FY20E
Share Holders Funds 1,899 2,093 2,342 2,652
Total Liabilities 15 14 14 13
Sources of Funds 1,914 2,107 2,356 2,665
Fixed Assets 552 567 561 550
Other Assets 727 727 728 727
Net Current Assets 635 813 1,068 1,389
Application of Funds 1,914 2,107 2,356 2,665
Source: Company, IIFL Research

North America accounted for 84.4% of Company Background

its revenue as on Q3FY18
Persistent is a leading offshore product development player that
helps build software products with services across all phases of the
product lifecycle. Its services span around design, development, and
maintenance and enhance the functionality of the software products.
The company caters to Infrastructure and Systems, Telecom and
Wireless, Life science, Healthcare, and Financial Services.

The company’s business strategy can be classified as (1) Services –

software and product development services for customers, (2)
Alliance – traditional product engineering services and IP-led product
development with IBM, (3) Digital – Enabling digital transformation
for enterprises (trusted partner of Platforms like Appian and
Salesforce) and (4) Accelerite – develops products (IP based, builds on
existing IP). Geographically, North America accounted for 84.4% of its
revenue as on Q3FY18.

Exhibit 1: Revenue by business line – Q3FY18

Accelerite, 6.5%

Alliance, 29.6% Services, 41.9%

Digital, 22.0%

Source: Company, IIFL Research

21 | P a g e
 Persistent Systems
Premia Research

Exhibit 2: Non-ISV business to drive growth with favorable base

IP ‐ Led, 26.8% ISV, 38.5%

Enterprise, 34.7%

Source: Company, IIFL Research

Digital the main growth driver

Major portion of digital revenues
includes platform based partnerships
with the likes of Salesforce, Appian, and
Oracle
Persistent is focused on Healthcare and Financial Services in
Enterprise digital transformation and has sizable new contracts. The
company is forging partnerships with institutions in health space via
joint development of IPs. Joint development with Partners Healthcare
and United Services Automobile Association, although in initial stages,
can be meaningful contributors in the long run. Major portion of
digital revenues includes platform based partnerships with the likes of
Salesforce, Appian, and Oracle. This has been the main reason for
digital posting ~50% yoy growth in FY17, although on a lower base.
Overall, we see Digital revenues growing at 31.5% CAGR over FY17-
20E.

Exhibit 3: Digital revenue CAGR est. at 31.5% over FY17-20E

700
600
44
500 37
32 150
USD Mn

400 38 140
132
300 126 160
98 128
200 70

100 195 207 218 230

-
FY17 FY18E FY19E FY20E
Services Digital Alliance Accelerite

Source: Company, IIFL Research

Profit warning on IP revenue decline – near term roadblock

Days before the end of fiscal year, Persistent gave out a profit
warning by informing that it is expecting a decline in IP revenues for
Q4FY18. This would impact the revenue and EBITDA margin for
Q4FY18 and FY18. The sequential drop in IP revenue is expected to be

22 | P a g e
 Persistent Systems
Premia Research

about USD8mn (~`52cr) for Q4FY18. Alliance business (IBM),

accounting for ~30% of overall revenue is made up of services
contributing~45% to alliance business and IP led product
development accounting for the balance (IP-IoT – 37% and IP-ex IoT –
18%). Although the drop was expected, as Q3 is a seasonally strong
quarter, we believe that the decline in revenue is more to do with
Accelerite business. However, we believe that the company will be
able to recover the lost revenue in FY19E and expect the margins to
improve going forward as the margins are on the higher side (gross
margins are generally above 50-60% for IP). We build Alliance and
Accelerite revenue CAGR of 5.8% and 5.2% respectively.

23 | P a g e
 Disclaimer
Premia Research
Recommendation Parameters for Fundamental/Technical Reports:

Buy – Absolute return of over +10%

Accumulate – Absolute return between 0% to +10%
Reduce – Absolute return between 0% to -10%
Sell – Absolute return below -10%

Please refer to http://www.indiainfoline.com/research/disclaimer for recommendation parameter, analyst disclaimer and other
disclosures.

India Infoline Limited (Formerly “India Infoline Distribution Company Limited”), CIN No.: U99999MH1996PLC132983, Corporate Office –
IIFL Centre, Kamala City, Senapati Bapat Marg, Lower Parel, Mumbai – 400013 Tel: (91-22) 4249 9000 .Fax: (91-22) 40609049, Regd. Office
– IIFL House, Sun Infotech Park, Road No. 16V, Plot No. B-23, MIDC, Thane Industrial Area, Wagle Estate, Thane – 400604 Tel: (91-22)
25806650. Fax: (91-22) 25806654 E-mail: mail@indiainfoline.com Website: www.indiainfoline.com, Refer www.indiainfoline.com for detail
of Associates.

Stock Broker SEBI Regn.: INZ000164132, PMS SEBI Regn. No. INP000002213, IA SEBI Regn. No. INA000000623, SEBI RA Regn.:-
INH000000248

For Research related queries, write at research@iifl.com

For Sales and Account related information, write to customer care: cs@iifl.com or call on 91-22 4007 1000

24 | P a g e