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com August 14, 2009

Allied Digital Services Emerging Star

Riding high on RIMS Buy; CMP: Rs379

Company details Key points

Price target: Rs532  Well positioned in a fast growing niche segment: Allied Digital Services Ltd
(ADSL) is a leading player in the fast growing and niche segment of outsourced
Market cap: Rs687 cr remote infrastructure management services (RIMS). According to a McKinsey-
52-week high/low: Rs794/146 Nasscom report, the outsourcing of IMS to India is expected to grow at a CAGR
of over 30% to USD13-15 billion by 2013. The growth would be driven by cost
NSE volume: 30,394
rationalisation, telecom and technology advancement, and increasing complexi-
(No of shares)
ties of IT systems.
BSE code: 532875
 En Pointe acquisition improves geographical reach: ADSL acquired an 80.5%
NSE code: ADSL stake in US-based En Pointe Global Solution Ltd (EGSL) at an equity valuation of
~USD24 million (total equity valuation ~USD30 million) in July 2008. The acquisi-
Sharekhan code: ADSL
tion has expanded ADSL’s reach into the US market as well as provided access to
Free float: 1.0 cr EGSL’s several Fortune 1,000 clients. Post-acquisition, ADSL has been able to sub-
(No of shares) stantially drive EGSL’s contracted revenue base to USD60-62 million currently from
USD40 million at the time of the acquisition. The acquisition would also enable ADSL
Shareholding pattern to leverage its offshore capabilities through its NOC and SOC in the RIMS market.
 Large deals/alliances, next growth driver: ADSL is believed to be close to sign-
Others ing a pact with one of the leading PC server manufacturers to offer its services as
19% a bundled offering to the OEM clientele. Such deals can potentially bring in sub-
stantial incremental revenues and act as the next growth driver for the company.
FIIs  Margins are sustainable: ADSL’s margins shall sustain in future in spite of a
Promoters
15% highly competitive environment owing to: (i) the higher proportion of revenues
56%
from the high-margin service segment; (ii) the improving EGSL margin as more
MF/ work gets shifted offshore; (iii) conscious efforts to reduce its dependence on
Institutions the onsite employees; and (iv) cost efficiencies.
10%
 Attractive valuation: Due to its unique positioning, ADSL shall ride the high
growth in the RIMS and solution market. This coupled with the sustainability of
Price chart
its margins will help it to grow its earnings at a CAGR of 19.6% (on adjusted
875 earnings basis) over FY2009-11. Considering its 19.6% earnings CAGR and healthy
750 return ratios, ADSL seems to be trading at attractive valuations of 7x FY2010
625 earnings estimate and 5.9x FY2011 earnings estimate. We initiate coverage on
500 ADSL with a Buy recommendation and price target of Rs532 (at 6x FY2011 EV/
375 EBITDA multiple). Our target price implies FY2011 PE multiple of 8.3x, which is
250 at ~30% discount to its average multiple of 11.6x since its listing in July 2007.
125
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Aug-09

Key financials FY2007 FY2008 FY2009 FY2010E FY2011E

Net sales (Rs crore) 156.0 297.4 525.1 658.7 769.2
Adjusted net profit (Rs crore) 22.9 43.6 81.3 98.3 116.2
Price performance No of shares (crore) 1.3 1.7 1.8 1.8 1.8
EPS (Rs) 18.0 25.2 44.9 54.3 64.1
(%) 1m 3m 6m 12m % y-o-y growth rate 40.3 78.1 20.9 18.2
PER(x) 21.1 15.0 8.4 7.0 5.9
Absolute 32.2 27.9 34.5 -50.8 Price/BV(x) 11.2 3.6 2.0 1.5 1.2
Relative 13.2 -5.3 -20.3 -52.7 EV/EBITDA(x) 14.8 10.1 6.8 5.4 4.7
to Sensex RoCE(%) 64.0 47.3 31.8 26.3 26.0
RoNW(%) 54.7 36.3 31.3 26.1 24.0

Sharekhan Ltd
A-206, Phoenix House, 2nd Floor, Senapati Bapat Marg, Lower Parel, Mumbai - 400013, India.
 stock ideas Allied Digital Services

Company background FY2009. The company operates through two strategic

Founded in 1995 ADSL is an information technology (IT)
infrastructure management and technical support services
outsourcing company. It currently operates in 132 locations
with an employee base of ~3,000 employees. It has over
two decades of experience in technology and enterprise IT
infrastructure implementation, management and consulting
on complex IT and business systems. ADSL went public in
July 2007.
business units (SBUs): IT service (consists of onsite
infrastructure management service [IMS] and technical
business process outsourcing [BPO]) and remote managed
service. In the IT service division, ADSL provides services
such as test and repair/service centre, technical BPO,
incident based support, annual maintenance contract,
onsite infrastructure services, enterprise management
services and infrastructure/professional services.

Business segments  NOC/SOC services in RIMS—a key differentiator: ADSL

Solution
The solution business accounted for 52.8% of the
consolidated top line with an earnings before interest and
tax (EBIT) margin of 30.6% in FY2009. In the solution
segment, ADSL carries out system integration and sets up
complete IT infrastructure for its clients on a turnkey basis.
ADSL designs the operating infrastructure on which
enterprise wide applications, such as enterprise resource
planning (ERP), supply chain management (SCM) and
customer resource management (CRM), run. It has
frequently won complex consulting and system integration
(SI) projects for large Indian companies despite competition
from prominent Indian and global vendors. The company
has joined hands with global technology companies, such
as HP, IBM, Microsoft and Echelon, to provide these
solutions. In this segment, the company is shifting its focus
from low-margin traditional SI services, which consist of
higher hardware sales, to high-margin consultancy-based
services. In view of the company’s highly competitive
solution business and focus on the high-margin consulting
business, we have considered only 10% compounded annual
growth in the solution business for the period FY2009-11.
Services
The service segment accounted for 47.2% of ADSL’s
consolidated revenues with an EBIT margin of 68.5% in
launched its remote management services through a
network operating centre (NOC) in FY2008. The NOC
monitors the critical functions of infrastructure on a 24x7
basis and provides faster solutions to common problems.
In terms of security operation centre (SOC), ADSL is the
first company to start SOC services in the RIMS space in
India. In the SOC, ADSL provides proactive protection and
risk management for enterprise security on a 24x7 basis.
The SOC facility has state-of-the-art physical security
systems ranging from biometric access control, closed
circuit TV, fire detection to suppression systems. ADSL has
tied up with one of the leading commercial SOC players in
Singapore, e-Cop, and is exploring exclusive go-to-market
strategy with the company.
The NOC and SOC were initially started with a joint
capacity of 50 seats (30 seats in NOC and 20 seats in
SOC). The capacity was later expanded to 150 seats.
ADSL charges USD800 per month to monitor one device.
At the same time, one seat can handle several devices
simultaneously. The EGSL acquisition would also enable
ADSL to leverage its NOC and SOC capabilities. We
believe the NOC and SOC service centres are the key
differentiator for ADSL and are likely to remain a prime
growth driver in future. Hence, we expect the service
business’ revenues to grow at a compounded annual
growth rate (CAGR) of 32.4% over FY2009-11.

Offering Clients Partnership

Solutions
IT solutions BPCL, NIIT, HPCL, Micro Inks, Deloitte HP, IBM, Microsoft, Novell, Ericom,
EMC, Symatec
Networking solutions SBI, GAIL, Reliance, Holcim, Cipla, Cisco, Nortel, Enterasys, Callup, Avaya
Pfizer, Tata Indicom, BSNL
Integrated solutions Gujarat Ambuja, MTNL, Cipla, GE Securities, Echelon,
Reliance Retail Quantum Automation, Cisco
Software solutions Plainburgh, Bhawan Group, IMAS Epicor, IMAS, Red Hat
Services
Onsite IMS Raymond's, M&M, IBM, Tata Power, Bajaj Auto, Global Services, Unisys, EDS
Maruti Suzuki, Kingfisher, OTIS, Reliance
Remote managed services ICICI, Reliance, McDonalds, e-corp, HP, LANDesk
Micro Inks, Emerson
Technical BPO Dell, BT, Reuters, Nokia (through Unisys), Unisys, IBM, EDS, Fujitsu, Siemens
Allied Telesyn

Sharekhan 2 August 2009

 stock ideas Allied Digital Services

Investment arguments Large deals/alliances and healthy order book, the

Well placed in high growing niche RIMS market next growth drivers
ADSL is a leading player in the RIMS market. It has uniquely ADSL is believed to be close to signing an agreement with
positioned itself in this space with its NOC and SOC. Due one of the leading PC server manufacturers to offer its
to its unique position ADSL is likely to be the key beneficiary services as a bundled offering to the original equipment
of the high growth to be seen in the RIMS market in the manufacturer (OEM) clientele. Such deals can potentially
years ahead. bring in substantial incremental revenues and act as the
next growth driver for the company.
According to a McKinsey-Nasscom report, the global RIMS
market stood at USD96-104 billion in 2008. Out of this only The bundled services to the OEM would be initially offered
~7% (USD6-7 billion) was outsourced globally. In the global in the USA and would be rolled out in the other continents
RIMS outsourcing market, India’s market share stood at as well in the next few quarters. Apart from this, ADSL
USD3.6 billion in the same year. The report suggested that currently has a healthy order book of Rs230 crore (solution
the RIMS market is likely to grow very rapidly over the business: Rs80 crore and service business: Rs150 crore),
next five years due to cost rationalisation by corporates, which has improved the visibility of its future revenues.
telecommunications (telecom) and technology Hence, we believe the ramp-up of the recently won deal
advancement, and increasing complexities of IT systems. and the execution of the order book would drive ADSL’s
The report also suggested that ~70-75% of the RIMS can be growth in the years ahead.
outsourced. On the back of these grow drivers, the business
of outsourcing RIMS is expected to grow at over 30% CAGR Margins are sustainable
to USD26-28 billion globally and to USD13-15 billion in India Going forward, ADSL’s margins are sustainable in future in
by 2013. Hence, due to its unique position in this space spite of the highly competitive environment that it operates
ADSL is likely to benefit the most from the high growth in. We have factored in a margin improvement of 150 basis
expected in the RIMS market. points for FY2009-11 to be achieved on the back of: (i) a
EGSL acquisition improves geographical reach higher proportion of revenues from the high-margin service
segment (driven by the NOC and SOC businesses); (ii) an
In July 2008, ADSL acquired an 80.5% stake in EGSL for
improvement in EGSL’s margin as more work gets shifted
~USD24 million (total equity valuation ~USD30 million). EGSL
is an IT infrastructure service provider and was a carved- offshore; (iii) its conscious efforts to reduce its dependence
out subsidiary of En Pointe Technologies (ENPT), a Nasdaq- on the onsite employees; and (iv) cost efficiencies.
listed company with revenues of USD340 million. The Revenue mix
transaction was done through a combination of cash and 100.0%
equity swap. ADSL made an upfront payment of USD10 21% 19% 20% 21%
80.0%
million and issued 745,000 equity shares of ADSL to ENPT. 47% 54% 56%
Besides, ADSL made an additional cash infusion of USD10 60.0%
million in EGSL.
40.0% 76% 80% 79% 79%
At the time of acquisition, EGSL had contracted revenues 53%
20.0% 46% 44%
of USD40 million from 32 clients (of which 11 were Fortune
1,000 companies). These contracted revenues have now 0.0%
increased sharply to USD60-62 million, thereby improving FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010E FY 2011E
the visibility of the revenues from the business, going Solution Services

forward. The acquisition has strengthened the opportunity Revenues and OPM trend
pipeline for the company in the US market for its remote
900 22.5%
service offerings (NOC and SOC). EGSL will receive ongoing 800 22.0%
marketing and business support from ENPT. ENPT has a 700 21.5%
21.0%
strong sales team, a wide reach and credibility established 600
20.5%
Rs (cr)

over the last 15 years of operations in the US market as 500

20.0%
400
well as an established presence across 44 states of the 19.5%
300 19.0%
USA with a client base that includes several Fortune 1,000 200 18.5%
corporates across the banking, financial services and 100 18.0%
insurance, healthcare, retail, manufacturing, aviation and 0 17.5%
FY 2006 FY 2007 FY 2008 FY 2009 FY 2010E FY 2011E
transportation sectors.
Revenues OPM (%)

Sharekhan 3 August 2009

 stock ideas Allied Digital Services

Key concerns healthy return ratios, ADSL seems to be trading at

Stiff competition in solution business attractive valuations of 7x FY2010 earnings estimate and
5.9x FY2011 earnings estimate. We initiate coverage on
ADSL may face stiff competition in its solution business
ADSL with a Buy recommendation and price target of Rs532
(which accounted for ~53% of its total revenues in FY2009)
(at 6x FY2011 EV/EBITDA multiple). Our target price implies
from the big players such as Tata Consultancy Services
FY2011 price/earnings (PE) multiple of 8.3x, which is at
(TCS), Wipro and HCL Technologies. This may affect its
~30% discount to its average multiple of 11.6x since its
growth momentum, going forward.
listing in July 2007.
High debtors days
Financials
The SI business generally has higher debtor days. ADSL
Profit & Loss statement Rs (cr)
has higher debtor days due to the higher revenue
Particulars FY07 FY08 FY09 FY10E FY11E
contribution from the solution business in FY2009. ADSL’s
Net sales 156.0 297.4 525.1 658.7 769.2
debtor days stood at 175 days (on a stand-alone basis) and
Operating expenses 123.0 231.8 423.5 529.2 609.0
at 140 days (on a consolidated basis) in FY2009. However,
EBITDA 33.0 65.5 101.6 129.5 160.2
we highlight that the company is now focusing more on the
Other income 0.2 3.8 7.0 5.0 5.5
service business as against the traditional solution Interest 1.1 1.4 4.8 5.8 7.7
business. Furthermore, even in the solution business, the Depreciation 0.9 3.3 5.0 8.8 12.8
company is now focusing on consulting services as against PBT 31.2 64.7 98.7 119.9 145.3
on hardware component sales (its earlier focus). This should Tax 8.3 21.1 17.5 21.6 29.1
reduce its debtor days going forward. In view of the PAT before exceptional 22.9 43.6 81.3 98.3 116.2
declining share of revenues from the solution business in Exceptional items 0.0 0.0 1.7 0.0 0.0
the total revenues and the improvement in the business RPAT 22.9 43.6 79.6 98.3 116.2
environment, we expect the company’s working capital Balance Sheet Rs (cr)
cycle to improve going forward.
Particulars FY07 FY08 FY09 FY10E FY11E
Integration of acquisition Share capital 12.8 17.3 18.1 18.1 18.1
Reserves & surplus 45.9 163.7 309.4 407.7 523.9
To fill up its service gaps and maintain its high growth
Net worth 58.7 181.0 327.5 425.8 542.0
trajectory, ADSL may go for further acquisitions. This may
Total debt 8.0 15.7 83.0 83.0 83.0
pose integration risk. We have already seen the impact of
Capital employed 66.7 196.7 410.5 508.8 625.0
the integration of the EGSL acquisition on ADSL’s margin Goodwill 0.0 0.0 110.0 110.0 110.0
in FY2009, though the company is currently working on Net fixed assets 6.7 16.2 33.8 53.4 73.7
offshoring EGSL’s work, which should improve EGSL’s Capital WIP 3.7 4.0 4.0 4.0 4.0
margins going forward. Furthermore, EGSL derives its Investments 2.9 47.5 25.0 25.0 25.0
revenues from the US geography. Hence, any protracted Deferred tax assets 0.5 0.0 0.0 0.0 0.0
recovery in the US economy may affect ADSL’s revenue Net current assets 52.9 129.1 237.4 316.1 412.0
growth. Capital deployed 66.7 196.7 410.5 508.8 625.0

Valuation and view Key ratios(%)

Due to its unique positioning ADSL shall ride the high growth Particulars FY07 FY08 FY09 FY10E FY11E

in the RIMS and solution market. This coupled with the OPM(%) 21.2 22.0 19.4 19.7 20.8
sustainability of its margins will help it to grow its earnings NPM(%) 14.7 14.6 15.5 14.9 15.1
at a CAGR of 19.6% (on adjusted earnings basis) over RoCE(%) 64.0 47.3 31.8 26.3 26.0
FY2009-11. Considering its 19.6% earnings CAGR and RoNW(%) 54.7 36.3 31.3 26.1 24.0

Sharekhan 4 August 2009

 stock ideas Allied Digital Services

ADSL’s current one-year forward multiple vs Historical average One-year forward EV/EBITDA
since its listing
1000 14x

20.0 800 11x

600 8x
Average 11.6x
400
10.0 5x
200

Jul-07

Jul-08

Jul-09
0.0

Jan-08

Jan-09
Oct-07

Oct-08
Apr-08

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Jul-07

Jul-08

Jul-09
Jan-08

Jan-09
Oct-07

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Apr-09

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Sharekhan 5 August 2009