Polaris BUY. Virtusa acquires majority in Polaris. Institutional Equity Research. November 05, Target Price Rs220. IT India.

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1 CMP* (Rs) 204 Market Cap. (Rs bn) 20 Free Float (%) 71 Shares O/S (mn) 100 Polaris Virtusa acquires majority in Polaris Virtusa Corp has purchased promoter and Citi s stake in Polaris of 53% for Rs220 per share with an open offer to increase its holding to 75%, as had been speculated in the media earlier. Polaris metrics vs. Virtusa (Exhibit: 2) such as lower revenueper-employee, similar offshore structure, lower op. margins, cross sell opportunities into Virtusa s base are opportunities; however the extent of spending rationalisation by Polaris top account is a key risk. Virtusa plans to continue operating Polaris as a separate listed entity and expects combined synergy benefits of US$100mn over 3 years. Stock price may be volatile in anticipation of increase in open offer tender price due to the limited stock premium over CMP, relative valuation differential and synergy benefits; we maintain with Target Price of Rs220. Acquisition at Rs220.7 per share Virtusa Corp., US-based IT services company has entered into share purchase agreement to purchase 53% in Polaris for Rs per share (8.3% premium over CMP of Rs204) from the promoter entities and Orbitech Pvt. Ltd (Citigroup entity). This deal will trigger an open offer and Virtusa will make an open offer for additional 26% shares. The deal may be an enabler for Polaris to expand its presence in key markets as well as engage in larger contracts; Virtusa s BFSI revenue is ~95% of Polaris BFSI revenue with Virtusa s deeper presence in retail & consumer banking as compared to Polaris deeper presence in corporate and investment banking and transaction processing. Share price (%) 1 mth 3 mth 12 mth Absolute performance 9.5 (3.8) 3.7 Relative to Nifty Shareholding Pattern (%) Jun 15 Sep 15 Promoter FII DII Others Year Stock Price Performance Polaris top account to remain strategic, albeit spending cuts ahead Citi is Polaris anchor client and the new Virtusa-Polaris structure will continue to remain preferred vendor for Citi for its IT services global strategy, even as the spend commitments of Citi is likely to reduce as part of productivity savings. We believe that substantial cut in spends by Citi are downside risks to our growth estimates, which can be mitigated by the synergy benefits for Polaris entity. We believe that Polaris slightly lower operating margin, 20% lower revenue-per-employee with similar offshore mix and cross sell opportunities may benefit Polaris ahead. 100 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Note: * CMP as on November 05, 2015 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Outlook and Valuation While the stock price may exhibit volatile swing in anticipation of higher open offer tender price based on the limited premium over CMP, high valuation differential (Polaris trades at ~50% discount to Virtusa s P/E multiples) and potential synergy benefits ahead. We keep our estimates unchanged and maintain with Target Price of Rs220. Key Financials (Rs mn) FY15 FY16E FY17E FY18E Revenue 18,942 20,609 22,565 24,907 EBIT 1,980 2,616 3,274 3,831 Net Profit 1,673 1,962 2,518 2,953 EPS (Rs) DPS (Rs) P/E (x) P/B (x) EV/EBIT RoE (%) Dividend Yield (%) Research Analyst: Apurva Prasad Contact: (022) apurva.prasad@relianceada.com 1

2 Other highlights ff ff Jitin Goyal, CEO of Polaris will take over as President of Virtusa s Global Banking Financial services and Virtusa plans to continue operating Polaris as a separate listed entity. Virtusa expects combined synergy benefits of US$100mn over the next 3 years. Virtusa is a NASDAQ-listed company (US$1.6bn market-cap and US$530mn revenue) with customers among Global-2000 companies and the leading software vendors in banking & financial Services, insurance, telecommunications, technology and media, information & education industries. It s headquartered in Massachusetts, USA and operates in US, Europe, India and SE Asia. 2QFY16 highlights Polaris last week, posted in-line revenue and slightly better operating margins, leading to strong growth in profitability. Revenue stood at US$77.6mn (RSec est. US$77.9mn), 2.3% qoq and Rs5,177mn, 4.4% qoq. EBITDA margin came at 13.5% (RSec est. 13%), +60bp qoq. APAT stood at Rs473mn (RSec est. 434mn). Among geos, Europe led the growth at 7.4% qoq in 2Q. Polaris had 4 wins during the quarter (4 wins in 1Q). Among verticals, retail banking led the growth; corporate banking and treasury & capital markets grew in-line with the company average. Among services, application maintenance continued to drive growth while testing services continued its decline. Employee base stood at 7,648 (343 net adds in 2Q) and attrition stood at 12.98%. Risks to the view ff Unfavourable appreciation in INR is a downside risk to our estimates; we ve factored USD-INR at 65. ff Sharp decline in top account is a downside risk to growth due to its high concentration Exhibit 1: Quarterly Performance Snapshot (Rs mn) 2QFY16 1QFY16 % qoq 2QFY15 % yoy 2QFY16E Var % Revenue (US$mn) (1.4) 77.9 (0) Revenue 5,177 4, , ,056 2 EBITDA EBIT APAT (3.7) EPS (Rs) (4.1) Gross margin (%) EBITDA margin (%) EBIT margin (%) APAT margin (%)

3 Exhibit 2: Virtusa-Polaris metrics Virtusa Polaris Combined Polaris/ Virtusa x Revenue (TTM US$mn) Revenue CGQR % (trail-4qtr) 5.0 (0.3) EBITDA % PAT margin % Segment Revenue Revenue-share by geo (%) - NorthAm Europe RoW Revenue - NorthAm Europe RoW Revenue-share by vertical (%) - BFSI Communications and Tech Media & Information and Other 10 0 Revenue - BFSI Communications and Tech Media & Information and Other Client Metrics Active Clients Revenue/ client (US$ mn) Top-10 Clients % of Revenue Top-10 Clients Revenue Employee Metrics Total Employees 10,364 7,648 18,012 Attrition (%) Utilization (%) Revenue/ employee (US$) 50,830 39,949 46,

4 Exhibit 3: Quarterly Performance (consolidated) (Rs mn) 2QFY16 1QFY16 % qoq 2QFY15 % yoy 1HFY16 1HFY15 % yoy Revenue (US$mn) (1.4) (0.9) Revenue 5,177 4, , ,135 9, Software development expense 3,651 3, , ,167 7, Gross Profit 1,525 1, , ,968 2, SG&A expenses ,630 1, Total operating expense 4,477 4, , ,797 8, EBITDA ,338 1, Depreciation & Amortisation (0.4) (6.3) EBIT ,202 1, Other income (71.5) (76.3) Interest expense MI & Others PBT (0.3) 1,241 1, Tax expense APAT (3.7) (6.0) EPS (Rs) (4.1) (6.5) Gross margin (%) EBITDA margin (%) EBIT margin (%) APAT margin (%) Exhibit 4: Revenue trend US$mn (2) 70 (4) 65 (6) (8) 60 (10) 4QFY13 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 Revenue % qoq (RHS) 4

5 Exhibit 5: EBITDA margin & Utilization trend (%) QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY Utilization (%) (LHS) EBITDA margin (%) (RHS) Exhibit 6: Revenue Mix (%) 1QFY14 2QFY14 3QFY14 4QFY14 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 Revenue by Geography (%) Americas Europe India Rest of World Total Revenue by Vertical Retail Banking Corporate Banking Treasury & Capital Markets Insurance & others Total Revenue by Service-lines Application Maintenance Application Development Testing Others Total

6 Profit & Loss Statement Y/E March (Rs mn) FY14 FY15 FY16E FY17E FY18E Revenue (US$mn) Revenue 24,991 18,942 20,609 22,565 24,907 Software development expense 15,909 13,996 14,603 15,766 17,186 Other expenses 4,542 2,686 3,107 3,204 3,537 Total expense 20,451 16,683 17,710 18,970 20,723 Gross Profit 9,082 4,945 6,006 6,799 7,721 Gross (%) EBITDA 4,540 2,259 2,899 3,594 4,184 EBITDA (%) R&D Expense 1, Depreciation & Amortisation EBIT 2,968 1,980 2,616 3,274 3,831 EBIT (%) Other Income (568) Interest expense PBT 2,389 2,315 2,823 3,596 4,217 Tax expense ,078 1,264 APAT 1,992 1,673 1,962 2,518 2,953 APAT (%) EPS (Rs) Balance Sheet Y/E March (Rs mn) FY14 FY15 FY16E FY17E FY18E Cash & Bank Balance 2,313 1,916 3,452 4,097 5,026 Current Investments 3, Receivables 3,622 2,382 2,654 2,906 3,207 Other current 3,594 4,036 3,317 3,632 4,009 Total Current Assets 13,239 8,439 9,688 10,925 12,563 Fixed Assets 3,787 2,347 2,530 2,770 3,058 Other non-current assets 3,692 2,167 2,257 2,542 2,795 Total Assets 20,719 12,953 14,474 16,237 18,416 Trade Payables 2,421 1,803 1,931 2,079 2,271 Short term borrowings Other current liabilities 2,622 2,602 2,947 3,227 3,562 Long term borrowing Other non-current liabilities Share capital Total Equity 15,474 8,523 9,571 10,907 12,558 Total Liabilities & Equity 20,719 12,953 14,474 16,237 18,416 6

7 Cash Flow Statement Y/E March (Rs mn) FY14 FY15 FY16E FY17E FY18E PAT 1,992 1,673 2,052 2,518 2,953 Depreciation & Amortisation Working capital changes 210 (931) 698 (195) (218) Cash Flow from operations 3, ,179 2,551 3,037 CAPEX (359) (737) (460) (555) (635) Cash Flow from investments (1,770) 219 (640) (723) (806) Changes in borrowings (1,121) (40) Dividend paid (581) (792) (1,005) (1,183) (1,301) Cash Flow from financing (1,719) (747) (1,004) (1,183) (1,301) Cash Flow changes , Opening Cash balance 2,057 2,313 1,916 3,452 4,097 Closing Cash balance 2,281 2,348 3,452 4,097 5,026 Free Cash Flow 3,356 (173) 2,719 1,996 2,402 Key Ratios Y/E March FY14 FY15 FY16E FY17E FY18E Growth (%) US$ Revenue (0.9) (5.6) Revenue 8.3 (24.2) EBITDA 7.0 (50.2) EBIT 13.0 (33.3) APAT (0.8) (16.0) EPS (0.7) (16.3) Ratios BVPS (Rs) RoE (%) RoCE (%) D/E (x) Valuation Ratios (x) P/E P/BV MCap/ Sales EV/ EBIT Dividend Yield (%)

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