IT services to drive growth…BUY Sonata Software with a Target of Rs 198/-



Sonata Software a ~Rs 1570 crore market cap mid-sized IT player focuses on three verticals: Travel, Retail & Consumer Packaged Goods and Independent Software Vendor (ISV).  In Q1FY16 34% of revenues come from the products of the ISV vertical, about 32% from the Travel and 16% from Retail and CPG.


Travel is the largest vertical, this business grew 23% in FY15 and the company offers a variety of solutions like Business Intelligence, Mobility Solutions, Omni-Channel Commerce, etc. The acquisition of Rezopia further strengthened Sonata’s position in cloud-based offerings for tour operators and online travel companies


Independent Software Vendors (ISV), the product engineering business is where Sonata has a strong presene with marquee clients, which include leading global ISVs in Enterprise Applications space (Microsoft). The company provides various services involved in Offshore Product Development and Engineering. Sonata is seeing traction in enabling enterprise software product companies to evolve into cloud-based SaaS & PaaS models. Apart from Product Engine

In the Retail vertical Sonata specializes  in Omni-Channel Commerce, Mobility and Analytics for retailers. Sonata has a track record of powering brick-and-click- led business transformation initiatives for some of the most well-known Retail enterprises across the globe.


Investment Rationale

Services business emerges as the key driver:


IT services is about 81% of PAT while only 36% of revenues, the higher EBITDA margins of around 21% in FY15 make this the deal doer or breaker going ahead.  The expectation is that revenues will grow at 13-14% for this vertical, the management has guided for a goal to double revenues from this vertical over the next four years.


Sonata specialises in implementation of select ERP solutions (Microsoft Dynamics AX, Hybris). Sonata also offers specialised solutions for Omni-Channel Commerce, Mobility catering to focused verticals (Travel, Retail/CPG).


Better client mining and cross-selling going ahead:


Sonata has a strong presence in several niche segments, and now with the acquisition of Rezopia and Halosys the company will expand into Cloud and Mobility solutions for Travel and Retail verticals. Company has also seen steady traction in IMS and Testing Services. The service mix and cross selling initiatives is likely to expand and enable improvement in client mining and aid in revenue stability. Currently Top 10 clients contribute 72% of total revenues and grew at 19.5% in FY15.


Re-Selling Business Contributes Solidly 

In the meantime the re-selling of Products and Licenses of Microsoft/Oracle/SAP in India continues to chug along.  While margins are thin it has very low capital employed and a negative working capital cycle and hence enjoys high ROE, and hence the company will continue to operate in this segment as it is a steady contributor to revenues.


Management Restructuring 


Sonata Software had seen major internal management restructuring in FY12. Mr Srikar who took charge in FY12 as CEO has undertaken several measures to revive growth. The first major restructuring on the operations front was the exit from TUI JV in October 2012, the JV was making losses at the net level in FY12. Sonata Software’s exit from the JV has helped improve the overall profitability. This was visible with the steep improvement in consolidated PAT in FY13. TUI Travel continues to remain a large client for the company.


 Valuation and risks: Q1FY16 was fairly modest, IT services revenues were flat on a sequential basis, the company has also guided for a soft Q2 due to  a large ISV account.  Keeping that in mind the revenue growth for this year is going to be lower but at the same time IT services business will soon take centre stage as deal sizes get larger. The recent correction also saw the stock come off a fair bit the weakness of a top client has weighed down on the stock, and while this may prove to be a drag in the near term consider the net cash of the company Rs 2.2 bn on balance sheet and their superior return ratios.  Assuming a FY17E EPS of Rs 18 and giving the stock a modest 11PE I would recommend a BUY in this stock with a target price of Rs 198/-



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