EQUITY RESEARCH: Birla Soft Ltd.

Birlasoft Ltd is an India-based corporation, that is engaged in supplying IT services, consulting, and business solutions. The Company provides various services, which incorporates digital and organisation technology and offerings. Its digital offerings include data analytics, connected merchandise, intelligence automation, linked products, cloud, and blockchain. Its business enterprise technologies and offerings encompass customer relationship management, manufacturing, execution structures, product lifecycle management, supply chain management, IT transformation, applications control, testing, infrastructure and cloud technology. Its solutions encompass intelliAsset, TruView agreement lifecycle management (CLM), TruLens, Supplier Risk Rader, submission automation, and AKOYA. It serves diverse industries, which consist of automotive, banking, production, capital markets, coverage, media and entertainment, power and resources, life science and healthcare and utilities.

Birla Soft Ltd.

SHAREHOLDING PATTERN:

Mr. Angan Guha, Chief Executive Officer and Managing Director, Birlasoft, said, “We have delivered a robust operating performance during the quarter on both the revenue and margin fronts. I am pleased to note that our quarterly revenue has crossed the $150 million mark for the first time, increasing 3.1% sequentially to $153.6 million during Q1FY24. Our growth performance during the quarter reflects our sharp focus on execution during a period that has been characterized by a high degree of macroeconomic uncertainty. We continue to strengthen our tech capabilities and have been early adopters of new technologies such as Generative AI where we have already developed multiple solutions. Our revenue during the quarter under review grew 9.4% year-on-year and 3.0% quarter-on-quarter to Rs 12,628 million, while the EBITDA margin expanded about 170 basis points to 15.3%. At the same time, we continued to generate strong cash flows with a quarterly collection of $153.7 million during Q1FY24, which is the third instance of quarterly collections crossing the $ 150M mark in the last five quarters. We continue to prioritize financial discipline and operational efficiency as we navigate through the prevailing uncertain market conditions,"

KEY FEATURES:

Robust order book brings strong earning visibility

Birlasoft closed transactions of $146 million in the first quarter of FY24, suggesting a healthy pipeline for upcoming engagements. TCV was $80 million, down 29% year over year and 30% quarter over quarter as contract closings were postponed from Q1 to Q2. Wins on renewal deals totaled US$ 66 million, a 10% YoY and 62% QoQ decline. Birlasoft has a better deal velocity than its more powerful competitors Zensar, Persistent, and LTIMindtree, with a total book-to-bill ratio of 1.7x as opposed to rivals with a range of 1x to 1.6x.

As a result of efficient client mining, the company's revenue contribution from its Top-5, Top-10, and Top-20 customers increased from 30.5%, 44.4%, and 60.4% in Q1FY22 to 33.3%, 49.6%, and 63.9% in Q1FY24. With committed initiatives from the company to drive growth in the medium term, contract wins for the company are anticipated to continue to be strong going forward. Future development of the IT industry as a whole, particularly Birlasoft, is anticipated to be impacted by the current challenges of macrouncertainty, rising inflation, and supply chain disruptions. The company's top 40 concentrated accounts, which account for around 75% of its income, have been the focus of increasing service lines. Going forward, the business anticipates reporting US$ 200 mn in registrations per quarter.

Birlasoft’s BFSI segment could perform sub-par growth going forward but greater push expected soon

In comparison to its competitors, Birlasoft generates the least amount of revenue from the BFSI sector (20.7% of revenue in Q1FY24), whereas that of its rivals ranges from 30% to 60%. The decreased mix has also lessened the effects of a BFSI vertical performance that has lagged below rivals historically. In contrast to Birlasoft, which is behind with a 10% revenue CAGR over the past three years, peers have experienced growth that has ranged from 10 to 30% CAGR.

Absent any exposure to the mortgage industry, Birlasoft has a strong deal pipeline. Lending, cards and payments, cybersecurity, and GRC services make up the company's BFSI portfolio. The company has no exposure to regional US banks. Since transaction flow has already begun to reflect this, we anticipate that the leadership transition will increase the BFSI vertical's exposure and reduce its risk from having a high customer concentration.

With a change in leadership and the appointment of new P&L heads across verticals, Birlasoft has started an organizational and cultural reform effort. The company just hired 25 executives from outside the organization and promoted 25 leaders from within, and >90% of the renovation is finished.

Strategic alliance with various partners and ties up with Microsoft to establish Generative AI CoE to widen its service offerings

To expand the range of its service offerings, Birlasoft has formed strategic alliances with a number of commercial partners. Microsoft, Oracle, JD Edwards, SAP, Infor, AWS, Google, Salesforce, and other companies are some of the company's major partners. Microsoft Gold Certified Partner Birlasoft has expertise across a number of technology domains, including Microsoft Dynamics Partner for Enterprise Solution Implementation and Microsoft Azure Cloud, among others. In order to land long-term transformational business, the organization is expanding its connections and relationships with diverse platform suppliers.

With 20 specializations and five advanced specialization offerings, Birlasoft is an Oracle Platinum partner. In the Oracle partner network, Oracle Platinum is the highest tiering. Birlasoft's Oracle practice was valued at US$150 million each year, including the cloud component, and Oracle Platinum partners get priority access to the company's internal development teams and executives. It has more Oracle knowledge than some more significant competitors, including KPMG and HCL Tech. Oracle has 90% ERP and 10% HCM products in its portfolio. (HCM: Human Capital Management, ERP: Enterprise Resource Planning)

Margins are expected to rise going forward

Margin improvement may be seen in H2FY24 due to lower supply side issues, moderated attrition, an improving business mix as BFSI may outperform other industry sectors, a rebound in the Life Science margin, and future cost reductions in other costs, S&GA, and subcontracting. The business is upbeat and anticipates reporting an EBITDA margin of 16%. For fiscal years 24 and 25, we forecast EBITDA margins of 15.5% and 16%, respectively.

Strong fundamentals led by healthy debt protection metrics and liquidity

• Birlasoft's financial profile is still robust, with consistent earnings, a sizable net worth, high liquidity thanks to sizable cash reserves, a sound capital structure, and favorable coverage ratios. In FY23, the company recorded a 16.1% YoY increase in consolidated sales to Rs 4795 crore.
• Over the previous three years, the company has had significant and consistent growth in revenue and profit, with a CAGR of 13.4% for revenue and 26% for PAT. Over the period of FY23 to FY25E, the company may report revenue and PAT CAGRs of 12% and 22%, respectively.
• Birlasoft kept a healthy amount of cash and liquidity on hand. As of June 30, 2023, cash and equivalents were at Rs 1312 crore compared to Rs 1117 crore (net of borrowings) on March 31, 2023.
• Since Birlasoft has no significant medium-term intentions for debt-financed expansion, its solid capital structure and debt-free status will continue to exist.
• Over the past 16 years, Birlasoft has always been generous with its dividend declarations. For FY23, the business advised shareholders to receive a dividend of Rs 3.5 per share. In FY24E/FY25E, respectively, we anticipate paying shareholders a dividend of Rs. 5.5/6.5 per share.
• The company may experience increased profitability and stronger return ratios in the future as a result of cost-cutting measures; we anticipate RoE to be 21.5% in FY24E and 25.5% in FY25E, respectively.

KEY CONCERNS

• The strengthening of the Indian rupee against the US dollar and the euro, price pressure, the retention of skilled workers, rigorous immigration rules or new local legislation, and an increase in visa costs are the main issues.
• The expansion of revenue and profitability for Birlasoft are anticipated to be directly impacted by pricing pressure, transaction re-negotiations, deferrals, talent retention, etc. in a highly competitive market.
• In Q1FY24, the US accounted for 84% of Birlasoft's sales and Europe for 10%. This puts the business at risk from regulatory changes like restrictions on H1B visas, economic slowdown, and clients' conservative approach to IT spending in these locations. Its business may be impacted by any geopolitical risk or economic unpredictability.
• The company faces a risk from client concentration because the top five, ten, and twenty clients each contributed 33.3%, 49.6%, and 63.9% of revenue in the first quarter of FY24, respectively. However, the business's long-standing connections with its most important clients help to some extent reduce this risk.
• More than 85% of the revenue in Q1FY24 was contributed by the manufacturing, BFSI, and healthcare segments. Future revenue generation for these segments may be further impacted if spending continues to decline.
• Birlasoft's pricing and negotiating power with customers are constrained by the fierce competition it encounters from established tier-2 and tier-1 IT businesses. Additionally, the low-margin distribution company's trading nature can hurt profits.
• The sustainability and scalability of such clients may be impacted by any modification to the contract conditions from large clients, such as non-renewal of contracts or increased discounts as a result of severe competition intensity.
• Invacare and Birlasoft agreed to a multi-year, $240 million contract in October 2019 for Birlasoft to supply IT services to the company that makes wheelchairs, bariatric equipment, mobility scooters, and respiratory products. Ten years were supposed to pass after the agreement was made. Invacare did, however, file for bankruptcy in February 2023. Birlasoft will get US$2 million under the settlement agreement for disengagement services that cease on May 31. The payment is important because Birlasoft's December quarter loss was caused by Invacare's insolvency. The IT services company has set aside Rs 151 crore as a reserve for possible unpaid receivables and contract assets. Furthermore, any unfavorable client behavior could affect revenue creation and raise future receivables.
• Debt-financed capital expenditures or acquisitions that are more than anticipated could have an adverse effect on cash flow creation.

CONCALL NOTES- AUG 24

Financial Performance:

• Q1 FY24 saw a strong start for Birlasoft, with robust performance in revenue and margins.
• Quarterly revenue crossed $150 million in dollar terms, a 3.1% increase QoQ.
• EBITDA margin expanded by 170 basis points QoQ to 15.3%.
• Birlasoft signed TCV of $146 million in deals, with a healthy pipeline for future engagements.

Partnerships and Collaborations:

• The company established a Generative AI Centre of Excellence in collaboration with Microsoft, training 500 consultants on Generative AI technologies.
• Birlasoft will continue its strategic partnership with Microsoft and explore relationships with other hyperscalers.

Industry Focus:

• Revenues from Lifesciences doubled due to reclassification and the conclusion of disengagement services with Invacare.
• Financial services and lifesciences are expected to drive exponential growth in the verticals.
• Birlasoft will focus on digital, data, infrastructure, and ERP service lines for future growth.

Business Outlook:

• The demand environment is uncertain, but the company remains cautiously optimistic about business growth and margin expansion.
• Birlasoft plans to give salary hikes starting September 1st, with an aim to maintain or improve margins.
• The company will continue to execute well and deliver sustainable QoQ performance.

Employee Growth and Development:

• The company's long-term incentive program is linked to performance-driven metrics.
• Headcount has increased, and Birlasoft plans to hire more employees in the future.

Overall, Birlasoft had a strong start in Q1 FY24, with increased revenue and margins. They are focused on partnerships, industry growth, and employee development. Despite the uncertain demand environment, the company remains cautiously optimistic about future growth and aims to maintain or improve margins.

FINANCIALS:

Q1FY24 FINANCIAL

• Despite the challenging climate, Birlasoft's results exceeded expectations. However, revenue and earnings for the quarter included US$ 2 mn in compensation for the disengagement of Birlasoft Solutions Inc. and Invacare.
• In Q1FY24, revenue increased by 3% QoQ and 9.4% YoY to Rs 1262.8 crore. Revenue increased by 3.1% QoQ, 3.4% YoY, and 2.7% QoQ in constant currency to reach US$ 153.6 million.
• EBITDA increased by 15.7% QoQ and 13.7% YoY to Rs 193 crore, and EBIT increased by 17.6% QoQ and 14.4% YoY to Rs 171.7 crore. The Q1FY24 EBIT margin was Rs 13.6% compared to 11.9% QoQ and 13% QoQ23.
• In Q1FY24, the company's net profit increased by 22.6% QoQ and 13.9% YoY to Rs 137.5 crore, while its net profit margin was 10.9%, down from 10.5% in Q1FY23 and 9.1% in Q4FY23.
• The number of employees at Birlasoft has risen to 12,235, and more recruiting is expected in the upcoming quarters. Additionally, the company's TTM attrition rate for the quarter was 18.8%.

Other operating highlights

• Growth during Q1FY24 was driven by BFSI and Manufacturing among verticals, and by both emerging tech and enterprise solutions including Infrastructure and ERP, among service lines
  • Digital & Cloud up 16.4% YoY
  • Top clients led growth during the quarter: Revenue from Top 5, Top 10, and Top 20 clients grew YoY by 12.2%, 8.9%, and 4.6% respectively
• Signed deals of TCV $ 146 M during the quarter: TCV new deal wins of $ 80 M and renewals of $ 66 M
• Active Client Count at 285 in Q1, reflecting an intent to rationalize the ‘tail’
  o > $ 1 M customers at 86, up by 4 YoY
  o > $ 5 M customers at 27, up by 2 YoY
• Cash and cash equivalents rose to $ 160.0 M by the end of Q1 FY24 versus $ 137.3 M at the end of Q4 FY23. In rupee terms, cash and cash equivalents increased to ₹13,123 M at the end of Q1FY24 from ₹ 11,278 M at the end of the preceding quarter.
• DSO is stable at 53 days, reflecting the quality of services being delivered to customers.
• Workforce strength increases to 12,235 as of 30th June 2023, and attrition improves further to 18.8% during Q1FY24 (from 22.1% a quarter ago and 27.9% a year ago)
• Birlasoft is establishing a Generative AI Centre of Excellence, in collaboration with Microsoft. This strategic initiative aims to accelerate value creation and foster innovation in the adoption of Generative AI, to deliver cutting‐edge enterprise solutions across industries.

VALUATION 

Prominent midcap IT provider, Birlasoft Ltd, specializes in delivering a comprehensive spectrum of IT services and products. Its service portfolio encompasses ERP, data & analytics, and a strong commitment to offering enterprise and digital solutions. Birlasoft's strategic focus centers on four key verticals: manufacturing, E&U (Energy and Utilities), BFSI, and healthcare.

In January 2019, the engineering division of KPIT Technologies was demerged from its IT services division and merged with Birlasoft. Since then, Birlasoft has made a concerted effort to bolster its leadership, streamline low-impact accounts, and extend the duration of existing engagements by promoting cross-selling opportunities.

During the first quarter of FY24, Birlasoft successfully executed transactions totaling $146 million, a testament to its robust pipeline of forthcoming projects. The Total Contract Value (TCV) reached $80 million, registering a 29% year-over-year decline and a 30% quarter-over-quarter decrease, primarily due to delays in contract closures from Q1 to Q2. Renewal deal wins amounted to US$ 66 million, reflecting a 10% year-on-year decrease and a significant 62% quarter-on-quarter drop. Birlasoft's top 40 priority accounts, contributing approximately 75% of the revenue, are at the forefront of the company's strategy, as they are central to expanding service offerings. The company foresees reporting US$ 200 million in quarterly bookings in the future.

Birlasoft has made remarkable strides in digital transformation, cloud adoption, and virtual engagement. The company's core focus remains on strengthening relationships with its key clientele and strategic partners, implementing a vertical sales structure, optimizing core and ancillary services, accelerating contract wins, and fostering cross-selling and up-selling incentives. Management changes, organizational restructuring, and the appointment of new vertical leaders may pave the way for a resurgence in growth momentum. The new CEO has appointed leaders with a specialized focus on specific industry sectors and geographic regions. For FY24E and FY25E, the company is expected to achieve sales growth of 7% and 13%, respectively.

As a member of the CK Birla Group, Birlasoft has a storied history of providing IT services, a diverse service portfolio, and robust customer and partner relationships. The company's revenue visibility in the medium term is underpinned by its potential for growth in digital and cloud infrastructure services, a heightened emphasis on developing critical business verticals through a micro-vertical approach, and a concentrated effort to augment contributions from top-tier clients. Notably, a temporary impact on margins is expected as Birlasoft initiates salary increases beginning on September 1st. We recommend a BUY position, with a target price of 597.

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