Hold Allsec Technologies, target Rs 189: Kotak Sec

Kotak has maintained hold rating on Allsec Technologies with target price of Rs 189.

Kotak Securities research repot on Allsec Technologies

We recently spoke to the management of Allsec to get an update on the business of the company and the recent acquisition in Manila. We also spoke to the management about the impact of the US sub-prime mortgage issues on the operations of the company. While the company has not been impacted directly by sub-prime issues in the US house mortgage industry, changes in Government regulations and the overall credit squeeze has had a bearing on the operations of the company.

We have considered these factors and also made suitable changes to our exchange rate assumptions to arrive at our revised earnings estimates for Allsec. We expect Q2FY08 results to be impacted adversely. After incorporating this, we arrive at an EPS estimate of Rs.9.2 for FY08 and Rs.12.9 for FY09. Based on DCF analysis, we arrive at a price target of Rs.189 for the stock. We note that the company had cash of USD 27 million as of Q1FY08 end, which translates to Rs.69 per share. We had maintained a cautious stance on Allsec in our previous report.

We had recommended a HOLD on the stock in our previous report. Despite the correction in the share price and a 33% upside, we maintain our HOLD recommendation, in view of the impact on the operations of the company. We will review out recommendation and price target once we get more clarity on the extent and duration of the impact. An accelerated slowdown/recession in major user economies and a sharper-thanexpected appreciation in the rupee against major currencies could further impact the company. We have assumed the rupee to appreciate to Rs.39 by FY09 end.

The main takeaways are as under: 

The company is present in the student loan consolidation business. We believe this business contributed about 10% of FY07 revenues. Student loans have been guaranteed by the US Government, thus facilitating the consolidation and selling of portfolios. According to the management, the US Government has recently raised the fees, which have to be paid to the Government by the consolidators. The fees were charged by the Government for facilitating consolidation of loans by making necessary changes in records. We understand that the increase in fees has made consolidation and sale of student loan portfolios unviable for private companies.

This has forced them to curtail business activities, in turn, impacting Allsec. While the new fees came into effect from end of September 2007, companies had already curtailed operations. This has impacted Allsec's Q2FY08 revenues. n On the other hand, the overall credit squeeze has impacted the scale up of CCRT revenues. Based on management's comments and looking at Q1FY08 employee additions (448 net employees - a 21% addition to the previous quarter base), we had assumed a scale up in CCRT revenues. n However, we understand that these scale-up plans have been affected. The scale up from CCRT and new clients is expected to happen in H2FY08. We believe the company has added significant employees on a gross basis in Q2FY08. 

Allsec has entered into an agreement to acquire 100% stake in M/s Kingdom Builders Inc, a company in Philippines engaged in BPO operations. This is in line with its intention of setting up an alternative delivery base in that country. The total cost of acquisition would be around USD 1.5 million of which, 50% is to be paid upfront and the balance on achievement of milestones. Kingdom has a revenue run-rate of about USD 2,50,000 per month and is breaking even. Allsec expects revenues to scale up to USD 5 million in the next year. n The acquisition will give Allsec two senior sales resources in the US in addition to the agent base in Philippines. 

We have not included this transaction in our earnings estimates. n Allsec has taken some currency hedges at levels of around Rs.41.50 per US dollar, which should allow it to negate some of the impact of the rupee appreciation. We do not have further information on the extent of hedges taken by the company. We have made changes to our assumptions of the exchange rate. We have now assumed the rupee to appreciate to Rs.39 per US dollar by FY09 end. 

After considering the above, we have revised our earnings estimates for Allsec downwards.  We now expect revenues to touch Rs.1.43 bn in FY09 end. Revenue growth in FY08 is expected to be impacted because of the factors considered above.  After falling in FY08, we expect EBIDTA margins to recover in FY09, on the back of higher revenues and better utilization levels. Thus, we expect profits in FY08 and FY09 to be Rs.145 million and Rs.203 million, respectively, leading to EPS of Rs.9.2 and 12.9, respectively. We have done our DCF analysis, which leads us to a fair value of Rs.189 for the stock.

Concerns 

Rupee appreciation beyond our assumed levels of Rs.39 per US dollar by FY09 end could provide a downward bias to our earnings estimates. A steep deceleration in major global economies could impact revenue growth of Indian vendors, including Allsec.