Sonata Software – Digital and IP business to drive steady growth
Sonata provides IT services to Industries like Travel, Retail & Distribution, Supply chain management and ISV. Company categorizes its business as International IT Services and Domestic products and services. In terms of verticals, company derives revenue from three verticals i.e., Travel, Retail & Distribution, ISV and Others.
Domestic Products: Company has long relations ship with large IT product developers where it provides product engineering solutions and services. In India, company resells their products to different customers and provides customized services on these platforms. This segment contributes around 68% to the overall revenues and 22% of company’s PAT (FY17). The margins in this business are very low but it is negative working capital cycle business. Company focuses on ROCE of this segment before finalizing any contract. The ROCE for this segment for FY17 stood at 36%. This segment is expected to grow around 7% per year in the coming future.
International IT Services: This segment contributes 32% to the revenues and 78% of PAT (FY17). Under this segment company provides product engineering solutions and enterprise IT solutions. Under the product engineering solutions, it provide services for software product makers like Microsoft, SAP and so on by developing and designing the product. Key focus verticals are Offshore Product engineering for Independent Software vendors (29% of IT services revenues), Travel with focus on Tour operators (27% of IT services revenues) and Retail and CPG (26% of IT services Revenues). Among service offerings, Sonata enjoys strong competence in delivering solutions on Microsoft Dynamics, SAP Hybris. Key clients include Microsoft, TUI Travel, Johnson and Johnson.
Enterprise IT solutions are provided to companies in Industries like Travel, Retail & Distribution and Supply chain management. In last 3 to 4 years company moved to value addition strategy through digital technologies than just automating and process efficiencies to companies. In its key areas like Travel and Retail where it has developed deep domain knowledge over the years, company wants to lead the industries and businesses in digital way. Capital allocation in last three years has been focused on to either develop its own IP (Brick & Click) or to acquire IP (Rezopia, Halosys, IBIC) through inorganic route. In the first half of FY17 company has added 11 new clients.
Digital technologies and IP Lead growth:
Company wants to double its revenues in the next four years in organic route at constant currency rate. This will be mainly lead by new digital investments. Currently digital component – which is different from normal commodity kind of IT services constitutes 30% of the revenues. The recent acquisitions (IBIC and Halosys) will provide immediate growth opportunities for the company. Management is expecting it to reach 40-45% of the revenue in in the next two years. Company is expecting to maintain operating margins at low 20’s.
Aided by expansion in the sales team, Sonata has seen strong new client addition as well. The majority of new client wins are led by Digital Offering (80% of our new clients wins). Sonata’s competency in IP led solutions as well as strengths in its focus areas (Microsoft Dynamicx and SAP Hybris) are also driving new client wins. Over the past two years, company added over 40 new clients. We believe mining the new accounts is the key metric to watch over FY18-FY20 as this would aid in lowering client concentration. Our interaction with the management indicates that Sonata’s initiatives are also focused on the same.
Company is trading at reasonable valuations (9.3x FY19E EPS) and at 30-35% discount to its key peers. Steady revenue growth, robust balance sheet (net cash of Rs3.1bn, ~18% of Mcap) and superior dividend yield (5.5% at CMP) provide attractive entry point and can generate favorable risk adjusted returns.