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Strong play on low code app development and BPM automation
We initiate coverage on Newgen Software Technologies with an ADD rating and a target price of Rs340. Newgen is a low code application development platform company which competes with an ecosystem of global players like Appian, Pegasystems, IBM, OpenText and TIBCO. Newgen is an established player in the markets of Business Process Management (BPM), Enterprise Content Management (ECM) and Customer Communications Management (CCM), which cumulatively represent an addressable market opportunity worth ~$22.5bn growing at 7-10%. We expect revenue, EBITDA and PAT for Newgen to grow at a FY18-FY20 CAGR of 18.5%, 27.7% and 31.9% respectively. Newgen is trading at a valuation of 18x FY20E EPS - elevated working capital, slow decision making In India Government (Smart City) and PSU banking segments and recent INR appreciation are likely to cap the multiple in near-term.
* Newgen participates in large and fast growing market segments. Newgen is a software platform provider which participates in BPM, ECM and CCM segments of the global software industry. ECM, BPM and CCM are large markets with market size of ~US$15bn, US$6.1bn and US$1.5bn respectively in 2017, as per Ovum. Global spends on ECM, BPM and CCM are expected to grow at a CAGR of 7.1%, 8.4% and 10% respectively from 2017 to 2021. The geographies where Newgen has a higher exposure, for example, Asia & Oceania (35.3% of revenues from India and 8.6% from APAC in FY18) and EMEA (32.9% of revenue in 2018), are expected to grow faster than the overall industry across ECM, BPM and CCM.
* Strong Software Product Capabilities. Newgen is one of the few vendors’ globally to be positioned in Gartner's Magic Quadrant's for all four practices of ECM, CCM, iBPMS and BPM-Platform Based Case Management Framework. In addition, Forrester has recognised the company as a "Leader" in 1) Cloud based Dynamic Case Management in Q1 2018, 2) Digital Process Automation Software in Q3 2017, and 3) Enterprise Content Management - Transactional Content Services in Q2 2017. Newgen has differentiated capabilities and market leadership in BPM and ECM market segments though is still referred to as a “niche player” or “strong performer” (as against being a leader) in the smaller market segment of CCM.
Competing successfully against marquee global players. Newgen competes with an established list of global players including Appian, Pegasystems, IBM, OpenText, Oracle, Software AG, TIBCO, Bizagi, Hyland and Kofax. The fact that Newgen regularly competes with and wins against global competition across markets, including the US, speaks to the depth of its product capabilities.
* Strong focus on in-house R&D spends. Newgen has applied for 37 patents globally with five patents already registered in India with another 28 patent applications outstanding in India and four in the US. Focus on R&D is also reflected from the fact that headcount in research and development has increased from 197 in FY15 to around 270 currently with R&D expense having increased from Rs250mn in FY16 to Rs369mn in FY18. Investments in R&D activities constituted 6.6%, 7.2%, 7.3% and 7.2% of total revenues in FY15, FY16, FY17 and FY18 respectively. Though R&D intensity (R&D/Sales) may seem lower than the 13-15% that mature market competitors operate at, Newgen gets the benefit of having access to lower cost engineering resources in India, while its’ pricing compares reasonably well with global competitors across markets.
* Diversified business operations. Newgen had over 520 active customers (invoiced in the last 12 months) in over 60 countries as at the end of FY18, having added 120 new customers in FY18. Likewise, the company has diversified exposure across verticals like Banking, Insurance, Healthcare, Government/PSU and shared services segments though BFSI is the key area of strength for the company having constituted 58% of revenues in FY18. In addition, Sales of product licenses, Annuity based revenues (AMC/Support/SaaS) and Sales of services (Implementation/Scanning) constituted a balanced 27%, 43% and 30% of overall revenue from operations in FY18. Annuity based revenues have grown from being 38.6% of revenues in FY15 to 43% in FY18. The company works with over 300 channel partners which include large SIs like HP, Infosys, Deloitte etc., among others. Customer concentration is also reasonably low for the company with the top 10 customers constituting less than 25% of overall revenues.
* Strong financial performance. Revenue from operations has grown at a CAGR of 18.4% from FY15 to FY18 with growth being 20% in FY18. EBITDA margin was flattish in FY18 at 19% vs 18.7% in FY15 with absolute EBITDA having grown at a CAGR of 19% from FY15 to FY18. Return on average capital employed, excluding cash, was ~20% in FY18. Key issue with respect to financials is that Newgen has very elevated working capital cycle with DSO including unbilled being 158 in FY18. Company’s target is to bring down the DSO to a range of 125-130 days, which would then be in-line with the DSO profile of global players like Appian and Pegasystems. It is important to note that despite a stretched collection cycle, provision for bad debts has been contained at around 1.5-2% of sales over years. OCF generation has also been reasonably healthy at around Rs602mn in FY18 vs reported PAT of Rs729mn.
* Investment View and valuation
Leadership position in fast growing markets, diversified operations and strong Industry analyst recognitions are the key underpinnings of our positive rating on the company. We expect revenue, EBITDA and PAT to grow at a FY18-20E CAGR of 18.5%, 27.7% and 31.9% respectively. Initiate with an ADD rating with a target price of Rs340, which discounts FY20E EPS by 19x. Elevated working capital requirements, high dependence on Q4 to make annual numbers (Q4 typically constitutes 35% of annual revenues and 70-80% of annual EBITDA) and high reliance on new logo acquisition for growth (repeat customers constituted just 77% of revenues in FY18) are likely to cap re-rating beyond our target multiple in our opinion. In the near-term, decision making delays in India Government (Smart City) and PSU banking clients and INR appreciation (~60% of billing is in USD) will need to be closely watched.
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