Investing is both art and science. While the “science” can be taken care of by use of ratios and formulae, it is the “art” part which is actually difficult and challenging. For us, this reality hit harder when we decided to analyse Persistent Systems. This was one company that was not easy to understand. A company that has had a completely different DNA compared to a traditional IT services company and is at an interesting point in its life. It has recently revamped its structure to gear for the next level of growth and is banking heavily on the new age technological trends. In this article we will critically analyse the 4 business verticals of Persistent and examine both the bullish and bearish view points.
Decoding the DNA of Persistent Systems
Before we try to understand what Persistent’s current business model is, it is imperative to understand what it has done till now. Persistent is a midsized IT company based in Pune, India. It was incorporated in 1991 by Dr. Anand Deshpande and Mr. SP Deshpande as a boutique company primarily focused on data base internals. Over the years it chose a radically different path to growth. While all other Indian IT companies focussed on outsourcing of services, Persistent created a name for itself in the “Outsourced Product development” or OPD. It did so with great success- until now.
What is Outsourced Product Development
Outsourced Product Development means outsourcing the development of new software products by Independent Software Vendors (ISVs) to third party vendors like Persistent Systems. Most of these ISVs are the big software product firms like Microsoft, Oracle and IBM. Imagine a company like Microsoft developing a new product. While most of its software will be developed by its internal software development teams (based locally in the US or EU) or in a captive centre in an offshore location like India , a chunk of the development work will go to the third pay vendors like Persistent as an OPD. [Diagram for OPD work split between inhouse, offshore and third party vendors]
While most of the earlier work in OPD involved extension of life span of software products but over time, the focus shifted to new product development. More than 50% of Persistent’s OPD is connected to new product development. The total OPD business addressed in India was around U$ 1.8-2 Billion as per Nasscom
Advantages of OPD to ISVs
- OPD allows ISVs to access large pool of developers at a fraction of cost
- It reduces time-to-market and lowers overall risk of product failure during the development product
- Staffing levels can be quickly adjusted by outsourcing some portion of the development work without adding significant cost
Differences between OPD and Traditional IT Services business
OPD business is very different from a traditional IT services business in three major ways
Firstly, the difference is in the approach. Traditional IT service projects start with well-defined requirements and vendors use time and money as variables to arrive at a reasonable cost estimate for the project. After completion, the project goes into maintenance mode. In OPD projects, requirements are not as clearly defined. The developers are given a fixed date of completion of projects and budgets are frozen. New requirements are identified as the product develops. Since all requirements can’t be incorporated in a single version, most product companies plan multiple versions of the product.
The basic difference of the requirements being a variable in OPD entails a different approach of product development.While most of the traditional projects follow what is called a “waterfall “ model of development with each steps following the previous one, Persistent worked on what is called Agile framework which is a more iterative way of developing the product. In “Agile” time criticality is of paramount importance. Rapid changes in competitors’ offerings and technological landscape lead to new product requirements by customers over a short period of time. This leads to iterative changes to software applications.
Secondly, OPD work entails higher skill sets in software development and requires the vendor to be abreast with major technological changes. This makes OPD inherently a tougher business to be in.
Thirdly, revenues from OPD work are lumpy with low visibility and often volatile. Technological obsolescence is high and client priorities can quickly change with software product development efforts being shut down. This has happened several times in past with Persistent for no fault of theirs. Furthermore, though the vendor does get repeat business due to multiple versions of the product being launched, there is no annuity component to the revenues like it is in the maintenance of IT services projects.
Despite the many challenges in OPD space, persistent thrived all these years. It perfected the art of “Agile” framework of product development using Scaled Agile framework in its working. Persistent positioned itself as a company addressing the full product life cycle.
It works closely with start-ups and leading software product companies which have provided it early insights into emerging technologies. Persistent identified SMAC (social, mobile, analytics and cloud) as an important trend as early as 2008 while the larger players like TCS started talking about it only in 2012. It became a front runner in cloud services with over 600 plus technical experts providing services involving consulting, cloud platform development and deployment, migration and management. It focussed on verticals like financial services, Healthcare, Telecom and Media. This strategy paid rich dividends and its revenues soon multiplied from U$ 10 million in 1999 to over $ 350 million in 2016. However, as Persistent set its sight on being a billion dollar company it was staring at the dark clouds gathering in the OPD space gradually.
Limitations of OPD sector
The OPD landscape has changed dramatically over the past few years. The ISVs seem to have significantly transformed the way they are developing software. Product development now uses a lot more tools, off the shelf modules and automation and requires less human efforts. As a result, the extent of efforts required to develop a piece of software has reduced by as much as 60-80%!
Though Persistent has been able to add new clients and mine the existing, the inherent disadvantages of revenue volatility and limited size of the niche (roughly U$ 2 Billion) remains. The contribution of OPD segment to overall revenues has been declining continuously in past few quarters.
[diagram of segmental revenue]
Pivot for Future Growth- 4 pronged strategy
Considering the problems in its main OPD business and sensing the rapidly changing business environment, Persistent has gone for a very clearly defined business strategy by identifying 4 business segments, each headed by a segment head. Following are its 4 main growth strategies.
Digital Business: Headed by Sudhir Kulkarni, it involves enterprise digital transformation projects and services related to digital partner ecosystem
IBM Alliance business : Includes focus on long standing multi-dimensional relationship between Persistent Systems and IBM. It involves work on IBM Watson and IoT. Michael Kerr is the president of IBM Alliance
Services business: Headed by Mritunjay Singh, it includes business related to software development or ISVs except IBM and certain services provided to enterprises. It includes Agile and experienced Design that are driven by mainstream adoption of SMAC technologies.
Accelerite: Headed by Nara Rajagopalan, it focuses on Products that includes both current product suite as well as takeovers of non strategic products from other technology companies.
Now, let us look at each of these growth strategies in detail and identify the key opportunities and challenges that Persistent faces in the present scenario.
Q2FY17 Revenue Mix
Q1FY17 Revenue Mix
Digital business: from B2B to B2C
Persistent has identified enterprise digital transformation (EDT) as the next growth engine. Persistent has decided to play to its strengths and has come up with a unique strategy to grow. It is bundling its “Agile’ development skills with IP and its platform migration skills to bulk up its EDT proposition.
Focussing on “How to” of Digital- Banking on its strengths in Agile framework SMAC and API centric architecture, Persistent has decided to focus on “How to” of Digital. Persistent is trying to differentiate itself by using a consultative sales approach by telling its enterprise customers on how to go about going digital or being software driven. This growth strategy combines a technology partner ecosystem, solutions and a unique architecture for EDT.
“Sell With “ strategy: Persistent plans to actively leverage its relationship with ISVs to get foot in the door of target enterprise customers. It plans to actively identify cross opportunities by getting insights into various digital platform capabilities due to its relationships with these ISVs and actively design and market solutions for the end customers.
Digital Transformation is NOT IT Modernisation ..or is it? Persistent is trying to actively pitch the idea that IT modernisation and Digital transformation are two completely different things. It is trying to toss the “two speed IT model” whereby clients use the services of niche vendors like Persistent for digital-related projects and depend on lower cost players for maintaining legacy platforms and infrastructure. This strategy is based on what Gartner and McKinsey have advised businesses regarding the enterprise- to position their organisation for the digital wave while maintaining their legacy IT.
Focus on the” middle” rather than “front end ”or “ back end” of Digital Opportunity-As per Persistent, enterprise digital transformation should start with an API (Application Programming Interface) layer. In layman terms an API is the language by which applications talk to each other. It is thus a software to software interface. Usually software companies release their APIs to public so that other software developers can design products that are powered by its service. The most famous example of this one is- Google maps, which is used by many mobile apps and websites like Ola and housing.com for location. By keeping APIs as the centre of its EDT strategy, Persistent is trying to play to its strength.
Focus on fewer accounts- Persistent is trying to have a focussed approach towards clients. It wants to go after big ticket marquee names, get a foothold in them and then mine them over a period of time.
What is going right for Persistent Now?
A lot is working in Persistent’s favour to make the above outlined strategy work
Large addressable market: Persistent has a large addressable market in the digital space. After Y2K this is perhaps the biggest technological opportunity. As per Naccsom, Indian IT vendors would derive close to U$ 50 Billion revenues from the digital space
Unique Skill Sets: Persistent has 10% ‘agile’ approach, a delivery mindset and strong capabilities in SMAC and APIs. Enterprise Digital Transformation projects are closer in nature to product development than typical IT service projects are. Thus, Persistent can play to its strength to garner the market share.
Strong relationships with ISVs: Persistent has deep long term relationships with ISVs and this helps the company to stay at the forefront of technological advancements in the digital space. The company has an innovative approach and regularly partners and invests in start ups to fill gaps in its offerings. We also like the company’s strategy to leverage the strong relationship with ISVs to get a foot in the door of enterprise customers.
No Cannibalisation of Legacy Systems: Persistent doesn’t have any presence in application maintenance services. This enables the company to be more responsive and agile in the digital space as there is no existing business to be cannibalised.
Differentiated positioning: We like the way Persistent is trying to sell the idea of IT modernisation being different from digital transformation. This strategy is consistent with the “Two Speed IT model” approach suggested by Gartner and Mckinsey whereby clients use the services of niche vendors like Persistent for digital related projects and depend on lower cost players for maintaining legacy platforms and infrastructure. If successful this strategy will help Persistent create a unique positioning in the mind of its clients without having to fight with strong incumbents.
Chinks In The Digital Armour
The digital strategy of Persistent, though strong on paper has several chinks in its armour:
Agile development is no moat: Agile approach to development can easily be replicated by competitors. Though Persistent has perfected the art and we agree that replicating this approach will require a certain change in mindset of competitors, we believe that it doesn’t offer a strong long term competitive advantage.
Organisation Structure and Incentives: We like the fact that for each of its business segment, the sales and delivery are headed by the same person. This will help to maintain the right balance between margins and customer satisfaction. However, for Persistent’s digital strategy to be successful, it will require close co-ordination between all business units which requires proper incentives in place. For example, the Services business will have to be properly incentivised for the “Sell With” strategy to work by spotting opportunities for the digital business. Similarly, the products business will have to be properly incentivised to acquire strategically useful products even if the non strategic products may give a boost to the revenues in the short term. There is a lack of clarity on how the incentive structure is designed. In fact, most of the recent acquisitions by Persistent are of non strategic products from digital business perspective.
Lack of domain expertise and understating of legacy systems:Now that Persistent has decided to become a predominantly B2C company, domain expertise is critical. Though Persistent claims to have strong expertise in BFSI, Healthcare, Telecom and media segments, its ability to talk the language of clients is unproved. Persistent also lacks the knowledge of legacy systems and this will curtail its ability to get end to end Digital transformation projects. EDT projects are increasingly taking centre stage in the minds of many CTOs and it remains to be seen if they will be willing to giving this important piece of business to a newcomer.
Separating IT Modernisation with Digital may not work: Most large enterprises have legacy systems and will look to vendors that can provide “end to end” digital solutions. Though hailed by Mckinsey as the right approach, customers may not buy these arguments and may prefer incumbent IT vendors.
Playing the middle ground shrinks the addressable opportunity: Persistents’ digital proposition starts with the API layer and Persistent is harping on being a specialist of “How to” of digital leaving the all important question of “What” of digital to be taken away by rivals. Most of the customers have strong incumbent IT vendors and they may pitch themselves as the “end to end” digital solutions provider starting from migration of legacy systems to new platforms to developing new APIs and solutions in the time to come.
Client preference on nature and size of deals: Persistent is a relatively new player in the client facing business. Digital transformation projects are increasingly taking centre stage in many boardrooms of enterprises. As such, the projects can be too critical to be given to a new player. Though the strong partnerships with ISVs will definitely help, a lot depends on how the customers would want to give business to the IT vendors. Would they prefer a single IT partner for their entire EDT project across the globe or would they want to carve out the deal into smaller projects and give each piece to strong players as per their capabilities. Taking a cue from what is happening in the banking space in the cash management related projects, we think it would be the latter and that augurs well for persistent. Clients mostly prefer to work with multiple vendors to reduce dependability on a single vendor. However, the risk of customers preferring larger vendors with deep understanding of the domain and legacy systems may pose a major threat to Persistent. Building credibility with clients is going to be a long painful process involving increasing marketing spends.
Strong Competitors: In each of its target customers, Persistent will have to fight it out with one or two strong incumbent competitors. This is evident from its lack of traction in the EDT business in recent past. Besides competitors have woken up to the digital opportunity and are ramping up their capabilities. TCS has more than 100,000 trained professionals in digital technologies’ agile approach to product development. All new recruits in Mindtree are trained in Agile technologies. Wipro has recently announced acquisition of Appirio for a consideration of U$ 50 million and with this Wipro will be creating one of world’s largest cloud transformation practice.
Lower profitability:Persistent will have to continuously invest in building its capabilities and this will cost money. It recently hired Anshul Verma as global head of sales from HCL and hired Jacqueline White as Chief Customer Officer. It also hired John Vitekar who comes from Dell, IBM and BMC as head of ISV business. These are expensive resources. Also, increasing sales and marketing spends to make inroads into customers requirements will certainly lead to pressure on its margins in the medium term.
IBM Watson Alliance Business
Persistent has recently announced its alliance with IBM focussed around IBM’s Watson IoT (internet of Things) strategy. This is a preferred alliance with IBM which will enable Persistent to take its solutions and services to industry 4.0 customer with a focus on digital transformation. As per the deal, Persistent will bring 500 people (based in US, Europe, Mexico and Israel) on board which will be a mix of experts from IBM and new talent from the market. In total around 1500 plus people will be working on IBM platforms. Persistent will also U$ 16 million annually (U$ 8 million upfront and another U$ 8 million in FY 17) on account of the facilities taken over by Persistent. Persistent expects to add 15-20% revenue on FY16 basis in the next financial year with significant potential in the long term.
(IBM) Watson. It is NOT elementary..or is it?
IBM Watson IoT in layman terms is a set of capabilities that learn from and infuse intelligence into the physical world. It has the capability to mine unstructured data, sort it based on algorithms and heuristics and even come up with decisions to provide relevant information based on core based models! Simply put, IBM Watson is a forerunner in the coming wave of internet of Things that envisages a completely transformed world where interconnected devices interact with each other. Imagine a world where street lights will dim in case there is no vehicle on road, your house will switch on AC based on the approach of your car, your washing machine will send a message to your phone informing that the clothes are washed etc. By 2020 we are expect to have over 50 billion devices connected to internet.
IBM is betting big on Internet of Things and expects to generate revenues of $ 10 billion in the next year. According to Mckinsey, it is projected with the IoT data will yield insights driving potential economic value to as much as U$70 trillion by 2025.
The following video will help you understand the capabilities of IBM Watson
Importance of this deal for Persistent
Persistent now has a credible presence in this emerging trend with the strategic alliance with IBM Watson. This preferred partnership gives a big differentiation to Persistent and coupled with “Sell with” strategy will help Persistent get an early lead in the coming wave of digital revolution. Persistent will make revenue from three sources:
1. Revenue from products taken over
2. Revenue from solutions developed for clients on IBM Platform
3. Revenue from system integration
Persistent has been a long standing partner with IBM and this deal is a testimony of its deep relationship with the ISVs
Downsides to this deal
There are quite a few downsides to this deal for Persistent especially in the near term:
Margin Compression: This deal will require Persistent to make investments and lead to a hit of 200-250 bps to margins over the next 2 years.
Not an “exclusive” partnership: Persistent is not an exclusive partner of IBM. Though a preferred partner, IBM may collaborate with other competitors in future who will then have same access to IBM’s clients.
IP still with IBM: On closer examination, this partnership seems to be similar to the usual ISV deal, only bigger. The intellectual property will still remain with IBM and it seems IBM has only given up the lower end development work and system integration part to Persistent.
Technological Obsolescence Risk: There are still early days for IoT and there are no industry wide standards developed yet. IBM Watson may soon become irrelevant given the speed of change in this area. Facebook abandoning its ‘Parse for IoT’ platform is a case in point. Further, other companies are also forming their own alliances and developing platforms. There is GE digital alliance, there is Google with its Google
Cloud Platform and Microsoft with its Azure platform. Even Amazon has joined the fray. To be fair to Persistent, it has deep relationships with all these players and so there is little risk that Persistent will be caught napping in the face of rapidly changing landscape of IoT. However, the risk remains that all the investments it made in IBM Watson may not bear fruit in the long run.
Focussed “Named Account” Strategy: Under the services business Persistent focuses on services for software and product development includes Agile and Experienced Design that are driven by mainstream adoption of SMAC technologies. This growth strategy continues with company’s focus on customers in the business of software, software vendors and businesses enterprises that are becoming software driven. Persistent had adopted a focussed approach and has chosen 4 industries it wants to service: life sciences, telecom, healthcare, media and financial services. It wants to go after few “named” accounts and mine them deeper. Persistent is hopeful of increased traction in this business in the coming quarters.
But Numbers tell a different story..
As on Q2FY17, Persistent had 314 clients in the services business, down from 340 in the previous quarter. However, in Q4FY16 the number of clients was 319. In fact, the number has increased from 273 in Q3 FY15 to 314 in Q2FY17
Also, the number of clients with >3 Million revenue is stagnant at 15 in last two quarters. The numbers suggest that this strategy isn’t playing out as well as it should for Persistent. Further, the revenues from ISV business are volatile at best.
We are ready to give Persistent the benefit of doubt as these are still early days for the company with its new strategy.
The Accelerite division is the IP business that focusses on products. The company has positioned “Accelerite” as a product brand with a variety of products in its portfolio to meet various customer needs. This strategy is to have a blend of high growth high risk products as well as low growth low risk ones.
A lot of software vendors have products in their portfolio that aren’t of strategic interest to them. Persistent approaches these vendors and offers to acquire these product lines along with its customer base, which is often a win-win scenario for the seller as well as Persistent. The non-strategic products often receive low R&D investment from the seller, and this disappoints their customers. The selling company benefits not only in getting a non-strategic product off their books and transferring the ownership to Persistent, but also by the fact that Persistent is willing to invest in the product and renew its road map, which makes the customers happy.
Persistent ensures two essential things before it acquires a product asset. First, they characterize each product acquired as either of a strategic/high-growth nature, or a low-growth/low-risk opportunity. "
Strategic products are the ones where the company sees an opportunity to grow the revenue by re-investing in the product, either pivoting the product to an adjacent domain where the investment to pivot is affordable, but the growth potential is high.
Low growth low risk products: These are the products where there is a strong customer base, reasonable potential for profitability and the stickiness of the products is high within its customers due to lots of custom integrations and long cycle to replace. But the growth potential is deemed as low.
The company evaluates these businesses with different metrics and executes the plan post-acquisition as per the design of the acquisition. If it is a product line deemed as low-profitability, low-risk, the company invests in “customer retention” and restructures the costs for high profitability. If it is deemed as high-growth, Persistent invests in product development as well as sales and marketing, positioning the product for high growth. The company also tries to cross-sell other products in the portfolio to the newly acquired customer base.
Persistent has a solid track record in acquiring products as per the above strategy. It delivered strong growth from FY 12-15 (475 versus company average of 14%). But the growth seems to be faltering lately .
Going forward, Persistent is expected to make more acquisitions aggressively to add to its digital capabilities. They expect more revenue share kind of deals to happen in future.
It needs to be kept in mind that revenues from IP business will be volatile. Most acquisitions seem opportunistic in nature and don’t serve the long term story of going digital for Persistent. Over and above, the revenue growth from IP business has been dipping in the past 2 quarters.
Investments in Start Ups
Since July 2013, Persistent has been investing in startups as a strategic investor.It invests in companies with a smilar technological landscape or a with a similar customer base. The typical investment occurs at angel funding round or as part of the first round of institutional capital. Amount invested usually is from U$ 100 to U$ 250k in any one company.
Persistent systems is at an interesting stage of its life. It can either prove to be its inflexion point from where it ran up to the next orbit of growth or it can prove to be a precipice which will lead to its inevitable downfall. We couldn't help but try to imagine various scenarios for Persistent. From an optimistic point of view, Persistent will reach its goal of U$ 1 BN revenue by 2020 and go on to be a U$ 10 Bn revenue company by 2030. On the other hand from a pessimistic point of view its digital strategy will fail and it will head into a downward spiral failing to make a mark in future. The table below shows the various scenarios from a shareholder perspective . In our enthusiasm we have also dreamt up unrealistic scenario of Persistent striking gold due to its investments in various start ups . Who knows?
Do let us know how you liked our analysis of Persistent Systems. If we have missed out on any vital piece of information do let us know as it may materially change our analysis.
Concall Summaries of Persistent Systems
Disclaimer: All the data and analysis is based on publicly available information. This is not an investment recommendation and the sole purpose of this analysis is to let investors make an informed decision about this company based on their own conclusions. I have personal holdings in this company.
Registration Status with SEBI:
I am not registered with SEBI under SEBI (Research Analysts) Regulations, 2014. As per the clarifications provided by SEBI: “Any person who makes recommendation or offers an opinion concerning securities or public offers only through public media is not required to obtain registration as research analyst under RA Regulations”.