Sasken: Hold

Shareholders can hold on to the shares of Sasken Communications with a two-year perspective. The stock, at its current price of Rs 301, trades at 20 times its trailing 12-month earnings.

At this valuation, the stock price appears to capture Sasken's near-term growth prospects. The share trades at a discount to other telecom software companies such as Subex Azure or Tanla Solutions but at a premium to Tier-2 software companies such as Hexaware Technologies and iGate Global Solutions.

The margin growth for the company has been steady, but slow. EBITDA (earnings before interest, tax, depreciation and amortisation) margin at 17 per cent is lower than Subex Azure, Tanla Solutions and Hexaware Technologies.

Sasken has hedged $46.6 million, around 40 per cent of its revenues, at Rs 43.02 to the dollar. This and the fact that Sasken's US exposure is restricted to 35 per cent of its revenues, the lowest among Tier-2 players, may provide some cushion against margin erosion due to rupee appreciation.

When Sasken's product business, a high-margin one, starts making higher contributions to revenues over the next 12-18 months, there would be scope for a higher profit margin profile. The volume growth and the highest contributor to revenues will continue to be the services business for the next few years.

Business

Sasken is a pure-play telecom software vendor. The company caters to requirements across the telecom business span — network equipment vendors, mobile handset vendors, semiconductor companies, telecom services companies and test and measurement companies.

However, the prime mover at this point in time appears to be the handsets business which provides services, develops protocols and multimedia applications for a variety of vendors. This is accomplished through a strong working relationship with Texas Instruments and Symbian for smart-phones chipset and operating systems. These help Sasken leverage on the middleware and application development capabilities.

Prime Movers

Sasken derives 44 per cent and 19 per cent of its revenues respectively from the EMEA (Europe and Middle-East Asia) region and India.

This is significant for a few reasons. Europe is the largest market for high-end telecom services and Sasken has strong relationship with clients such as Nokia which are looking to expand market share there. This may help Sasken tap a potentially sound market in the next few years.

In West Asia, some countries such as Qatar are inviting applications for second or third telecom player licence, thus opening a vista of opportunity for telecom players. Sasken works with Nokia, Nortel, Motorola, Lenovo and Samsung which are potential suppliers of network equipment and other infrastructure to players who may win the licences.

This again presents a potential opportunity for Sasken to deliver on its R&D capabilities and services business as well.

This geographical diversification also means that Sasken's exposure to the US markets and any potential slowdown is lower.

The company's revenue model with respect to its handsets business is based on a royalty/licensing component and a services component. This gives Sasken a sustainable revenue stream linked to the sale of handsets.

This model is working reasonably with NTT DoCoMo. The shipment of Motorola phones is to start from the third quarter and is expected to contribute to revenues in the medium term.

The shipment of Lenovo mobile phones has been delayed but is expected to contribute significantly to revenues, as Lenovo phones are targeted at the Chinese market, which is the second fastest growing telecom market.

In the handsets business, the company works across technologies such as 2G, 2.5G and 3G. This diversity is important for a market such as India that has requirements across the low- and high-end phones.

Working with clients which have India and China as their top priority markets is a good augury for the company.

Risks

The mobile handset products business and royalty model depend on offtake for these handsets in the various target markets of clients.

The top five customers contribute over 74 per cent of Sasken's revenues, representing concentration risk. The semi-conductor and network equipment segments of the company are witnessing relatively slower growth and may not contribute significantly to the margins.

Attrition, at over 23 per cent, among the highest in the IT industry, poses execution risks.