Equity Research: Intellect Design Arena

Intellect Design Arena look attractive and financially strong with increasing service revenue imparted by SaaS and leading partnership with Microsoft to jointly sell Intellect’s iGTB products.

Intellect Design Arena is a global leader in Financial Technology for Banking, Insurance and other Financial Services. A uniquely focused Products business, Intellect addresses the needs of financial institutions in varying stages of technology adoption. Intellect Design Arena (Intellect) provides software products to retail, corporate banking, insurance & treasury. The business is making the switch from being a product company to being a platform company. 55% of Intellect's revenue comes from developed regions, with the remaining coming from emerging economies. The margins recently changed (from 5% in FY20 to 24% in FY22).

A weaker Q4 for Intellect was caused by reduced License revenue (flattish sales, lower margins). Sales of advanced markets expanded less quickly than normal for the company in FY22 (India was the fastest). Intellect is increasing senior sales personnel in advanced areas.

Growth Intact:

With License/AMC expanding just 2% y/y, Intellect's $68 million in revenue (Q4) slowed overall growth. The GeM contract is set to be extended until December'25 due to SaaS income, which increased by 81% year over year.  more consumers are preferring SaaS over upfront licence. Lower gross margins quarter over quarter show that hiring increased along with costs; the company has increased sales efforts (including the Microsoft collaboration) to accelerate next year. Performance in advanced markets has improved. The 23.7% EBITDA margin for the fourth quarter decreased by 247bps in the third quarter and 180bps in the fourth quarter. In addition to increasing costs and staff, the company lost around $4 million in licence sales in the fourth quarter, which put pressure on margins. It anticipates quarterly sales of $75 million and is hence confident in margins. Additionally, it has no plans to exceed 30% margins because reinvestment would be necessary to maintain growth rates. Adjusted for capitalization, Intellect's EBITDA margin decreased from 20.6% to 18.5%.

Microsoft to support further growth in International market:

After two consecutive quarters of better-than-industry performance, Intellect's revenue was flat in Q4, missing predictions and coming in at a slower growth rate than the sector as a whole (q/q). The company thinks that a performance measure of year-over-year basis should be used to gauge the performance of the product business. Year over year, Q4 revenue increased by 25%, marking the seventh straight quarter with growth that was at or above the industry growth median. The managed-services agreement with the RBI (instead of an upfront licence agreement) was another factor in the income shortfall. It is noteworthy that it did not benefit from a lower base (6% growth in FY21) like some of its contemporaries, which made FY22 growth (25% y/y organic) more notable. Its sales in advanced markets are the one area where it falls behind of peers (for example, Temenos now earns 33% of licence revenues from the US versus just 10% in 2014 and is now seeking 43% by FY25), a problem that management is attempting to resolve through sales partnerships. With the signing of a collaboration with Microsoft this quarter, it should be able to grow its income more quickly and gain access to clients in developed regions (the US and Europe). By building stronger sales teams for its products, access will be gained. In addition to working together on other projects, Microsoft will jointly promote Intellect's GTB products (exclusively on Microsoft's end). In contrast, 23% of Newgen Software's (BFS, 67% of revenue) revenue comes from the US and 35% from EMEA. The business has developed a solid pipeline of Fortune-2000 companies in the US and Europe and is working on a strategy centred on sales through international system integrators.

Strong Client Base:

Revenue from licence and AMC decreased sequentially, coming in at $29.9 million (down 14% q/q and only 2% y/y). This increased for four consecutive quarters before dropping in Q4 and was the main factor in the little revenue shortfall. Estimated services revenue (including SaaS implementation) exceeded all-time highs in Q4 and was $38 million, up 5% quarterly and 33% year. Increased SaaS revenue growth and an increase in the share of managed services engagements are reflected in the implementation revenue growth. The company's primary focus is on license-related revenues, which increased from 54% in FY21 to 57% in FY22.

The company's remarkable clientele are eight of India's top ten banks (incl. the RBI, HDFC, ICICI, Yes and IDFC). The top three banks in Saudi Arabia, eight of the top ten banks in the United Arab Emirates, and the top banks in Singapore, Malaysia, the Philippines, Indonesia, Vietnam, and Australia are also among its clients. The UK, France, Spain, Germany, and Sweden each have one of the top three banks in advanced markets, where Intellect is quite weak. 

On the SaaS side, the company is attempting to extend the GeM platform contract by two years, which is set to expire in December 2023.

In FY15, Intellect broke away from Polaris and has been running as a separate product business ever since. After six years of operation, it has significantly increased its revenue from $99 million in FY15 to $252 million in FY22. Its new revenue goal for FY23 is $300 million.

Company Growth prospects overcomes its setbacks:

The EBITDA margin decreased in Q4 by 245bps q/q to 23.9%, mostly as a result of wage increases, a rise in the number of employees, and travel-related costs. The business anticipates raising its investments in S&M, the Microsoft relationship, and product development in the future. It has selected three countries—one each in Asia, the Middle East, and Africa, and Europe—where it intends to raise investments and, in two to three years, double the run rate—currently $3 million to $5 million—from these nations. Additionally, it intends to boost investment on R&D by 17-22% in FY23. It reiterated its 32% margin target but said that it doesn't plan to run at margins higher than 31%. The EBITDA margin, adj. for capitalised R&D, was 16.9% (down 245bps q/q, 49bps y/y). The capitalized amount was Rs290m (up 4.5% q/q, 3.8% y/y) and is likely to increase as inflationary pressures would be reflected here. On a TTM basis, EBITDA has grown more rapidly than that of the industry. 

Net income in Q4 was down sequentially (4.5% q/q, but up 16% y/y) despite PBT being 9% lower q/q due to higher income from associate company (unlikely to recur). The Q4 margin fall was cushioned by better other income. The effective tax rate was 22%, the highest of the last eight quarters. Ahead, we expect the tax rate to move to 25%, then to 26% in FY24, against the company guidance of 27.5%.

Financials:

Valuation:

Developing products for corporate banks, NBFCs, Central banks, retail banks, wealth/asset managers, and insurance firms, Intellect is a promising Indian software startup. It contends with reputable large-product firms like Temenos ($967m, 9%) and FiServ ($16.2bn, rising 9%) in advanced markets.  The company is now in a phase where it is seeking to further improve efficiencies and net cash. 

Microsoft order inflow to start by Jan and this partnership should give good access to clients in Europe and the US. Microsoft will exclusively sell Intellect’s GTB products. This partnership should offer some tailwinds to the company’s growth. By FY23, it hopes to establish sizable operations in the US through collaborations with major system integrators like IBM and Hexaware. It already has substantial operations in Europe, the Middle East, and Asia Pacific. Europe, particularly Germany and the UK, is experiencing an increase in intellect. It most recently collaborated with Microsoft to market Intellect's iGTB products together.

We are still optimistic about the counter in light of its outstanding performance in FY22 in terms of growth and margins. The balance sheet has also changed for the better, indicating profitability. We believe the company should price at 26x FY23e adj. EPS, in line with its international rivals (OFSS at 12x, Newgen at 14x, Bottomline at 38x and Temenos at 23x). This is a result of the continued high demand for digital banking as well as Intellect's ability to produce profitable growth with higher margins and better cash flows than in the past. Company looks attractive at Current market price for a further upside move.

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