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Friday, December 5, 2008

Stock view on Allied Digital

THE GLOBAL IT infrastructure management services (IMS) business is estimated to be $100 billion. Around 60-70% of the IMS activity can be outsourced, which translates into a huge business opportunity for Indian companies in this space. There are some players who try to benefit from the cost arbitrage model, as is done by many IT services companies. But others follow a slightly different business model. Allied Digital Services is one such established company in this space, which focuses on technology and a centralised service approach to solve most of its customers’ problems. Such a business model has dual advantages — less dependency on manpower skill, which is scarce in the market, and better manpower utilisation.

With the fall in the broader market indices, its stock has almost lost one-third of its value from its peak. But the company’s fundamentals remain strong and it has managed to grow at a healthy rate of more than 50% in the past few quarters. We believe that the current growth momentum will continue for the next few years and investors can enter the stock at the current price levels.

BUSINESS:

Allied Digital is into IT infrastructure management, security management and technical support services. The company, which has long been present in the domestic market, is now also looking at global markets. It has set up a network operation centre and security operation centre in Mumbai to serve its customers. As part of network maintenance, it tries to use different kinds of software tools to solve the problems of its customers. Currently, it solves 70-80% of the problems through technology, whereas the remaining 20-30% need human interaction. This model is 30-35% cheaper than the peoplecentric model. It also offers a package of managed security services to the clients.

FINANCIALS:

Allied Digital’s net sales have risen more than three times over the past two years. Net profit has grown by four times during the same period. It has consistently tried to improve its operating margins over the past few years by using a better mix of technology and people. Its current operating margin of 24% reflects an improvement of about 500 basis points over three years. It has maintained a higher return on capital of more than 50% in the same period. Its debt-equity ratio is around 0.1. This provides enough space for the company to acquire small companies in new geographies to access new markets.

GROWTH DRIVERS:

The company has started venturing into overseas territory, mainly the US and Australia. It acquired a US company called EnPointe Global Services, a carved-out subsidiary of Nasdaq-listed EnPointe Technologies in July this year. Since the deal is a mix of cash and stocks, Allied Digital will leverage the sales and marketing expertise of the parent company (EnPointe Technologies), which holds stocks of Allied Digital. This will drive its overseas earnings in future.

On the domestic front, the company sees ITenabled services, pharma outsourcing, knowledge process outsourcing and contract manufacturing as some of the demand growth areas for its network and security operations.

VALUATIONS:

The stock is trading at a priceearnings (P/E) multiple of 10-11. A major part of the company’s revenue is annual in nature. Though the current economic outlook is bleak, it will be difficult for many of Allied Digital’s existing clients to cut down on non-discretionary expenses like network and security management, which are critical for the survival of any business. Further, as global majors resort to outsourcing to cut costs, it will provide more business opportunities for Allied Digital. The company’s fundamentals look sound. Its stock has always outperformed the Sensex in the past one year. Investors can consider adding this stock to their portfolio.

Beta: 0.35

Institutional Holding: 23%

Dividend Yield: Nil

P/E: 10.3

M-Cap: Rs 520 cr

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