Stock Review: Zylog Systems

 

Buyouts Will Help Firm Expand Market Reach and Benefit From Increasing IT Demand

 

THE stock of mid-tier IT solutions provider Zylog Systems has outperformed in the past one year. It has gained over 70% during the period against a 32% gain in the benchmark index. The company is expected to continue with its double digit growth in the next few quarters, given its focus on inorganic growth.

   Headquartered in Chennai, Zylog was incorporated as a pure-play IT services company. Over the years, it has adopted the inorganic route to expand its product portfolio and market reach. It has acquired five companies during the past three years. The inorganic expansion has added a new set of deliverables for Zylog, including product-based solutions, e-governance and wi-fi services. The management has reiterated its strategy to grow through acquisitions in the coming quarters.

   Zylog acquired a Canada-based consulting and engineering services company, Brainhunter Inc, in February 2010. Nearly 35% of Brainhunter's revenue comes from agencies and departments affiliated to the federal government of Canada. This has provided Zylog with an opportunity to crosssell its products and services to the Canadian government, thereby adding to its top line in a big way.

   Inorgainc growth has helped Zylog to reduce its dependence on the US market. Three years ago, the US contributed nearly 95% to the company's business. Over the years, it has expanded its market reach to the Middle East, Europe, Asia-Pacific and now Canada. This has reduced Zylog's US exposure to about 45%. 

   The benefit of the increased client base is also reflected in the results posted by the company in the quarters that followed the acquisition. Its sales and profits doubled in the June 2010 quarter. This is likely to continue even in the September quarter.

   One concern, however, is the rising operating costs due to higher staff costs and inorganic expansion. In the June quarter, its operating margin fell by 100 basis points (bps) to 14.7%. Due to a high number of experienced recruits,

 

Zylog's wage bill is likely to remain on the higher side in the coming quarters.
   Leveraging on the expanded client base, the management expects to continue with the same growth momentum in its top line for the next two to three quarters.

   At the current market price of 579.5, the company's stock trades at nearly nine times its earnings for the trailing 12 months. Given the improved demand scenario and increased IT spending globally, Zylog looks poised to do well in the coming quarters.