A Mumbai based company, Rolta was promoted by Mr. Kamal K. Singh (Chairman and MD of Rolta group of companies). He is a first generation entrepreneur and is also an executive committee member of the FICCI. After completing his Bachelor of Engineering (Mechanical) and MBA, he started the Rolta group in 1970s. He is recognised as a pioneer in CAD/CAM/GIS field in India. Mr. Singh’s tenure as the company’s Managing Director is contractual and expires in 2008. Rolta is primarily engaged in providing computer aided designing (CAD), computer aided manufacturing (CAM), automated mapping (AM), facilities management (FM), geospatial information services (GIS) and photogrammetry services and solutions, product design automation (PDA) and mechanical design automation (MDA) solutions and engineering design services in the plant and mechanical domains. The company also offers specialized FT/software services and solutions relating to e-business. The company earns 60% of its revenues from domestic operations providing CAD/CAM solutions to central and state government and their agencies.

Rolta has organized its business into three strategic business groups:

(a) GeoSpatial information systems
(b) Engineering design automation (EDA or ESO)
(c) E-Solutions

Investment highlights

Strong order book, additional growth from JVs

The order book currently stands at Rs.6,900m executable in next 18-24 months. The pipeline was Rs.12bn plus Rs.1.5bn in annual maintenance contracts (AMC), equivalent to more than 250% of FY06 revenues. Rolta has also established two JVs with international partners (Thales and Stone and Webster) in the defense and power areas. We believe that Rolta is well placed in all its three business lines. Per our recent meeting with the management, we estimate that Rolta will grow at a 33% CAGR for FY06-09 and generate revenues of Rs.9,526m by FY08.

Improving billing rates

Blended billing rates in GIS, ESO and eSolutions segments have grown 6%, 10% and 18%,respectively, on an annual basis for the past two years. Rolta has improved its margins over the past 2 years, we expect this trend to continue based on improving billing rates.

Strong financials and attractive valuation

Currently Rolta trades at a P/E of 17.0x and 11.2x and an EV/EBITDA multiple of 9.8x and 6.8x of our FY07 and FY08 estimates, respectively. The company has a healthy dividend payout policy, dividend payout ranging 18% to 24% of profits.

Strong growth of Indian IT Industry

The company grew at a 23% CAGR for FY04-06, while the industry grew at a 32% CAGR for the same period. Going forward we estimate Rolta’s growth to move towards the industry average, our model factors in a 33% CAGR revenue growth through FY09. While the current business is niche, we believe there is a lot of traction. Catalysts to watch for are opportunities arising from the proposed Indian National Map Policy and Indo-US nuclear co-operation deal.

Investment positives

Improved billing rates

Rolta’s ability to evolve from a project-based service provider to providing more complete, value-added services has enabled it to raise its price realizations (US$/hour). In the GIS business, the company has delivered projects that involved mapping the city of Dubai, enabling British Telecom to upgrade its nationwide cable network, and creating solutions for the Indian Ministry of Defense to create topographical maps to help decide army responses. We understand from the discussion we had last month with Rolta’s management that the company is now working with other city municipalities in the Middle East, large telecom companies, and defense agencies in India and Middle East on large projects.

We see Rolta improving its realizations by winning projects in both domestic and export markets. In its plant design services, the company has moved away from providing digital plant designs, 3D modeling, and data migration services to providing turnkey ‘as built’ plant designs. In its mechanical design services, it now provides a higher proportion of product life-cycle management services than delivering part of the value chain projects.

Alliances

Rolta has partnerships with major technology companies that include global leaders like intergraph (geospatial technology, plant design automation), Z/I imaging (photogrammetry and imaging), PTC (mechanical design automation and product lifecycle management), IBM, Microsoft, Oracle (eBusiness and eCommerce), Computer Associates (eSecurity and network management) and others.

Strong order book

Per Q2FY07 earnings call, the company has bid for projects worth Rs.12bn plus Rs.1.5bn annual maintenance contract which is more than 250% of FY06 revenues. Per our discussion with management, historically Rolta had a success rate of 50% of procuring an order post bid. The current order book stands at Rs.6,900m, of which Rs.2,700m would be billed as revenue in FY07, Rs.3,850m in FY08, and the balance in FY09.

Higher profitability as compared with its peers

Rolta historically enjoys high margins as compared to its peers. Although margins have dipped to 42% in FY06 from 54% in FY02. For H1FY07, EBITDA margin declined slightly to 40% due to increase in operating cost. We believe the margins would improve mainly on account of higher billing rates and higher employee utilisation. The company expects overall 40-42% EBITDA margins in the next few years. Although, we believe that there would be a considerable pressure on margins due to annual wage increase of around 15-17% of which 5-7% would be compensated
by the improving billing rates and the balance by increasing productivity leading to higher realization. Management stated that the EBITDA margin from Indian operations is higher than the international operation due to cost advantages and substantial market shares in the relevant segments. In future we see these margins stabilising at current levels.

Strong growth of Indian IT Industry

According to National Association of Software and Services Company (NASSCOM), within the Indian IT industry, some of the key business segments in which Rolta operates – content development, animation and CAD/CAM/GIS services – are expected to show particular strength. These businesses, which accounted for revenues of US$ 465m (Rs.21,390m) for FY02-FY03, are expected to grow at a 36% CAGR to US$ 3bn by 2008 (Rs.195,500m).

GIS

Huge core infrastructure development in India.

– All such projects require geospatial technology.
– Expected liberalization of map policy.

Opening up of the Indian defense sector to enhanced private participation.

– GeoSpatial technology is the core foundation for C4ISTAR*, which is dominated by Rolta.
– Increasing utilization of C4ISTAR to dramatically improve efficiency across operations, intelligence and logistics through a ‘common operating picture.

Growing demand for advanced GIS applications for urban planning and utility management,world over.

ESO

Capacities in refining, petrochemicals, pipelines and storage are expected to double over the next decade, in India.

Domestic power generation is projected to increase from 115,000MW to 245,000MW till 2017 through conventional methods.

Recent U.S.-India nuclear agreement will open a huge opportunity for turnkey nuclear power plants.

Increasing traction for India as a destination for cost-effective engineering services.

Growing demand for as-built digital.

E-Solutions

Increasing demand for IT security and network management world over.

Definitive agreements with CA for North America and European markets.
Strengthening partnership with Oracle for ERP.

Microsoft gold certified partnerhigh level expertise in MS environment.

Increasing need for application development services in the specialized domains of geospatial and engineering solutions.

Entering new markets and expanding its presence in Asia Pacific
Internationally, Rolta has plans to establish new subsidiary companies in Asia Pacific region and is also planning to set up a development and delivery center in the UK. Rolta is planning to set up subsidiaries in Qatar, Abu Dhabi and expand its presence in the Asia-pacific region. However, we note that Rolta contends with much larger competitors such as ESRI, ERDAS and Fugro NV in international markets.

Rolta’s revenue from Indian market has declined to 59% in FY06 from 65% in FY04. The revenue from domestic market and international operations has grown at 19% and 32% CAGR for FY04-06. It can be seen that Rolta has been trying to de-risk its revenue portfolio especially in terms of geographic revenue distribution as it tries to increase the proportion of international revenues and reduce its dependence on the local market. We believe that the revenue contribution from the
domestic market would increase at a slower pace as compared to international revenues. Per our meeting with the management we estimate that domestic proportion in total revenues would come down to 40-45% within the next 2-3 years.

Low attrition levels

The attrition rate at Rolta is a favorable 9% as compared to 10-12% in its peer group and 16-18% in the Indian IT industry at large. Rolta requires engineers with a process or plant background, compared to other companies` requirement of a mechanical engineering background. Around 80% of the total technical employee base is engineers including 70% degree holders and 10% three year diploma holders. We see that Rolta’s staffing numbers are increasing in proportion to the growth of its business. In Q2FY07, the employee base was 3,400 which rose from 2,900 in FY06. Management further expects it to rise to 3,800 (+350 to 400 in SWRL) by FY07 and to 4,500-5,000 (+ 500 to 600 in SWRL) by FY08. Per management, the salary cost per employee is around Rs.0.5-0.6m/annum. We could extrapolate the growth of Rolta’s business based on its ramping up employee numbers.

To take care of its growing demand for skilled manpower, the company has set up a training academy which will be operational in the near future as it plans to ramp up its employee base.

Valuation

Rolta trades at 17.0x and 11.2x our FY07 and FY08 earnings estimates, respectively, with a current PEG ratio of 0.7. We estimate that the company trades at a significant discount relative to its peers on a P/E basis (about 22% as comparedto close peers* and 40-50% as compared to the top 25-30 Indian IT companies**). We believe that with improved business visibility and an encouraging business environment, the current discount is excessive. Considering the strong future prospects of global IT industry and the company’s strong position in GIS and engineering services businesses, we believe the company is well poised to achieve 30-35% organic growth through FY09. In addition, the Thales JV, in which Rolta has a 51% share, is expected to contribute US$ 45-50m to its revenue base in FY08 onwards, which would shift the growth path to 38-40%. We have estimated Rolta’s revenue and net profit to grow at CAGRs of 33% and 34%, respectively, for FY06-09 (excluding Thales JV). On a long term basis, we have estimated 31% revenue CAGR for FY06-12, bolstered by its service offerings, geographic expansion, and deeper cross selling opportunities. Furthermore, acquisitions and India`s map policy and the expanding nuclear power program are long-term potential catalysts.

We argue that the stock should trade 29-32% higher than current levels bolstered by its strong order book, improving margins, and sustained EPS growth