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Firstsource Solutions Ltd (FSL) - Buy or Sell - A Tech Perspective

Weak quarter, missed on both revenue and margin fronts: For Q1FY2016, the revenues of Firstsource Solutions Ltd (FSL) were down by 0.9% QoQ to Rs746.9 crore, owing to multiple headwinds, such as (1) lost Rs4 crore on domestic business on account of planned shutdown of two centres, Rs3.3 crore hit on EBIT; and (2) operational challenges and delay in marketing programmes issue in US telecom client led to a Rs12.5-crore shortfall in revenues (Rs4.9 crore impact on net income), thus EBITDA margin also got affected, down by 120BPS QoQ. The other income was at Rs4.3 crore (Rs1-crore one-off on account of forex translation gain). The net income for the quarter was down by 8.9% QoQ to Rs56.7 crore.

Management maintained 6-8% revenue outlook for FY2016, which looks unlikely: The management has maintained its revenue growth of 6-8% for FY2016, though it expects some pain even in Q2FY2016 on account of a delay in spends from a telecom client; total impact for FY2016 will be around $13-15 million. However, led by tentative takeout deals signing of 110 million pound (9-10 years’ deal, which also involves $10 million of upfront cost) will drive the growth in Q3-Q4FY2016 and also negate the revenues shortfall from the telecom client. For the quarter, the growth in actual contract value (ACV) deals remained muted and grew from $495 million to $501 million sequentially, with net deal wins of $5-7 million. On the margins front, the management reduced its EBITDA margins guidance level for FY2016 to 70-90BPS from 100-150BPS earlier in FY2015, leading to margin pain in H1FY2016.

Downgraded to Hold with a revised price target of Rs38: Owing to client’s specific issues and transition impact in the Indian business, FSL’s revenue growth has been sluggish in FY2015 and looks unlikely to improve in FY2016, contrary to our earlier expectations. Further, the margin improvement story is also getting delayed led by lower revenue growth and increasing cost of growth. We have lowered our earnings for FY2016E and FY2017E by 6.6% and 7.5% respectively. Though we continue to see balance sheet improvement and cash flow generation for FSL, we expect a delay in earnings growth would restrict re-rating on the stock in the medium term. Thus, we downgrade our rating from Buy to Hold with a lowered price target of Rs38.

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