Virtusa Consulting Services Private Limited

April 06, 2018

Summary of rated instruments Previous Rated Amount Current Rated Amount Instrument Rating Action (Rs. crore) (Rs. crore) Non-convertible debentures 2,000.00 2,000.00 [ICRA]A+(Stable); reaffirmed Total 2,000.00 2,000.00

Rating action ICRA has reaffirmed the long-term rating of [ICRA]A+ (pronounced ICRA A plus) for the Rs. 2,000-crore1 non-convertible debenture (NCD) programme of Virtusa Consulting Services Private Limited (VCS)2. The outlook on the long-term rating is Stable.

Rationale The rating reaffirmation continues to factor in VCS’s strong parentage, namely Virtusa Corporation (Virtusa), which is an established Information Technology (IT) consultancy and IT enabled Services (ITeS) provider with annual revenue of ~$860 million in FY2017. Virtusa enjoys a healthy business position characterised by a steady client base with repeat business, its global execution capabilities and an experienced management team. Further, Virtusa (consolidated) has witnessed robust year-on-year (YoY) growth of 70% in revenues from the Banking, Financial services and Insurance (BFSI) segment in FY2017, given the strong market position of Polaris Consulting & Services Limited (Polaris), which was acquired (74.2% stake) by the Group in March 2016. The rating also factors in the comfortable leverage profile of Virtusa with negative net debt status as on December 31, 2017 because of its healthy cash balances and liquid investments.

The rating also factors in the steady growth in VCS’s operating income (OI), in line with the trend in Virtusa. VCS’s healthy operating margins supported by fixed transfer pricing mechanism with Virtusa also support the ratings. With healthy OPBDITA generation and adequate liquidity, VCS has been able to comfortably meet the interest servicing requirements of the NCDs so far.

However, the rating is constrained by the dependence of VCS’s revenues on workflow from Virtusa, which remains susceptible to any adverse legislation in the US/Europe that may restrict the outsourcing to low-cost countries. Any reduction in business flow from Virtusa may adversely impact the revenues and cash flows of VCS, thereby impacting its ability to meet debt-servicing obligations. Though there have been no significant dividend payouts from VCS to Virtusa as yet, any dividend payout or upstreaming of cash flows by VCS (to support Virtusa’s own debt repayment commitments) may adversely impact its liquidity.

1100 lakh = 1 crore = 10 million 2For complete rating scale and definitions, please refer to ICRA’s website www.icra.in or other ICRA Rating Publications

ICRA also takes note of the completion of the recent open offer for Polaris’ shareholders by VCS, wherein the company increased its ownership in Polaris to 92.8% from 74.2% earlier and applied for delisting of Polaris from stock exchanges. The delisting is expected to be completed shortly, which along with increased ownership in Polaris is expected to provide greater operational flexibility to VCS. However, the acquisition of additional stake in Polaris has been funded through issue of fresh NCDs and compulsory convertible debentures (CCDs) to Group companies and ultimately through outside borrowings in the Group. This has resulted in increase in VCS’ leverage and debt servicing commitments, thereby stretching its cash flows. ICRA also notes that VCS plans to increase its stake in Polaris to 100%, which may lead to addition of more debt and use of its existing cash.

VCS is also in the process of merging two Group entities (delivery centres in India) – Virtusa Software Services Private Limited (VSS) and Virtusa Technologies India Private Limited (VTIPL). The combined entity is expected to meet increased interest servicing obligations comfortably. However, the company would need to explore alternate options to meet its debt-repayment obligations, including support from the parent company and access to cash from Polaris either by way of its merger with the latter or upstreaming cash from the same.

Further, the rating takes into consideration the revenue-concentration risk faced by Virtusa as more than 60% of its revenues are contributed by the BFSI segment, exposing it to any slowdown in this segment. Like other companies in the industry, Virtusa faces challenges with respect to employee attrition rates. The profitability of VCS also remains exposed to adverse foreign exchange movement, given that most of the company’s revenues are generated in dollars and a significant part of expenses are in rupees.

Outlook: Stable The Stable outlook reflects ICRA’s expectation that Virtusa will be able to maintain its strong position in the IT services industry. This in turn will result in healthy workflow for VCS, leading to steady revenue growth for it. Further, VCS is expected to maintain healthy operating profitability supported by fixed transfer pricing arrangement with Virtusa. The outlook may be revised to Positive, if VCS witnesses better-than-anticipated growth in revenues and improvement in its liquidity position. The outlook may be revised to Negative, if any adverse macroeconomic developments in the US or Europe lead to reduction in workflow from Virtusa to VCS, thereby impacting its revenues, the outlook may also be revised to Negative if there is upstreaming of cash flows from VCS to Virtusa, adversely impacting the liquidity position of the former.

Key rating drivers

Credit strengths  Established position of Virtusa in IT services industry - Virtusa’s established position in the IT consulting and ITeS segments is characterised by its established client base, global execution capabilities and experienced management team. The company reported a healthy CAGR of 27% in its OI during FY2013–FY2017, driven by revenue growth across the major business verticals of BFSI and communications & technology (C&T).

 Strengthening of the consolidated entity in BFSI segment with acquisition of Polaris - The Group completed the acquisition of a 74.2% stake in Polaris (a financial technology company for BFSI vertical) in March 2016. This strengthened the Group’s position in the BFSI vertical by enhancing its client base and market reach, as reflected by the robust YoY growth of around 70% in its consolidated revenues from the BFSI segment in FY2017. In February 2018, the Group further increased its stake in Polaris to 92.8%.

 Steady increase in operating income of VCS, along with healthy operating profitability - VCS reported a healthy CAGR of 16% in its revenues from FY2013–FY2017, driven by steady workflow from Virtusa. Further, VCS has a fixed transfer pricing arrangement with Virtusa, wherein it bills the latter at a cost-plus fixed margin irrespective of the terms of the same with end customers. This arrangement resulted in healthy profitability for VCS, with OPBDITA margin of 17.6% in FY2017.

 Comfortable leverage profile of Virtusa; negative net debt due to sizeable cash holdings - The debt on Virtusa’s books ($ 185.6 million as on March 31, 2017), primarily comprises term loans availed for financing the acquisition of Polaris. Virtusa’s leverage profile remained comfortable with Total Debt/TNW of 0.3 times as on March 31, 2017. Further, Virtusa had sizeable cash holdings and liquid investments to the tune of $237 million as on March 31, 2017, which made it a negative net debt company.

Credit challenges  Significant dependence of VCS’ revenues on workflow from Virtusa entities in the US and Europe - VCS derives around 75-80% of its revenues from work off-shored by Virtusa’s Group entities in the US and European markets. Thus, the operations of VCS remain susceptible to any legislation, especially in the US/Europe, which may restrict outsourcing to low-cost countries like India.

 Increase in VCS’ debt-servicing obligations post recent debt-funded acquisition of additional stake in Polaris - VCS recently completed the open offer for Polaris’ shareholders, wherein it increased its stake in Polaris to 92.8% from 74.2% earlier. The acquisition was funded through issue of Rs. 640-crore NCDs and Rs. 286-crore CCDs to Group companies and ultimately through outside borrowings in the Group. The NCDs carry an interest rate of 8% per annum and are repayable in bullet repayments in December 2024 and February 2025. This has led to an increase in VCS’ leveraging and debt-servicing commitments, stretching its cash flows. The company would need funding support from parent and/or Group companies to meet these commitments.

 Vulnerability of profitability to competitive pressures; forex risk remains a concern - The profitability of VCS remains vulnerable to competitive pressures from other low-cost countries. Moreover, the profitability of VCS is exposed to adverse foreign exchange movement given that most of company’s revenues are generated in dollars and a significant part of expenses are incurred in rupees. However, this risk is hedged at the parent company level, primarily by entering into forward contracts.  Significant vertical-concentration risk - Virtusa derives a significant proportion of its revenues (~64% in FY2017) from the BFSI segment. This makes the Group’s operations vulnerable to any slowdown in the segment.

Analytical approach: For arriving at the ratings, ICRA has applied its rating methodologies as indicated below.

Links to applicable criteria:

Corporate Credit Rating Methodology

Rating Methodology for Entities in the Information Technology (Services) Industry

About the company VCS was incorporated in 2008 as a multi-level step-down subsidiary of Virtusa. The parent company is headquartered in Massachusetts and provides IT services including IT consulting, application development and maintenance, systems integration and managed services. VCS is one of the major delivery centres of Virtusa in India, accounting for 11.5% of the parent’s revenues in FY2017. VCS has offices in Hyderabad, Pune and Bangalore. The company mainly performs the work offshored by Virtusa and other Group companies such as Virtusa Netherlands and Virtusa UK. VCS acquired a 74.2% stake in Polaris in FY2016. The stake was increased further to 92.8% in February 2018.

In FY2017, VCS reported net loss of Rs. 58.1 crore on an OI of Rs. 663.4 crore vis-à-vis profit after tax (PAT) of Rs. 104.0 crore on an OI of Rs. 620.6 crore in FY2016.

In FY2017, Virtusa reported PAT of $16.3 million on an OI of $858.7 million vis-à-vis PAT of $ 45.0 million on an OI of $600.3 million in FY2016.

In FY2017, Polaris reported PAT of Rs. 161.4 crore on an OI of Rs. 2,079.7 crore vis-à-vis PAT of Rs. 102.0 crore on an OI of Rs. 2,051.4 crore for FY2016.

Key financial indicators (audited) - VCS FY2016 FY2017

Operating Income (Rs. crore) 620.6 663.4 PAT (Rs. crore) 104.0 -58.1 OPBDIT/OI (%) 23.7% 17.6% RoCE (%) 11.3% 4.5%

Total Debt/TNW (times) 2.1 2.1 Total Debt/OPBDIT (times) 9.2 11.7 Interest Coverage (times) 14.0 0.9 NWC/OI (%) -5% 18% Source: VCS annual reports, ICRA research

Status of non-cooperation with previous CRA: Not applicable

Any other information: None

Rating history for last three years Chronology of Rating History for the Current Rating (FY2019) past 3 years Date & Date & Date & Amount Instrument Amount Date & Rating Rating in Rating in Rating in Rated Type Outstanding FY2017 FY2016 FY2015 (Rs. (Rs. crore) April November March January crore) NA 2018 2017 2017 2016 Non- Long [ICRA]A+ [ICRA]A+ [ICRA]A+ [ICRA]A+ Convertible 2,000.0 2,000.0 - 1 term (Stable) (Stable) (Stable) (Stable) Debenture

Complexity level of the rated instrument ICRA has classified various instruments based on their complexity as "Simple", "Complex" and "Highly Complex". The classification of instruments according to their complexity levels is available on the website www.icra.in

Annexure-1: Instrument Details Date of Amount Issuance / Coupon Maturity Rated Current Rating and ISIN No Instrument Name Sanction Rate Date (Rs. crore) Outlook Non-Convertible Feb 29, 2016 9.0% Apr 15, 2023 1,360.0 [ICRA]A+ (Stable) INE571O08018 Debenture

Non-Convertible Dec 26, 2017 8.0% Dec 26, 2024 330.0 [ICRA]A+ (Stable) INE571O08026 Debenture

Non-Convertible Feb 06, 2018 8.0% Feb 06, 2025 310.0 [ICRA]A+ (Stable) INE571O08034 Debenture

Source: VCS

ANALYST CONTACTS Sabyasachi Majumdar Harsh Jagnani +91-124-4545304 +91-124-4545394 [email protected] [email protected]

Sachin Sachdeva Rajat Jain +91-124-4545307 +91-124-4545844 [email protected] [email protected]

RELATIONSHIP CONTACT Jayanta Chatterjee +91 80 4332 6401 [email protected]

MEDIA AND PUBLIC RELATIONS CONTACT Ms. Naznin Prodhani Tel: +91 124 4545 860 [email protected]

Helpline for business queries:

+91-124-2866928 (open Monday to Friday, from 9:30 am to 6 pm) [email protected]

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