JPMorgan: Four Reasons Why Ness Technologies is Poised for Growth

Jun. 4.07 | About: Ness Technologies, (NSTC)

On Friday, JPMorgan initiated coverage on Ness Technologies (NASDAQ:NSTC) with an Overweight rating. Ness Technologies is a global provider of IT services and generates almost 50% of its revenues within Israel.

NSTC competes locally in Israel with companies like Malam, Matrix (NASDAQ:MTRX), Elbit (NASDAQ:ESLT) (see our previous articles on Elbit), and Teldo. Ness also competes against multinational firms like Accenture (NYSE:ACN), BearingPoint (BE), Computer Sciences Corp. (NYSE:CSC), Electronic Data Systems Corp. (NASDAQ:EDS), International Business Machines Corp. (NYSE:IBM), and Hewlett Packard Company (NYSE:HPQ). Its offshore development group competes against Cognizant (NASDAQ:CTSH), TCS, Infosys (OTCPK:IFNY), Wipro (NYSE:WIT). It also competes against product development firms (think Persistent Systems), and against internal IT departments of potential clients.

JPMorgan lists four reasons why NSTC is poised for growth:

  • Penetrate North America and Emerging Markets: JPMorgan cites that 40% of global IT spending is spent in North America. Ness recognizes this opportunity and is looking to penetrate specific niche areas (like product development) which align with its existing domain expertise. NSTC is also focused on building out its presence in emerging markets like Eastern Europe and Asia. Having almost 50% geographic exposure to Israel has always been an issue surrounding Ness, and it appears that NSTC is serious about diversifying its revenues globally.
  • Maintain Leadership Position in Key Verticals: JPMorgan is encouraged with NSTC’s leadership position in defense and government verticals in Israel, and in Independent Software Vendors in the United States. NSTC can leverage these leadership positions to expand geographically and build competencies in other verticals. Ness and Israel are on the cutting-edge of defense technologies, and certainly can parlay this experience into competing for the U.S. Department of Homeland Security's spending dollars.
  • Maintain Long-Term Client Relationships and Build Out Offshore Presence: Ness is attempting to lock-in customers into longer-term relationships, representing a more annuity-type revenue stream. JPMorgan cites that repeat clients represent 85% of the company’s revenue in Q107. The banking firm is also encouraged by Ness’s focus on building-out its low-cost delivery capabilities, particularly in India and Eastern Europe. This will take the lumpiness out of NSTC’s revenues, and allow Ness to pursue lumpy contract work for the U.S. Department of Homeland Security.
  • Pursue Strategic Acquisitions: So far, Ness has pursued small tuck-in type acquisitions to build delivery competence, penetrate new geographies, or expand its service line/industry vertical capabilities. JPMorgan expects the company to continue along this path.
  • That said, all is not clear sailing for Ness. JPMorgan expects a soft second quarter due to Jewish holidays in Israel, some continued weakness in the U.S. and Indian business. Down from a high of 17 in late ‘06, NSTC hasn’t performed well in 2007. Margins may be compressed in the near future (due to Rupee appreciation and Israeli commercial biz), and need to trend higher for investors to start feeling more comfortable in the stock.

    JPMorgan likes the stock for investors seeking one of the best Israeli IT companies expanding internationally with good Free Cash Flow, and a strong balance sheet (A 35% increase in backlog probably also helps).

    Disclosure: The author’s fund is long NSTC as of June 1, 2007.

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