Niche IT companies

While the IT sector no longer commands the valuations it did a few years back, with growth tapering down and valuations following, there are some companies in this sector which, though not large, excel at what they do. They have mastered certain domains and skills from the environment in which they grew and have made them their own calling cards. Some of these companies have attracted the right kind of attention globally while others are still striving for it. 

Oracle Financial Services Software (formerly iflex Solutions and CITIL prior to that) was formed out of COSL (Citicorp Overseas Software Ltd., a captive for Citigroup) in 1991. While COSL's mandate was to serve Citicorp’s internal needs globally and be a cost center, CITIL's mandate was to be profitable by serving not only Citicorp but the whole global financial software market. As is well known Oracle bought Citigroup's 44% stake in the then i-flex solutions in Aug. ’05, a further 7.52% in March and April ‘06, and 3.2% in an open-market purchase in mid-April ’06. In January ‘07, after an open offer price to minority shareholders, Oracle increased its stake in i-flex to around 83%.

The main interest of investors and market players is waiting for Oracle to delist this company as the valuations are not exactly cheap here quoting at more than 20 times earnings though growth has not kept pace in the same proportion.

Kale Consultants was incorporated way back in 1986 by technocrat entrepreneurs, Mr. Narendra Kale (who later founded Patni as well as Silverline) and Mr. Vipul Jain who till date heads the company (even after the takeover by Accelya, a Spain-headquartered BPO company). It is one of the few mid-sized Indian IT firms serving customers in the airline, logistics and travel industries, and has most of the airlines as its customers using its flagship product for their core operations.

It attracted the attention of Accelya after about 25 years during which time it consolidated its operations (it sold off its banking division, which was mainly into services, to Polaris a few years back) and established firm focus on the niche travel and aviation domain. Its fortunes now will be dictated by how it works with Accelya and manages to be in its priority list. However, considering that Accelya now has a significant cost advantage in getting its work done thru Kale, the company should do well ahead. The only major risk could be the step motherly treatment it may receive from its parent the way Mphasis did from its parent HP in terms of pricing and more recently Patni from iGate (thankfully iGate paid a premium to get it delisted recently and it may have a level playing field if it is fully merged into the parent; that it got delisted recently doesn’t automatically mean that it will merge with iGate).

Besides the above, who have already attracted global attention, there are a few small IT product companies, strictly small cap, which could attract the attention of global players in their domain at some point in time (more likely a few years) with their niche products and skill sets.

Polaris Financial Technology (earlier known as Polaris Software Labs), headquartered in Chennai, was setup in 1993 to cater exclusively to the requirements of Citibank. In 1994, they implemented an end-end Retail banking solution for Citi Bank India. Gaining from this experience, they set up more development centers to cater to the banking sector technology needs as also exclusively for Citibank. In 2003 they acquired OrbiTech, a Citigroup subsidiary. Through this acquisition, they acquired the Intellect suite of products (mostly surround banking applications such as Lending) and formalized this brand as their flagship. All their products were and are now being launched under this brand. Besides the products, they also have supporting practices in the financial sector such technology services and consulting which contribute a significant part of their business. The company has since moved away from having Citi as a sole customer and has a large number of global banks and FS firms as their customers.

Citigroup through Orbitech merger and on its own has a stake of about 30% in the company. Franklin Templeton holds about 5% in the company. Institutional holding at 33% is quite high and within this, FIIs own nearly 22%, rest being with domestic financial firms such as insurance companies and mutual funds.

The main trigger for Polaris would be when Citigroup looks to exit it by selling its 20% stake. There would surely be many suitors for this stake since the buyer would not only inherit a great set of products but also strong domain expertise in the FS sector, A while back, there was rumor that IBM was eyeing this stake, but nothing came of it. However, interest of other biggies in Polaris can’t be yet ruled out since there are firms like HP without a significant application products portfolio and CSC which is primarily into Insurance. The stock, along with the rest of the midcap IT stocks has been beaten down much more than warranted and is now quoting in single digit PE multiples.

Four Soft is a small company in Supply Chain Logistics space with some marquee customers like DHL, Maersk which are leaders in logistics space. That these companies have bought its products for their core operations speaks well of the company. Its other products include solutions for etc. They have product suites addressing a lot of areas of the supply chain such as freight forwarding and logistics, extended warehouse management, customs brokerage, shipping line execution etc which can be bought in a modular manner and implemented. Promoters (P. Srikanth Reddy and associates) hold about 30% in the company with PSR himself holding about 22%, Kotak Mahindra VC fund hold about 10%, Ashish Dhawan (former head of PE Chrys Capital) personally holds about 3.6% of the stake. The company came out with an IPO in 2004 and is still in its growth phase and hence has not shown any worthwhile results to speak of. Considering the niche area it operates in, it may be worthwhile to keep an eye on it in the coming years. But being a small cap, there will be the usual issues of corporate governance, transparency etc and it might be some years before it catches anyone’s eye. But when it does, the returns could be bountiful.

Take Solutions is a global technology solutions and service provider, with significant focus across two principal business areas – Life Sciences and Supply Chain Management.

Started in the year 2000, TAKE has grown exponentially over the decade and is today represented by over 750 employees catering to more than 390 marquee clients across 6 countries. With its global headquarters located at Chennai, India and US headquarters at Princeton, NJ, TAKE makes its global presence felt through its well-established offices across North America, European Union, Asia Pacific, Middle-East and South-East Asia. In the Life Sciences space, Cadila Pharmaceuticals, Reliance Life Sciences, Indoco Remedies, NATCO are some of their customers in India while they claim to serve Novartis, Pfizer and Johnson & Johnson abroad.

4 years ago, there was a proposal to merge both Take Solutions and Four Soft due to the overlap in their Supply Chain and Logistics domain which did not take off due to valuation issues.

Recently Take has started focusing on the current hot technology of cloud computing. The company has designed a cloud-based product for SME for effective management of information flows covering the entire supply chain structure. They have already tied up with Amway and Toshiba for the product. The company feels the global logistics and supply chain market will be looking for specialized software that focuses on continued technology advancement.

Four Soft and Take Solutions are more or less in an identical space with Take having an added area of Life Sciences, though how much progress it makes in this specialized area remains to be seen. Four Soft is competing with companies such as Kale Consultants and Take Solutions in the Logistics space.

Subex is again a much focused company in the telecom domain and has been battered over the last few years due to the travails of the global telecom industry. Even so, it has quite a few of the global telecom giants as its customers. Its most celebrated products are in Revenue Assurance and Fraud Management and Credit Risk Management applications for telecom operators.

It came out with an IPO in July ’99 @75/share and since then has given 2 bonuses – first in Aug ’00 and then in Feb ’06, both times 1:1. In spite of this, its equity is not too high @69 crores. So in that sense it has been investor friendly. It is only the global environment that has led to its sorry state of affairs. That it did not deviate from its focus area is a commendable thing (as some firms did over the last 10 years especially in times of global crises; shifting to flavor of the season from Y2K to ERP to open systems and whatever was in vogue at a particular time and took their fancy). It is quoting at a P/E of about 14 which is quite high for a midcap company and that too focused on the telecom domain. But once its immediate troubles are over, it should be on its way to stability. 

That it hasn’t been acquired yet is not really a surprise because the global telecom industry has not had a smooth 5 or 10 year run in the last 10 years and the likely acquirers themselves were in a spot during such times. However during this period, it acquired a few small companies across US and Europe with mixed success - UK-based Azure Solutions in 2006 was a great success, the Canadian telecom software firm, Syndesis Ltd in March 2007 for $164 million (funded through $180 million of FCCBs maturing in March 2012 later became a millstone around Subex' neck). The acquisition of Syndesis turned bad at the height of the financial crisis in 2008, when Syndesis clients failed to place orders as expected, making it look overpriced. Revenue at Syndesis, projected at $50 million for the 2008 fiscal, turned out to be half that. The FCCBs that were due for conversion into equity by March 2012 at Rs656/share, or redeemed at a total $245 million, accentuated the distress. The Subex stock was beaten down to as low as Rs18 in mid-March 2009 from an all-time high of Rs803 in mid-January 2007.

The main issue which hung over the stock, was the repayment of USD 130 million of FCCBs. RBI has now cleared their proposal to restructure these bonds over another 5 years. So the current set of FCCBS which were maturing on July 9 will now be extended/rolled-over for another 5 years at competitive interest rates currently prevailing and Subex will save quite a chunk on their annual interest outgo. Once the bondholders clear this proposal over the next 2 months, things should look up for this.

Promoters hold nearly 12% stake and among its main shareholders are the Govt of Singapore with close to 6.5%, and Rakesh Jhunjhunwala with nearly 2%.

Geodesic operates in a niche area of developing various innovative products in the ICE (Information, Communication and Entertainment) space. Geodesic, owing to its inventive capabilities across all aspects of communication and collaboration, is widely recognized for its pioneering universal instant messaging system which is a scalable content, contact management, presence, real-time communication and collaboration platform. The company offers its products and services under the "Mundu brand name for the retail segment. The company has effectively used the above platform to build and deploy innovative front-end applications, viz. Mundu Instant Messenger(IM services including AIM, ICO, MSN, Yahoo and G Talk on the web, desktop and smart mobile phones), Mundu Radio (allows users to tune into thousands of internet radio stations on their mobile phone), Mundu Speak (VOIP on Mobile), Montage, etc., for the retail segment.

The company has redefined a seamless user experience across content and communication. Sometime back, they acquired Chandamama - a 60 year old children's magazine, which is in the process of being digitized and mobilized as part of the company's vision to draw in multimedia content. Geodesic has signed several agreements with leading Radio stations, TV Channels, Cell companies and Movie production houses to further Chandamama's foray into these exciting new digital mediums

Fidelity thru its various arms holds about 10% stake in the overall FII stake of about 33% (which itself is quite high and reassuring). This along with other midcap IT stocks has been battered down and is now quoting in single digit PE multiples. As and when it starts unlocking value in its products either thru direct sale or thru partnerships with global biggies, its fortunes should improve significantly.

Recently this space of communication and collaboration has attracted the interest of several social networking players such as LinkedIn and Facebook (Glancee just a few days back, Tagtile, Instagram a short while back). So it would be interesting to see how the promoters take Geodesic forward.

There may be other companies too claiming niche in certain areas without actually having anything to show for it. For e.g. take the case of e-governance. I am not sure how this can be called a niche when all you are doing is automating a department in a public or private sector firm or for a government. It is after all a service that is provided and the IT service firm next door is likely to provide it as well as anyone else. The tools and technologies used are also not something requiring a great deal of specialized knowledge for anyone to claim sole superiority in their usage. So that would exclude from my list firms like Mastek and NIIT Tech among others who claim to be a niche player in this area.

i-flex was formed in 1991; so it took about 15 years for a small company like i-flex to come to the notice of a large global IT company like Oracle. So these companies are only for the very patient ones who can stomach a few years of ups and downs as surely there would be. And there is no guarantee either that all of these will hit pay-dirt over that period. But even if a couple of them click, it may be worth the wait. After all i-flex came out with an IPO only in June ’02 @530/share and has multiplied 5 times in the period since, primarily due to Oracle acquisition.

Tuesday thoughts

Cox & Kings (CK) has been hitting new lows everyday without any particular reason, which therefore can be attributed to the general pessimism in the market given the adverse news flows and policy decisions of the government. 

Sir John Templeton’s, the founder of the Templeton Group (which was later acquired by Franklin Templeton Investments), was a great investor of the 20th century, and believed in investing with a bargain hunter's discipline. He would say that the time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell. I, for one, am a firm believer in Sir John Templeton’s philosophy. If someone had bought Wockhardt in early ’09 when it was close to Rs 100, you can imagine where the person would be today when it is quoting around 700. And that was the time when the market didn’t want to touch Wockhardt with a bargepole.

The same theory can be applied to Cox & Kings. One swallow doesn’t make a summer and one or two bad results should not be the basis for shunning a stock which used to command investor fancy not too far back. There can’t be a unidirectional movement in any stock, however good it may be and there will be occasional blips which would provide the opportunity to get in. CK is probably going thru a similar phase. While I can’t say for certain whether it will fall further or not, I do believe that now is as good a time as ay to buy it. If it dips further, buy more and wait for the rollercoaster to change trajectory and start the ride up!

Areva T&D's global business was acquired by a consortium of Alstom and Schneider Electric in June 2010. Following the buyout, Alstom & Schneider Electric in December last year said they had assumed operational control of Areva T&D India. Alstom in India is mainly into power generation equipment while Areva T&D India is a leading transmission & distribution player. To reflect this parentage, Areva T&D renamed itself as Alstom T&D. Further, under a scheme of demerger, it demerged its distribution business to Schneider Electric Infrastructure leaving the high-voltage transmission, power electronics and automation business operations under the control of Alstom. The name of the remaining company may yet change to reflect the changed business profile. I had commented on this development last April and the script is still shaping up.

Following the above corporate development, Scheider Electric finally listed around 65 on the exchanges in March ’12 and currently quotes around 90. Now that this has finally happened, there are 2 separately listed companies each having a different owner and my thinking is that this could play out in 3 ways:

1.  Alstom may not want 2 separately listed companies in India, merges the transmission business company (Alstom T&D India) with itself and either buys out the minority shareholders in it or allots its own shares after a valuation process. In this case, the shareholders of the company will get either money (and I guess quite a bit as Indian shareholders are not know to let go easily) or shares in Alstom Projects India (which itself may not be a bad thing considering its standing).

2.   Schneider may choose to delist its listed Indian arm, since it has no listed presence in India of its own and may not want it now. Again there would be a buy-out of the minority shareholders.

3.  Both companies remain listed, majority owned by their global MNC parents. In this case, each company would be valued separately and find its own level which may be significantly higher considering the niche positions each parent enjoys in the power space globally.

Chances of options 1 and 2 happening appear brighter considering that it has been a forced listing for Schneider and while it is present in India and growing, it is not listed. Alstom on the other hand has been present in India in a listed form for quite some time now, and may also consider consolidating its operations into a single entity.

Wednesday wares

After the delisting of Atlas Copco at a fantastic price of Rs 2750/- @P/E of 35 which was way over market expectations, spotlight may well shift to its MNC twin Ingersoll Rand (India), whose parent is US-based. There is nothing in the air at the moment regarding its delisting and neither is it in the desperate-75 bracket. However, such things happen fast and once the market gets a whiff of it, the stock just zooms out of grip.

Consider the facts:

Ø  it is in the same business as Atlas Copco that of making air compressors;

Ø  at about Rs 525, quotes @ ttm P/E of about 20.6;

Ø  it is debt-free and has cash of about 600 cr. on its books which alone gives a value of 190/share on an equity of 31.6 cr. So the real operating P/E is only about 13-14.

Ø  Their new factory is not fully operational yet; once it does, it should boost its bottom-line further leading to an even attractive valuation

Ø  Promotes hold 74% in the company, so it is not in the desperate-75 bracket.

Considering all of the above, it should give a steady growth in times ahead. If there is any development on the delisting front, that will be a bonus.

INOX Leisure became the promoter of Fame multiplex when they acquired a 50% stake after fighting a bloody battle with Reliance Capital. Fame recently came out with a rights issue. Before this rights issue, Inox held 50% and Reliance Capital 33% stake in the company. But post the recently concluded rights issue of Fame, they have been able to raise their stake in the company to 68.35%.

Inox is promoted by Gujarat Fluorochemicals which is a cash rich company with decent cash earnings every year, which they deemed fit to invest in the consumer–oriented multiplex business since their own business isn’t really a cash guzzler (it may be an interesting exercise to study the cash flow/operating model of GF, but that’s a separate exercise). Usual all multiplex companies generally go for the lease model but in case of Inox many of their properties are company owned. This would give them dual benefit – low/discounted lease rentals as well as appreciation of the properties owned.

While Fame has moved from 45 to 55 (about 25%) in recent times, this increase in its share price is not reflected in the price of Inox though they hold 68% stake. As per recent reports, Cinepolis, the world's fifth largest Mexican multiplex operator with more than 2,500 screens, is in talk with Reliance to either take a meaningful stake in the BIG Cinemas or buy out some of the latter’s cinema halls. And not too long back, Disney bought out UTV from Ronnie Screwalla & family. So this industry has started to attract the attention of global biggies. Gujarat Fluorochemicals may not necessarily view their stake in Inox as a strategic business and down the line once they reach a critical mass may not be averse to exiting it. So it might be a good time to log into Inox at this time and wait for either a sell off by the promoters at an attractive price or as most analysts are gung-ho about, the great Indian consumption story to play out. Besides Inox/Fame, other significant players in the multiplex business are Cinemax, BIG Cinemas and PVR with an all-India presence.

Focussed entertainment

Prime Focus is a company focused on providing creative and technical services to the visual entertainment industry covering films, broadcasting and advertising. The services they provide include post-production services as well as visual effects to movies, feature films and commercials.

In 2005, to provide the commercials industry with a boutique facility, with infrastructure and interiors at par with international studios, they setup a studio in Lower Parel, Mumbai and a facility in Chennai was commissioned to cater to the South Indian Film market. They also have a facility in London which offers visual effects services for film and television clients, and another in Mohali near Chandigarh focusing on 2D- 3D conversion.

In 2006, it acquired the GBP 20 million, UK-based media service company of VTR Group. This has given it a footprint in the UK and European markets where outsourcing of services for visual effects as well as post production is a growing trend. As the visual effects-based films become more and more popular, the percentage of spend in the films in Bollywood is ramping up to the levels of about 30% to 40% of the budget, in certain cases. And, this has led to growth for the business in which Prime Focus operates.

It came out with an IPO in May ’06 at a price of about 42 (price adjusted for stock split in Nov ’10 to fv 1 from 10  earlier) and in the next 2 years went on to scale highs of 127 before the 2008 crash when it came down to as low as 10-12. However, considering its unique position in the industry and growing scope of services, it again bounced back four-fold to levels of about 40 in the next 2 years and is currently quoting around the 50 mark.

Notable among its works is Avatar where it did work worth $5 million with a 35% margin. Post this success they had large orders from Hollywood studios for converting a lot of their 2D films to 3D. Major successes in their portfolio are the films Clash of Titans and Harry Potter & the Deathly Hallows where they provided these services. Continuing this trend, last year they were selected by the US-based Lucasfilm to work on conversion of Star Wars: Episode I The Phantom Menace into 3D for theatre release. They also delivered three big movies for the US market - Green Lantern, Transformers - 3, and Harry Potter 7B.

Closer home, last year they signed a multi-film deal with leading movie studio UTV Motion Pictures, to service the entire production and post production requirement of a slate of the latter's films. This would include visual effects, sound and lab services, as well as provision of cameras lenses and more. In addition, Eros International Media tied up with the company for digitising and cataloguing its entire library of movies. The company also won was selected by Star TV to upgrade its content operations infrastructure.

Promoters hold close to 50% of the equity capital while FIIs hold about 10%. Rakesh Jhunjunwala holds slightly more than 6% stake in the company. A key development to note is that a few days back they allotted close to 1 crore shares to the promoters @55/share leading to increase in their stake by about 2%.So close to 70% of the equity is in strong hands lending enough confidence in the long term prospects of the company.

Currently 35-38% of its revenue comes from US, about 35% from UK and around 30% from India, leading to a fairly balanced distribution across local and global markets.

A focussed approach towards a niche domain and sound global infrastructure for servicing their clients, quite a few of them reputed names in the global film world, makes this a unique play in the media and entertainment sector, though a bit expensive on the valuation front which may be justified by their niche position.

Check out their site http://www.primefocusworld.com/

Thursday tidbits

Dhanalaxmi Bank has lately been in the news for all the wrong reasons. First it was the employee union vs. management in Sept. ’11 where the management was charged with financial mismanagement. Then RBI frowned upon such goings on and ordered an inspection in its books wherein it found discrepancies in certain accounting practices. For instance, it has already booked income from certain businesses that should have been done over a period of time.

The bank had also proposed to place about 20% of its equity with FIIs, a deal which also fell thru as one of the proposed investors, US-based Customers Bancorp Inc. backed off from the deal after failing to secure the local regulator’s approval. This was a setback for the cash strapped bank as it was looking to improve its financial ratios thru this funding.

The bank till some time back was headed by the high profile Amitabh Chaturvedi, an ex-Reliance Cap head, who the conservative bank folks considered too aggressive. He apparently spent a lot of money on hiring people (bankers and execs from private banks) and expanding the branch network, but income did not grow to that extent. This led to the bank board losing faith in him and him moving out. An old timer has since been at the helm of the bank.

While all has not been hunky dory at the bank over the last few months, it is still managed by some eminent people from the financial world - G.N. Bajpai, former chairman of SEBI, is chairman of the bank and the board consists of the reputed CA Shailesh Haribhakti along with an ex-SBI MD.

Considering the shaky situation the bank finds itself in, it may sooner than later find itself as an M&A candidate, voluntarily or otherwise. And RBI may only be too willing to lend a helping hand if someone credible comes along. With its deep reach in the south (esp. Kerala), there would surely be enough takers were this to happen. After the hullabaloo created by the employees union and later RBI, the stock had taken a beating to below 60. Over the last few days it has soared by nearly 25% and surely looks set for more. This may be accelerated if the above starts taking shape. It used to quote way above 100 not too long back.

Lloyds Steel, a steel making company of the Lloyds group, was till last April (2011), a sick company under BIFR fold. It had announced allotment of shares to ARCIL last year and to SBI this year against a part of the debt it owed. The company has an iron plant in Wardha, Maharashtra, which incidentally is the mining district in the state. The plant is fully integrated with iron ore mines in Garhchiroli, which were allotted to it. Also, the plant is close to the coal mines of Wardha and sources its requirements from the local mines.

The lenders to the bank were actively scouting for buyers of their stake to recover their dues when Miglanis of Uttam Galva Steels apparently showed interest, and finally in early Feb. 2012, picked up a 24% stake in it. This was not done thru the publicly listed company but thru their own private companies. Uttam Galva Metallics Ltd., the unlisted arm of Miglanis, operates a pig-iron plant at Wardha and Lloyds Steel sources 80% of its raw materials from this plant. This move will obviously bring a great deal of synergy to both the companies leading to great cost savings. Lloyds Steel promoters will continue to hold over 30% stake in the company after the stake sale. Lloyds Steel is also in the process of demerging its engineering division.

Reportedly, Miglanis are keen to increase their stake further in Lloyds Steel. Since they are already close to the threshold of 25% (under the new SEBI guidelines), it will result in an open offer once this limit is crossed. Lloyds Steel currently quoting around 11 is quite close to its yearly low of 7, while the yearly high is about 23. The risk reward ratio thus appears quite favorable at this point. Again this being a takeover case, things may move at their own pace over the next few months.