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Flextronics buyback: Is it a fair deal?

May 5, 2005

Our concerns have come true! When the Singapore-based Flextronics acquired a majority stake in the erstwhile Hughes Software Systems (now Flextronics Software Systems of FSS), we had asked investors to take this news with caution as MNCs have a history of delisting their subsidiaries from the Indian bourses (remember Digital?). The turn of FSS has come as Flextronics has announced its proposal to delist this India-based subsidiary from the Indian bourses through a buyback of all the outstanding publicly held shares. Flextronics currently holds a 69.7% share in FSS through its wholly owned subsidiary, Flextronics Sales and Marketing Ltd. Let us take a look at what this deal would imply for Indian shareholders in FSS.The deal...
Flextronics intends to acquire the shares through a reverse book-building process in accordance with the delisting guidelines of the Securities and Exchange Board of India (SEBI). Shareholders may tend their shares to Flextronics at a price at or above the "floor price" determined in accordance with the SEBI guidelines, being the average price of the company's shares quoted on the National Stock Exchange (NSE) 26 weeks prior to the date of the public announcement of the delisting. Flextronics has indicated that it is prepared to acquire the outstanding shares offered to it at a price of Rs 575 per share, subject to all necessary shareholder and regulatory approvals. This price represents a 9.7% premium to the average share price of FSS shares quoted on the NSE for a period of 6 months preceding the date of the delisting announcement and a premium of 4.5% to the closing price of the shares as on May 3, 2005, the last trading day after which the announcement was made.

Is the price worthy of acceptance?
We had mentioned in some of our earlier write-ups on FSS that there was a possibility of a buyback after Flextronics had bought a majority stake in FSS during mid-FY05. The main point to understand is that, is this an investor-friendly move, and in particular, is the price right for investors to tender their shares?

We need to consider a few factors before coming to a judgement. One thing is clear, that the investors will not be able to participate in the future growth of the company, particularly given that the global telecom industry appears to be on a revival after the recession witnessed two to three years ago, which had affected FSS' financial performance adversely. In fact, this year, the performance has been encouraging, albeit on a lower base. However, another factor to consider is that given the volatile nature of the global telecom industry, the financial performance of FSS has been quite inconsistent.In fact, profits have grown at a modest CAGR of 7% from FY01 to FY04 and even if our expectations of a 30% profit growth is taken into account for FY05, the CAGR from FY01 to FY05 works out to just around 12%. Revenues are expected to grow at a CAGR of 25% during this period, clearly under-performing the other niche players like Geometric and i-flex. The stock price of the company has, thus, borne the brunt of the same (see chart on the right).

Is the offer fair?
 FY05EFY06E
EPS29.2 35.7
P/E19.7 16.1
P/S4.1 3.2
P/BV4.5 3.6
* Based on the offer price of
Rs 575 per share
The offer price of Rs 575 implies a price to earning multiple of 16.1 times and 12.9 times our estimated FY06 and FY07 EPS respectively. On a price to sales basis, the offer price is around 3.2 times our estimated FY06 sales. Considering these valuations and also the fact that the stock has been one of the most volatile ones from the sector in the past, we believe that FSS' shareholders have got a fair deal from Flextronics.

All said and done, there is no denying the fact that FSS' retail shareholders will miss out on the growth opportunities that beckon the company in the future. Also, this deal marks another incidence when the foreign parent has opted for delisting shares of its subsidiary from the Indian bourses. Investors should, thus, consider this aspect while investing in companies that have 'foreign hands' working behind them. As for FSS, investors can use this opportunity as an option to exit.

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