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Polaris: Summer wedding

May 23, 2002

The long wait seems to be over. Polaris’ move to merge with OrbiTech Solutions is perhaps the first sizable merger in the IT space post the technology meltdown. The reason for the merger is very simple, the combined entity will have sales of around Rs 6 bn (US$ 125 m). This makes it the sixth largest software company in the country. The advantage of size is that corporates aboard while awarding large contracts prefer to work with the top ten companies from the Indian industry. Large contracts are executed over a period of time and the business continuity of the vendor is a must. Therefore, bigger and better known names are the obvious choice.

Also, the Polaris will add to its portfolio the service offerings provided by OrbiTech. Since, OrbiTech is a Citigroup company, its IT skills are likely to be in the banking, financial services and insurance (BFSI) domain. According to I-flex’s offer document, ‘OrbiTech Solution’s principle business is software development, software consultancy and turnkey projects in the financial services domain’. ObriTech brings with it IPRs (intellectual property rights) like OrbiPack framework, which has the capability to process over 10 m customer transactions.

Polaris, on other hand, has traditionally focused on the banking segment and has a product known as BankWare. The merger is expected to create a set of complementary skills that can address the BFSI segment. This segment is one of the major revenue earners for the Indian software industry. Majority of software companies earn a significant portion of their revenues from this domain. The list includes Infosys (37% of revenues), Satyam (39% of revenues) and Polaris (72% of revenues).

The concerns with the merger are that the combined entity will have more than 60% of its revenues coming from Citigroup. However, Citigroup is a very large group and the revenues come from 8 to 10 different business divisions. The client concentration, therefore, may not be as risky as it seems at the first glance. The company too plans to address this concern. It is re-organising into three strategic business units (SBUs) Products, Citigroup and Non-Citigroup.

In terms of valuations, Polaris seems to have got a very good deal. For 25 share of OrbiTech, 14 fresh shares of Polaris will be issued. Considering the 100 day moving average, the price of Polaris’ share is Rs 210. Therefore, the price of one share of OrbiTech works out to be Rs 118. While the exact number of shares for OrbiTech is not known, the merged entity will have 110 m shares. As on 31st March 2002, Polaris had 51 m shares outstanding. This means a fresh issue of about 58 m shares. Considering the merger ratio this effectively translates to 105 m share for OrbiTech pre-merger.

(Rs m) Polaris Group OrbiTech Combined
Revenues 2,938 3,234 6,172
Net profits 589 1,078 1,667
Net profit margin 20.0% 33.3% 27.0%
No of employees 2,544 1,256 3,800
Revenue per employee (Rs) 1,154,874 2,574,841 1,624,211
Profit per employee (Rs) 231,368 858,280 438,579
No of shares (m) 51.2 105.0 110.0
EPS (Rs) 11.5 10.3 15.2
Share price (Rs) 210.0 117.6 303.0
P/E (x) 18.3 11.5 20.0
Market Capitalisation (x) 10,752.0 12,348.0 33,332.0
Market Capitalisation/Sales 3.7 3.8 5.4
Share price of Polaris based on 100 day moving average
Share price of the combined entity based on assuming a P/E multiple of 20x

On net profits of Rs 1,078 m and 105 m shares, the EPS for OrbiTech works out to be Rs 10. This implies that ObriTech has been approximately valued at a P/E multiple of 12x for the merger. This a very good buy for Polaris considering the fact that ObritTech has higher revenues, and much better productivity figures. The number of employees for ObriTech has been calculated by taking in to account the fact that merged entity will have more than 3,800 employees and Polaris Group had 2,544 employees as on March 31st 2002.

While we have assumed a P/E multiple of the combined entity to be 20x, the valuations could move to higher. The company has announced plans to foray into the BPO space. This is likely to fuel significant interest. Retail investors should keep an eye on the valuation (P/E multiple) at which they are buying the stock. Considering the fact that Nasscom and top rung software companies expect 20% growth in FY03, it would be safe to work with valuation that factors in a similar growth rate.


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