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VisualSoft: Unpredictability hits valuations - Views on News from Equitymaster
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  • Jun 13, 2001

    VisualSoft: Unpredictability hits valuations

    VisualSoft, once a success story, has now for quite some time been an untouchable, thanks to the unpredictability in its product sales. It is quite ironic that it was the same 50% contribution of product related revenues that made the stock so popular and ergo, expensive. Then of course there was the profit warning in March that caused the stock to the object of the markets loath.

    In hindsight it is always easier to realize that the risk was always there. Let us look at VisualSoft’s product sales for FY01. The product sales for the four-quarter have shown unpredictability. The sequential growth rates have fluctuated between a drop of 38% to a growth of 45% during FY01

      FY00 FY01
    Sequential growth Q1 Q2 Q3 Q4 Total Q1 Q2 Q3 Q4 Total
    Products - 18.5% 25.9% 30.2% - 22.0% 2.1% 45.5% -38.9% 86.3%
    Services - 17.6% 13.7% 17.0% - 18.1% 22.8% 26.6% 10.0% 100.1%

    Assuming that the products businesses have higher margins (as very few software companies have margins as high as Visualsoft) the stock is valued at a P/E multiple of 7 times its FY01 earnings from products. The reason for such a low valuation could be the fact the company does not have products that are widely accepted or used. These products are of a discretionary nature and therefore, are prone to volatility in sales. In the company’s product portfolio ‘VisualSoft Web Project’ has the lion’s share of 50% followed by COM/DCOM components which had a share of 24% and Java Beans around 22%. These products mostly used by software companies are facing drop in sales as the software industry itself is facing tough times.

    The services business on the other hand has shown greater predictability in revenues. The company has 51% of service related revenues coming from offshore business and the remaining 49% coming from onsite business. However, the company’s services are to a large extent consists of product customization and customer training. Therefore, in a scenario where the product business suffers the services business is likely to follow suit. This is quite evident from the fact that in 4QFY01, while company’s product sales dropped by 38% (sequentially), services related revenues grew by just 10% (lowest in 8 quarters). Of the onsite revenues, product related services accounted for approximately 39% of the revenues and project related services accounted for approximately 61% of the revenues. VisualSoft in provides services to only 35 clients and had managed to add around 5 clients in 4QFY01, which was very tough for the company.

    (Rs m) Services Products Combined
    Sales (FY01) 692 622 1314
    Net Profit Margin (assumed) 35.0% 59.3% 46.5%
    Net Profit (assumed) 242 369 611
    No of shares (m) 20 20 20
    EPS 12 18 31
    Market price (Rs)     125
    P/E (based on market price) 10 7 4

    Therefore, considering these facts it is very interesting to note that the products business is valued lower than the services business. The point that is in favour of the company is that the operating margins for the company are far greater than its peers in the industry, but unless the company can come up with some kind of predictability in sales, it is going to be valued at such low levels.



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