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SSI: Anomalous expansion

Jun 28, 2001

SSI that started as a software education company in 1991 and was quite successful in the business. Then it moved into software services just like most of the software education majors (NIIT and Aptech) have done. Presently it has about 90% of its revenues coming for software education and the remaining 10% from software services. The company has 7% market share in the education market making it the third largest player in India. Though SSI has not specifically put it in words, the company might be facing difficult times due to the slowdown in the US. In fact for 3QFY01, SSI saw operating margins come down by almost 500 basis points compared to 3QFY00. However, a recent move by the company has raised eyebrows in the investing community. The company borrowed Rs 500 m from IDBI at 12%, inspite of the fact that it has Rs 2,500 m in cash. Though the company has not given any specific reason as to why it has borrowed the cash, one of the reasons could be that SSI earned better returns (excess of 12%) on its investments in the past. Therefore, the company would be able to generate returns on the spread i.e. the difference between what it has to pay to IDBI and what it generates from its investments.

According to SSI it had managed to get returns to the tune of about 15% on cash it has in its books by investing the money in pure debt mutual funds in March 1999 and pulling out April 2001. Therefore, the company got spread across three assessment years from 1999 to 2001. The effective yield that the company got on these gains was overall 15%. And, in the future the company expects to generate returns of about 14% from its investments.

However, this decision does not seem to make sense and on the contrary has raised many concerns. SSI on the 31st of March 2001, had investments of Rs 1,762 m. The cash and bank balance totaled Rs 1,672 m. These two items together were Rs 3,434 m. According to Mr. Suresh Kalpathi, the CEO of SSI, Rs 185 m was invested with mutual funds and the rest were with banks. Therefore, what was the reason behind the company's decision to borrow even after having so much cash in its books? To earn interest spread? But as far as we recollect the company is in the software education and services business and is not exactly a finance company.

Secondly, even though debt instruments are closest to being risk free, returns to the tune of 15% cannot be guaranteed. Therefore, there is an uncertainly in the returns the company will be able to generate. However, it will have to pay 12% to IDBI as interest.

The other income figure for the company was Rs 219 m for the first nine months for FY01. This translates to a return of 12% on its investments (Rs 1,762). However, considering the fact that it had a similar amount in cash (Rs 1,672 m), the return on cash and investments comes to just 6%. Had the company taken loan to expand its business activities it would have made more sense as the company itself has operating margins of about 27%. Therefore, by investing the money in itself the company could have generated more returns.

Returns FY00 FY01*
Other income (0I) in Rs m 168 219
% Return on Cash (OI/cash) 4.8% 13.1%
% Return on investments (OI/investments) 14.6% 12.4%
% Return on cash and investments 3.6% 6.4%
* For FY01 OI figure only for 9 months

There seems something wrong in the management's ideologue, or we are too na´ve to understand their financial wizardry. In both the cases, the lack of transparency comes out as a big concern, especially in such a difficult time for the software and related companies.

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