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CMC: A good sell

Oct 8, 2001

The government has finally done it! Done something concrete about divestment. But on the flip side GOI has been prompt to sell a technology company at a time when the technology sector has almost become a taboo with the investment community. That is the first thought that comes to mind when you hear of CMC’s divestment. But a little pondering on the matter would bring to the surface that the valuations the government has realized is not disappointing at all. For a quick recap Tata Sons have paid Rs 1,520 m for a 51% stake in CMC. This comes to around Rs 197 per share. Is this valuation fair? Let us take a look at CMC before taking a call on the valuations.

CMC has a host of service offerings just like any other IT services company. The company’s service portfolio includes software development, education, facilities management, third party hardware management and systems integration.

The major chunk of CMCs revenues comes from the customer services business unit. This unit is more into services like network implementation and third party hardware maintenance. These areas traditionally have been low margin business. The systems integration business unit is the software arm of the company. However, the contribution to the revenues is small. The Indonet business unit provides a value added network for commercial businesses. This is the only business unit of CMC that has shown a healthy growth. The company also has interest in the education and training business. However, the education segment is passing through very tough times due to the slowdown in the US economy.

(Rs m) FY99 FY00 Change FY01 Change
Customer Services 1,811 2,545 40.6% 2,979 17.1%
% of revenues 53.4% 55.7%   54.9%  
System Integration 474 774 63.2% 825 6.6%
% of revenues 14.0% 16.9%   15.2%  
Indonet 60 76 25.9% 131 71.6%
% of revenues 1.8% 1.7%   2.4%  
Education and Training 337 411 22.0% 588 43.0%
% of revenues 9.9% 9.0%   10.8%  
International 707 765 8.2% 909 18.8%
% of revenues 20.9% 16.7%   16.7%  
  3,389 4,571 34.9% 5,431 18.8%

Thus, considering that it is essentially an IT services company, the operating margins are very disappointing. Wipro Infotech, which operates in a similar domain, has operating margins in the range of 9.5%. GTL (formerly Global Tele) has even higher operating margins at around 25%. Also, during FY01 other than the training and education segment all other areas should have shown strong growth. This was seen in the case of other companies that operate on similar lines. Therefore, the incumbent management could not make much of the software boom.

(Rs m) FY99 FY00 Change FY01 Change
Sales 3,389 4,571 34.9% 5,342 16.9%
Other Income 73 117 60.4% 180.11 54.2%
Expenditure 3,253 4,398 35.2% 5,020 14.1%
Operating Profit (EBDIT) 136 173 27.3% 322 86.6%
Operating Profit Margin (%) 4.0% 3.8% - 6.0%  
Interest 31 31 2.8% 29 -8.0%
Depreciation 69 61 -12.2% 83 36.5%
Profit before Tax 109 198 81.3% 391 97.9%
Tax 53 80 52.4% 146 82.8%
Profit after Tax/(Loss) 56 118 108.3% 245 108.2%
Net profit margin (%) 1.7% 2.6% - 4.6% -
Prior period ajustments 17 10 - 0 -
PAT after adjustments 73 127 - 245 -
No. of Shares (eoy) 15.2 15.2   15.2 -
FDEPS 3.7 7.8 108.3% 16.1 108.2%
Price paid - - - 197 -
P/E (x) - - - 12.2 -

CMC, however, has been confined to the domestic markets and its major clients have been most public sector units or institutions like the Indian railways. Thus, the company’s ability to get projects is largely a function of its parentage rather than its competitive abilities. Not to say that the company does not have some international clients, the list includes GE, Digital, CDC, Silicon Graphics, Sun Microsystems, Apple Computer and N C R (AT&T).

However, Tata Infotech that has a very similar business model is valued at a P/E multiple of 7. The Tata Group paid a P/E multiple of 12 times FY01 earnings. Considering this the deal seems to be fairly valued. It is likely that the government that has got a better deal. However, the balance sheet for FY01 is not available, limiting the accuracy of our valuations.

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