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Digital: Going cheap!

Dec 1, 2003

Global technology major, Hewlett Packard, which owns a 50.6% stake in Digital Globalsoft (Digital), has decided to buy-out the entire stock of publicly held shares of Digital. While HP has offered a price of Rs 750 per share, the actual price of the buyback would only be determined after the reverse book-building process. This offer, however, brings into reality the fears that arose earlier (read story) regarding HP delisting Digital from the Indian stock markets. In this write-up, we would discuss briefly about Digital's performance in the recent past and see what this offer from HP means for the shareholders of the company.

Digital is one among the Indian software companies that have a diversified revenue stream catering to services like IT infrastructure management, systems engineering and BPO services. Of late, Digital has increased its focus on the BPO services though its contact centre business (DCC), and this can be seen in almost 100% sequential growth in revenues from this segment (11% of revenues) in 2QFY04.

On its clients' side, in a perfect role as a parent, HP continues to contribute to the biggest chunk (around 81% in 2QFY04) to the revenues of Digital and the latter continues to gain from the strong sales and marketing support of the former. While Digital is also focusing in growing its non-HP businesses, the ongoing integration of the company with HP's other subsidiary in India, HP-ISO, has aided further the growth of HP's contribution to Digital's revenues. While this integration is still in its initial phase, Digital has been undergoing structural changes in the form of integrating with HP-ISO on the sales and marketing fronts and this has reaped in increased business for the former.

HP's offer offers less!
FY03 FY05 FY07
Revenues* (Rs bn) 4.2 12.0 20.5
PAT*** (Rs bn) 1.1 2.4 4.1
EPS (Rs) 32.4 73.4 125.4
P/E** (x) 23.1 10.2 6.0
* Management estimates for FY05 and FY07;
** At the offer price of Rs 750/share;
*** Assuming a PAT margin of 20% for FY05 and FY07

As said earlier, even when the actual price for the buyback would be determined after the reverse book-building process, when we consider the present offer of HP (at Rs 750 per share), the price looks unattractive considering the growth that Digital's management estimates the company to achieve post its integration with HP-ISO. As seen from the table above, the management expects Digital's revenues to increase by three-folds in FY05 and by five-folds in FY07. Considering this, the decision of HP to de-list Digital's stock from the Indian markets would deny Indian investors of a good investment opportunity and a share in Digital's growth story.

Considering the history of MNCs de-listing their subsidiaries from the Indian markets and thus denying Indian investors share in growth of these subsidiaries, investors need to practice caution regarding their investment decisions in companies with major foreign ownership. Also, they need to look carefully at the offer price as it factors in the long-term growth of the company rather than its present performance.

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