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Software: Sweet deceit comes calling - Views on News from Equitymaster
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  • Dec 6, 2001

    Software: Sweet deceit comes calling

    Happy days are here again! Software scrips are on the run. The gainers list over a month (BSE ĎAí Group) has 9 stocks (almost all from the technology sector) giving more than 90% returns. An investorís dream comes true. Not quite. Although, a speculators moment of ecstasy certainly. These returns may tempt many at this point of time and the stocks might run even higher.

    But, heard of the bigger fool theory? The theory is very simple, buy anything that is lowly priced, rig the price, make up a story and then find someone gullible (often the retail investor, that means you) to buy the story. Alternatively, the operators often find a smart fund manager (who works for a government owned fund that of course manages other peoples money and is answerable to none). And once the deal is struck the 52-week high low varies from Rs 1,585 to Rs 25

    Top 10 gainers over the month: BSE 'A' Group
    Dec 5, 2001 (Rs) Nov 05, 2001 (Rs) H/L (Rs)
    TRIGYN TECHNOLOGIES 82.5 29.0 184.3% 445†/†21
    SHYAM TELECOM 69.2 29.3 136.6% 299†/†23
    SILVERLINE TECH 77.3 36.4 112.7% 335†/†23
    PENTAMEDIA 74.4 35.3 111.1% 388†/†20
    UNITED BREWERIES 177.9 84.5 110.5% 185†/†60
    GTL LIMITED 151.7 75.8 100.1% 1,205†/†48
    SHREE RAMA MULTI 50.4 25.4 98.2% 75†/†21
    HFCL 112.9 57.8 95.2% 1,585†/†25
    POLARIS SOFTWARE 173.2 89.3 94.1% 453†/†50
    MASTEK 174.6 95.6 82.6% 579†/†53

    Let us look at some of these companies. Trigyn, erstwhile Leading Edge, had losses of Rs 16 m in FY01, the figure increased to Rs 22 m in 1QFY02 and in 2QFY02 it registered a significant 185% jump in losses to Rs 64 m. The topline declined 37% sequentially in the 2nd quarter of FY02. Since the first quarter of FY02, Trigyn has been making operational loss.

    Wait there is a bonus! The Companyís investment in its subsidiaries total Rs 6,486 m as at September 30, 2001. "Taking into account the current market conditions, the Board believes that there may exist decline other than temporary in the value of these investments at September 30, 2001. Accordingly, the Board is in the process of reviewing in detail such decline, the effect of which has not been considered in the above results, since it has not been ascertained."

    Silverline in 2QFY02 posted a loss of Rs 312 m (US$ 7 m) due to a provision of Rs 384 m (US$ 8 m) as restructuring expenses and bad debts. Of the total (Rs 354 m) Rs 249 m (US$ 5.8 m) was provided towards bad debts. For 1HFY02, Silverline has already written off Rs 589 m (US$ 11 m).

    The company lowered its topline revenue growth guidance for FY02 to Rs 7.5 bn - 7.8 bn (US$ 160 to 165 m) down from Rs 9.1 bn - Rs 10.0 bn (US$ 190 to 210 m). This translates to the fact that Silverline has revised its topline growth figures from the previous range of 22% to 35% to 3% to 6% currently. Silverline expects to earn Rs 5.7 bn to Rs 6.0 bn (US$ 120 to 125 m) from the solutions business. The operating income is expected to be Rs 1.4 bn to Rs 1.6 bn (US$ 30 to 35 m). The operating margins, therefore, are expected to be in the range of 19% to 21%. The figure is very low compared to the industry average of 33%.

    To read more on Silverline, please click here.

    The companyís management traditionally has had a negative perception because of which the stock was trading at abysmally low valuations sometime back. However, Silverline has a fundamental business model and size to its advantage.

    Read our research report on Silverline.

    Then there are GTL and HFCL, which are being investigated by the SEBI for alleged involvement in the stock market scam. According to our estimates, GTL revenues and operating margins are expected to fall sharply in FY02, due to slowdown in the IT sector. At Rs 151, the stock is trading at a P/E multiple of 8x its 2QFY02 annualised earnings. The earnings are expected to grow at a CAGR of 11% between FY02 to FY04, which gives the stock a reasonable valuation.

    Read our research report on GTL.

    Therefore, it would be wise to keep off most of these stocks figuring in the list. Also, in many of these stocks operators are stuck with huge exposures and this rally could just be an eyewash to call in the bigger fool. Or the Nasdaq is too optimistic about recovery in the technology sector. On the on contrary, it may be the beginnings of the technology come back. If so why not stick with the leaders.

    However, we would like to break the myth here that only low priced stocks give high returns. Another point is that whenever a rally starts itís the blue chips that gain the most.

    Thus, it brings us to the question of what should the investor do?

    Itís all a question of time frame. Compared to September end the returns on these stocks are brilliant compared to any time frame so it would make sense to book profits. Also, from a longer-term perspective Infosys seems to be a good bet. Satyam, has a management that is a wizard in dot com valuations, so on hopes that they can manage to get a deal (as good as Indiaworld) for Sify, the balance sheet could become more attractive providing a better investment opportunity. A global valuation comparison shows that Infosys is priced more expensively than its global peers. However, Infosys is expected to grow at a far higher rate as compared to the global services majors. For FY02 we estimate Infosys topline growth to be around 35%. However, our estimates for growth in IBMís services business are around 8% for the year ending December 2001.

    Company P/E ratio
    Infosys 34
    Wipro 51
    Satyam 18
    IBM 26
    EDS 26
    CSC 24

    As on 5th December 2001.

    To conclude we would like to make a simple point. Investment is like owning a business. On the one-end you have companies like Infosys that have a very clean management that has proved its mettle over a period of 20 years. The company has the best operating metrics in its industry and it has set standards in reporting and human resource management. On the other end you have companies that keep on changing their business model every other day.

    As the investorís best friend we can only inform, the ball is in your court.



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