Polaris: A case of corrupt DATA? - Views on News from Equitymaster

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Polaris: A case of corrupt DATA?

Dec 15, 2000

Early this year, Polaris Software initiated a move to acquire a New Jersey based firm, DATA Inc., for a consideration of Rs 975 m. DATA Inc. provides software solutions for banking and financial sectors just like Polaris. The benefits of the acquisition for Polaris were global reach, better delivery facilities, ensuring shorter customer acquisition time and most of all a readymade global development center. However, the marriage was not meant to be. In October, DATA Inc. filed a lawsuit against Polaris and its managing director Mr. Arun Jain for backtracking on the acquisition agreement. It claimed reimbursements of major expenses incurred following the acquisition promise of Polaris. It also claimed that it had revealed extensive confidential information to Polaris during the negotiations and this could seriously compromise its competitive position if the deal did not go through. However, Polaris has denied the charge of breach of agreement.

DATA Inc. claims that Polaris went back on the price agreed and wanted to settle for a figure considerably lower. The reasons for this had nothing to do with DATA Inc.’s performance or future prospects. Mr. Arun Verma the owner of DATA Inc claimed that Polaris had gone back on the deal on the advise of its accountants. They had advised Polaris against the potential negative effect, which the down payment of Rs 700 m will have on its Profit & Loss statement based on the Indian GAAP.

What went wrong? Was the valuation that was done by UBS Warburg too high? Or did the due diligence report by KPMG bring out some hidden issues?

Mr. Jain of Polaris claims the latter. According to him after the three standard audits - business, legal and financial, KPMG had asked Polaris to back away from the deal.

Lets look at Polaris’s balance sheet. In FY00, it had investments of around Rs 650 m. Of this, Rs 485 m (or 76%) are into mutual funds and other investment schemes. Polaris’ 1HFY01 revenues stood at Rs 1,149 m (85% of its FY00 earnings). Assuming, Polaris achieves the same revenues even in the 2HFY01, then the total revenues stand at Rs 2,298 m. This figure does look achievable as its focus areas (i.e. finance and telecom) are showing strong growth. In light of all these facts, the issue of Rs 700 m down payment affecting its P&L statement does seem surprising.

(Rs m) 1QFY01 2QFY01 1HFY01 Change
Sales 519 630 1149 21.2%
Other Income 9 15 24 69.5%
Expenditure 403 484 887 20.0%
Operating Profit 116 145 261 25.3%
Operating Profit Margin (%) 22.4% 23.1% 22.7%  
Interest 0 0 0  
Depreciation 11 17 28 46.6%
Profit before Tax 113 143 256 26.6%
Tax 3 3 6 5.7%
Profit after Tax/(Loss) 110 140 250 27.2%
Net profit margin (%) 21.2% 22.3% 21.8%  
Diluted number of shares 17.1 17.1 17.1  
Diluted Earnings per share* 25.9 32.9 29  
* annualised        

More than impact of the down payment, the issue seem to be that if Polaris had acquired DATA Inc. at the proposed valuations it might have deflated its EPS and hence its market valuation. Therefore it backed out. The conclusion is that the ugly situation could have been avoided had Polaris done its homework well.

Polaris stock took a hit, as the impact of the acquisition on revenue growth had already been factored in. Now the markets seem to be re-rating the stock. The stock is trading at a P/E multiple of 19 times based on its 1HFY01 annualised earnings. Its valuations are quite low compared to others in the software industry.

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