Getting a grip of the situation on hand
The Chief Executive Officer (CEO), Balu Ganesh Ayyar, the new oracle of MphasiS, in his ‘Dear Shareholder’ takeaway to the equity holders, muses that the partnership with Hewlett Packard (HP) had a big role in the success of the company. But he goes on to add that as a part of the transformation we want to retain that intensity around the HP partnership, and at the same time tune up our success in the direct market. Very tactfully, and knowing full well that there are more than two sides to any one sided sweetheart relationship with the parent, the CEO was able to foresee the probable pitfalls of being a total flunky of an MNC. (MphasiS is a 60% subsidiary of HP). One wonders however what leeway he will have on going full tilt on the latter aspect. Following recent reports about HP deciding unilaterally to squeeze the sibling of this many sided partnership just a wee bit more, for the greater glory of the group, the share price of MphasiS has seen a southward journey in the secondary market. However, since the fall in the share price is not of Ayyar’s making his job is more than safe.
As it is there is evidence of sorts that the company is being squeezed every which way. The auditor's in their report to the shareholders' state that the income tax (IT) department has made claims for a disputed amount of Rs 819 m in three different tranches, and over three years, where the nature of dues under dispute is the 'adjustment for transfer pricing and other disallowances' for the three assessment years 2003-04 to 2005-06. The appeals filed by the company against the claims of the IT department are being heard in different fora.
A labyrinthine group
The description of the MphasiS group reads that it is a global, multicultural organization, headquartered in Bangalore. It also appears to be the flagship company of the domestic operations. 'Global' also compulsorily and eerily implies having to set up a labyrinth of affiliate companies which is as complex for the layman to unscramble, as the Rubik's cube. MphasiS is not lacking in this endeavor. The list of its immediate associates is as myriad as it can get. It has 10 wholly owned subsidiaries and one 91% owned direct subsidiary at last count, which includes 9 incorporated in foreign shores. It also makes do with another 9 step down subsidiaries and/or subsidiaries of step down subsidiaries - the majority of which are incorporated abroad.
In keeping with the flavor of the season, MphasiS has a company incorporated in the idyllic island republic of Mauritius. It goes by the name of MsourcE Mauritius, and it is a subsidiary of MphasiS Europe BV. The latter, incorporated in the Netherlands, is a step down subsidiary of MphasiS Corporation. This company in turn is incorporated in the US, and is a subsidiary of MphasiS Ltd. The story does not end here. The Mauritian company has a subsidiary called MsourcE (India) Pvt. Ltd incorporated under Indian laws. The latter in turn has promoted a BPO subsidiary called MsourcE India BPO Pvt. Ltd, and so on and so forth. Not to mention the 58 other direct or indirect subsidiaries of the parent, HP. The latter list includes four companies based out of India - RelQ Software, Hewlett Packard Financial Services, Hewlett Packard India Sales, and HP India Software Operations. Why the need to resort to such unbridled lunacy? What is the real game plan here please? It also has capital account transactions with a group company called MphasiS India, which does not even appear to feature in any of the investment schedules - unless this company is also known by some other phantonim.
Subsidiaries treading their own path
Mercifully, the brief results of the direct subsidiaries which have been appended to the annual report make for fairly pleasant reading. (It has furnished the brief individual results of 17 of the 20 wholly owned direct /step down subsidiaries, as three of them are not up to anything as yet). On a combined share capital base of Rs 2.3 bn, and a total asset base of Rs 17.2 bn, the subsidiaries and their ilk toted up a turnover of Rs 22.8 bn and a pretax profit of Rs 1.2 bn. (The total book value of its equity investment in its 10 direct subsidiaries is Rs 4.5 bn, before write-downs). None of the companies declare any dividends, but the management is not complaining, and besides, that is a separate issue by itself. There are no doubt other unquantifiable spinoff benefits for sure.
Though it has direct investments in 10 subsidiaries, just two companies account for the vast bulk of the investments. One is MphasiS USA (also referred to as MphasiS Corporation for some reason) with a book value of its investment at Rs 3.7 bn, and MphasiS Consulting, the UK based subsidiary, with a book value of Rs 686 m. These two investments together add up to a cumulative total of Rs 4.4 bn, or 98% of the total investment in group companies. The shares in the US subsidiary were acquired at a most fanciful price of Rs 1.2 m per share of the face value of US$ 0.01 per share, while the UK entity was acquired at a price of Rs 86 per share of the face value of GBP 0.0002 per share. (On what basis are these premiums to the face value decided on please?) Separately, it also has another company called MphasiS UK, but this is a subsidiary of MphasiS Europe, B.V.
However the top dog in terms of paid up equity capital among the subsidiaries is MphasiS Europe BV with an equity base of Rs 1.3 bn. That alone accounts for 55% of the total equity base of all the 20 subsidiaries. Next in line is MphasiS Mauritius with a paid up capital of Rs 628 m, followed by MphasiS Shanghai with a capital base of Rs 239 m. The paid up capital of its two biggest investments - MphasiS USA is a mere Rs 1,000, while the paid up capital of MphasiS Consulting is a piddling Rs 1.3 m! The many twists and turns that go with corporate investments!
In terms of turnover, it is MphasiS USA which is top dog with a turnover of Rs 11.7 bn, and accounts for almost 50% of the total turnover of all the direct subsidiaries. This is followed by MsourcE India and MphasiS Australia respectively. It appears that the size of the equity base of its subsidiaries does not necessarily have any bearing whatsoever with the turnover that the subsidiaries are able to crank out. On what basis then does one judge the performance parameters of companies?
The group in a nutshell
Unlike other hydra headed companies, MphasiS starts with the consolidated results, and then gravitates to the results of the standalone company. The consolidated revenues of the group for the year were Rs 50.4 bn, a growth of 18% over the preceding year. The consolidated net profit was Rs 10.9 bn - up 20%. During the financial year there were also several mergers and acquisitions, and one buyback of shares within the immediate group. MphasiS FinSolutions was merged with the parent, while Eldorado Computing was merged with its subsidiary MphasiS Corporation. This subsidiary also acquired Fortify Infrastructure Services which was renamed as MphasiS Infrastructure Services. One of the two subsidiaries of Fortify, going by the name of Fortify North America was also merged with MphasiS Infrastructure, while the other subsidiary operates separately. In the meantime MsourcE India engineered a buyback of some of its own shares for Rs 368 m. The mergers were resorted to, to bring greater synergy to its operations - but what of the buyback of shares please?
Inspite of the many capital account transactions that the group deems fit to execute in order to face the brave new world; the company was on a roll in the last accounting year. On a 10.7% rise in revenues to Rs 37.7 bn, the operating profit recorded a much higher rise of 19.7%. This inspite of the fact that the single biggest item of expenditure, namely payroll costs, rose 26% to Rs 13.5 bn. But simultaneously it managed to pare the cost of the next biggest item of expenditure, Software Development Charges, including Software support charges fell to Rs 8.5 bn from Rs 8.9 bn previously. This is a truly a wondrous achievement, and a feat worthy of accolades. What is the mantra here? Other major items of expenses such as Rent, Depreciation, and Commission were also tempered in similar fashion. The other big game changer was the rise in 'Other income' to Rs 1.1 bn from Rs 503 m previously. This receipt largely emanates from interest income and forex gains. This is one of the few forex dependant companies which were on the right end of the forex call in both the years.
The flipside attractions
Being a lackey of an MNC also has its flipside attractions. Almost 79% of its revenue generation or Rs 29.6 bn (86% previously) was from sales effected to group companies. The biggest group client was EDS Information Services with sales of Rs 17.9 bn; followed by a category called Others at Rs 5.5 bn. (It is quite likely that the EDS in question is some sort of a collection point or some such). Inspite of this overdependence on the group, the total debtor outstanding at year end was a mere 15% of sales (11% previously). This is indeed a revelation for a software biggie, and would have helped the company gain badly needed traction on the cash flow front. (But given this peculiar client base, the debtors outstanding can undulate from year to year and in no fixed pattern at that-so can sales). The company is also brimming with cash resources; so much so that it is not only debt free, but had also invested a cool Rs 12.3 bn in debt securities at year end. To use an idiom it can even cock a snook at the big three in the Information Technology sector. Not to forget the inter-corporate deposits, and advances to group companies that it had outstanding at year end. It may also be noted that on a paid up capital base of Rs 2.1 bn, the reserves and surplus amount to a humungous Rs 27 bn.
As is with revenues, the Software development charges and which includes Software support and Annual maintenance fees paid to group companies added up to Rs 6.6 bn. This payment accounted for a humungous 77% of all such costs, against a much higher Rs 8.4 bn or 95% previously. The vast bulk of this or Rs 3.3 bn was paid to MphasiS USA, followed by HP Services (Singapore) with 1.5 bn. The latter appears to be some sort of a purchase hub of the HP/EDS group than anything else. Also is one to understand from this that MphasiS outsources software purchases from group companies, or that it subcontracts software development work to group companies? What value addition does it do post purchase?
The only Indian group company featuring in its revenue deals is RelQ Software Private Ltd to which it has apparently outsourced software development. It has a few minor inter-se dealings with another Indian group company on account of capital account transactions.
Paying its tithes
A very interesting one sided deal here is that MphasiS pays a variety of tithes to its principals and group companies. In 2009-10 it paid out a total sum of Rs 845 m (Rs 1 bn previously) totally under three head of account - Commission, Communication charges, and Other Expenses. But, the schedules do not show any receipts from group companies under these heads of account. The tithes exclude the cash dividend that the parent EDS APAC Holdings etc is entitled to.
Whatever may the several minor flaws in its functioning, this company is a very tightly run ship. The only point to note is that it is basically a 'back office' operation of the parent, if one may call it so, and there is no knowing the bag of tricks that the parent may have up its sleeve. Whatever, it is a company well worth taking a look at.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.