Oracle Financial Services: Making a bundle from products
Need for more accountability
There are a few striking revelations in the latest annual report and accounts of Oracle Financial Services Software. But the one that stands out for pure imbecility is the reason given for not declaring a dividend for the financial year end. The directors' report states that the company plans to capitalize on the opportunities emerging from the current market conditions, and needs to invest in business growth. With this in view, the board has decided not to declare a dividend for the year. Now, consider the following evidence. The company was sitting on Rs 17.6 bn in cash at year end, and invested all of Rs 86 m in gross block during the year. (As a matter of fact, against a gross fixed asset base of Rs 4.9 bn, it had cool Rs 3.2 bn locked in deposits for premises!). It had non-income bearing equity investments in its subsidiaries with a book value of Rs 7.2 bn (and thought nothing of it). And, it generated Rs 6.9 bn in cash flows from operating activities during the year. It has so much surplus cash that it loaned Rs 993 m to its subsidiaries. The excuse proffered for omitting dividend payment is about as preposterous a reason as one could give. One wonders which nincompoop in the organization drummed up this spin.
The ESPS scheme unclothed
Interestingly enough, inspite of 'x 'ing out the term 'dividend' from its lexicon, the company was rolling out employee stock option schemes (ESOP) till a few years ago. They are being subscribed to, if not in full gusto. And, those who converted their options in FY10, were more than well rewarded for sticking their necks out. The options were apparently converted into equity at Rs 820 per share, while the current market price is ruling at nearly 3 times the conversion price. The ESOP scheme apart, it has also very intelligently instituted the employee stock purchase scheme (ESPS), wherein the company buys the balance publicly held shares of the company from the market, and then distributes them to its longer serving employees. Arguably a much better way perhaps at back door 'privatization' than resorting to floating public tenders to take the company completely private.
The costliest acquisition ever!
The other startling observation is its investment strategy in its subsidiaries, when it germinates them. Its American subsidiary, Oracle Financial services Software America, accounts for the vast bulk (87%) of the parent's equity capital investment in its subsidiaries. Oracle America also has the largest asset base among all the subsidiaries. At year end, this subsidiary had a total asset base of Rs 16.4 bn. Oracle has an equity cum preference capital stake of Rs 6.3 bn in this subsidiary. But the acquisition price that it paid for this 'has been' subsidiary is a standout by any reckoning. It subscribed to one equity share of USD 0.01 each paid up (a total of 1 cent that is), for Rs 3.4 bn! Furthermore it also subscribed to 100 Convertible Participating Preference shares of USD 0.01 each fully paid up (a total of $1 that is) in the subsidiary, for Rs 2.8 bn! That is a combined total investment of Rs 6.3 bn! Not that such shenanigans make any difference given the holding company's equity hold in the Indian company. But this investment must easily rank as the costliest acquisition ever of a share in a company by an Indian company. Needless to add the subsidiary pays no dividend to the parent. One is tempted to ask on what logic the parent dreamt up this premium on the face value. Also unexplained, is the nature of the expensive assets that the Yankee subsidiary created out of this largesse.
Revenue generation angle
To cut to the chase, the Indian company markets, and sells a banking solution product suite called 'Oracle Flexcube' in its various formats to the financial services sector, across all geographies. All geographies, that is, except strangely enough, Latin America. It also markets a host of support services for Flexcube, 'Oracle Revelus', and 'Oracle Mantas', to its customers. Consulting services, Application services, and Technology Services round up the list of add-ons offered. The product revenues accounted for 68% of all revenues, with service revenues bringing in the balance. Product revenues are infinitely more profitable with operating margins of 51%, while services revenues had operating margins of 18%.
The company's revenue generation is fairly complex in its methodology. To start with it has 10 companies which are defined as fellow subsidiaries (subsidiaries of the parent holding company or some such). It in turn has 8 direct subsidiaries and a further 14 subsidiaries of subsidiaries and so on and so forth. The product and service revenues are either generated through direct sales, or by sales to its subsidiaries. Close to 72% of its billed revenues in FY10, or Rs 16 bn (out of total revenues of Rs 22 bn), accrued from sales to its subsidiaries. Of the total sales to its subsidiaries, some 90% revenues came from sales to just three subsidiaries: its US, Dutch and Singapore units. What is more pertinent is that 78% of all trade debtor dues at year end came from its subsidiaries. Then there are unbilled revenues and, deferred revenues, accruing to or from its subsidiaries, which do not make any immediate sense. There are also assorted 'provisions for trade debtor dues' accruing from the subsidiaries. Here too, these provisions are apparently both due to, and also due from the subsidiaries. It is indeed a very complex accounting process. The sales to the subsidiaries could well be on some sort of consignment basis.
The company's billing for sales is such that the subsidiaries apparently cannot add much value to their purchase price, when they sell the product offerings to the end user. While the parent returned a net post tax profit of Rs 6.6 bn from a turnover of Rs 22 bn, the subsidiaries could conjure up only a 'post tax' profit of Rs 1.1 bn from an almost identical turnover of Rs 21.6 bn. One can make any number of suppositions from this, but in the absence of any firm evidence, they are best left unsaid. However the consolidated sales for the group are shown as Rs 28.7 bn which is completely at odds with the above breakdown.
Talking about subsidiaries, it appears that Oracle Financial has a collection of colorful siblings. Mantas, is one such. It has a paid up equity of Rs 5.7 bn (the second largest after the American sibling), has total assets of Rs 4.9 bn, no revenues whatsoever to show, but still managed to clock a loss of Rs 22 m. The lack of any turnover makes no sense as the parent also offers support services for the Oracle Mantas suite. However, the Singapore subsidiary with a miniscule equity base of Rs 6 m, somehow managed an asset base of Rs 9.3 bn, and rang up a turnover of Rs 5.5 bn. The most comical appears to be the American duo. In reality there are 2 American subsidiaries. One with an equity capital base, and another without. The one with an equity base of Rs 5.8 bn has no turnover, while the one without an equity base (god knows how it is capitalized) logged a turnover of Rs 7.9 bn. Both companies however recorded profits at the net level. Strange, but true! To make a long story short, 10 of the subsidiaries had no turnover, but managed to record some profit, or as the case may be, some loss. It is simply bewildering how subsidiaries are used and misused by parent organizations.
Profit generation by other means
The company eked out a meager 1.4% increase in turnover during the last financial year. The higher bottom-line appears to have happened with some deft accounting (above the line), such as the reversal of professional fee charges to the tune of Rs 59 m. In the preceding year the debit on this account was Rs 205 m. That is a neat turnaround of Rs 264 m in the bottom-line. The other big reverse entry in the expense schedule is the provision for doubtful debts. A reversal of Rs 16 m in the latest year has to be juxtaposed with an expense entry of Rs 349 m in the preceding year. This too works out to a neat reversal in fortunes by Rs 365 m. A sharp reduction in other administrative costs helped no end either.
The Chairman of the Board in his letter to the shareholders makes no mention of the turnover mishap. His emphasis was on the 36% growth in operating income, regardless of how it was achieved. His letter ends on a very cheery note. The debacle which almost claimed the financial services industry has turned out to a boon for the company he says. Oracle has introduced offerings to conduct stress tests for capital and liquidity and it has won it top deals with the top banks, he adds.
Disclosure: Please note that I am a shareholder of this company
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.