Subex Ltd: The future had better be bright - Outside View by Luke Verghese

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Subex Ltd: The future had better be bright
Sep 27, 2010

Baptism through fire

This 16 year old company is undergoing its second baptism - through Agni. The rather philosophical and born again chairman of the board, Subash Menon, in his letter to the shareholders acknowledges as much. Says he 'Adversity, I had written last year is a great opportunity to introspect and improve. Your company did exactly that during the just concluded financial year'. This is followed by a quixotic comment from the chief operating officer, which is a takeoff on what the great helmsman had to say. And I quote 'The overarching theme that is emerging now is the need to do more with less, the challenge is very significant'. Well, time will tell what exactly the management has learnt from its death defying experience.

Corporate Profligacy

Subex is a classic example of the pitfalls of corporate 'profligacy' so to speak. This niche telecom software player whose client list includes 36 of the top 72 telcos globally has very little to show for the special effects that it puts on. The company operates in 2 business segments - telecom software products and telecom software services. By the company's own admission, the latter segment, which deals with staff augmentation services of telcos in the United States, is slowly becoming a no-brainer. A consolidated turnover (excluding other income) of Rs 4.6 bn, which in itself is 17% lower than what it recorded in the preceding year, is not exactly the stuff of dreams. This revenue generation, is the group effort of 9 entities, including 8 subsidiaries of the parent. Seven of these subsidiaries appear to operate out of foreign shores. The value add by the subsidiaries to the consolidated turnover was actually a mere Rs 1.4 bn. As for the claims of the management for having turned the corner, it would be more apt to state that the jury is still out on this one.

Subex set up 7 subsidiaries in quick succession between 2005 and 2007, six of them in the very competitive Western markets in the UK and the US. This imposed severe financial demands on the parent. It was compounded by the management's inability to finance the seed capital, with the right mix of equity and debt, which led in large part to the group's undoing. For example, two of the subsidiaries, Subex Inc and Subex APAC Pte., have paid up capital bases of Rs 392 and Rs 58 respectively. Nothing wrong here per-se, except that the former, (which is a subsidiary of Subex UK) drummed up a turnover of Rs 1.2 bn, while the latter clocked in a much smaller Rs 295 m. It is not magicians alone who pull rabbits out of a hat. Both the companies also wallow deep in red ink. Subex tried to make amends for its many follies, by issuing convertible share warrants, but with not many takers to the conversion option, the company was left holding lemons. It is now wised up to issuing 8 m shares in one or more tranches to Rayed Holding & Finance S.A. at a price of Rs 80 per share. This will further bring down the minority stake of the promoters post issue.

Proposed Issue of Capital

The proposed issue of capital is just as well, as the company is borrowed up to the hilt, in terms of its ability to service its debt, and repay the principal from its cash flow, as the cash pumped in is not generating adequate returns. The total book value of its equity stake in its subsidiaries amounts to Rs 14.3 bn, that is, before provisioning for the diminution in the value of its investment in Subex America to the tune of Rs 5 bn. Add to this the loans and advances outstanding at year end to its subsidiaries to the tune of Rs 528 m. The subsidiaries did deign to pay a 'paltry' interest on these loans though. On what basis this interest rate was decided on is not known. Now you know why the shoe pinches.

Depreciated Gross block

The company is so cash strapped that it has difficulty adding to its revenue generating gross block. As a matter of fact at the rate at which the gross block is depreciating, it will have very little fixed assets left on paper soon enough. Its biggest fixed asset, on paper, is its intellectual property rights which accounts for some 56% of its total gross block. Given the direction in which the company is proceeding, the directors have done well to almost completely depreciate this asset in its books. The rest of the physical gross block too is substantially (73%) written off. Overall, 86% of the gross block is a gonner. In other words, for all practical purposes, it is now left with only its human resources gross block.

Creative Accounting

Like most companies which are flitting in and out of financial penury, the management of Subex has spent long hours seeking the advice of the denizens of the accounting world, on presenting some respectability to the annual report and accounts. The accounts of both the years are studded with a plethora of plus and minus accounting entries, which must have taxed the mindsets of the best accounting brains. Needless to add, the entries are not very easy to comprende, if at all. The net result is that it has revealed a net profit after exceptional items of Rs 1.4 bn against a loss of Rs 1.8 bn in the preceding year, or a turnaround of Rs 3.1 bn. The company has very wisely passed over dividend payment in either year. If it had attempted to do so, it would have been scraping the very bottom of the barrel.

That is only a part of the big picture. Suffice to say that 'other income' constituted a hefty 38% of the 'profit before tax including exceptional items' of the consolidated entity. This other income is almost completely made up of 'provision for doubtful debts written back'! Now how is that for creative thinking? Not including the exceptional items (on capital account ) appearing in the P&L account which amounted to Rs 945 m against Rs 2 bn in the preceding year.

Book Profits Vs Cash Flow

One of the wonders of financial accounting is that a company can show a book profit but still have a negative cash flow from operating activities, and vice versa. In the case of Subex it is a total paradox. In the preceding year it reported a book loss and had a positive cash flow while in the latest year it was exactly the other way round. Its problems during the latest year were exacerbated by the difficult market conditions during the year. A higher holding of trade debtors, (75% of the trade debt dues at year end are from its subsidiaries) loans, and advances, and a lower holding of trade creditors acting in concert, did a full monty on the company's finances. So it issued share warrants, raised more debt, and even got some of the subsidiaries to repay some of the monies that it had advanced to them, to balance its books. It is definitely a year that the company would like to forget.

Subsidiaries are a Scream

The subsidiaries are a scream, and then some more. The biggest subsidiary by far is the UK operations which recorded a cumulative turnover of Rs 2.6 bn, followed by the American subsidiary with a turnover of Rs 985 m. The three companies including the holding company that make up Subex Americas have accumulated 'negative reserves' of Rs 5 bn which far exceeds the collective paid up equity. Whether the foreign subsidiaries are plain vanilla marketing companies or also develop and, market software of their own is not very clear. But the management clearly believes that the less you say the less you reveal.

What is known from various extrapolations is that more than 58% of the total sales and service income (Rs 1.9 bn) of Subex was derived from sales to its subsidiaries against 56% (Rs 1.7 bn) in the preceding year. What value these subsidiaries are adding in turn to their purchase cost is not known. Not known also is the other means deployed by its younger siblings to derive their balance sales income, as the cumulative sales of the subsidiaries in FY10 came to Rs 4.7 bn. One of the non performing subsidiaries of Subex Americas even managed the feat of recording a pretax loss of Rs 18 m on a non -existent turnover.

All in all a very depressing picture. But the company seems determined to fight the odds, and is putting on a brave public façade. The cover of the brightly painted annual report says in bold - "The Future Is Bright".

Disclosure: Please note that I am not a shareholder of this company

This column Cool Hand Luke is written by . 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.


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Oct 27, 2010

right time to pick the stock

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