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The Rediff Business Special/ The software sector

Soaring exports promise bright future

Abhijit Joshi in Bombay

Part I

Part II

Lloyds Securities sales manager Hiren Gada questions the interest in infotech stocks. ''After all, the kind of price that software stocks are commanding are clearly not justified by the company's turnover or equity. Take Infosys Technologies. The stock is priced closed to Rs 3,000 while the company's turnover is only Rs 2.60 billion and equity is around Rs 160 million.''

Gada is also sceptical of the high P/E ratios assigned to software stocks. A high P/E ratio means the market is placing very high premia on this sector. While most software stocks show a P/E of more than 30, this is ironically higher than the BSE Sensex P/E itself which was about 11.6 ratio in the middle of August 1998.

But R Sukumar, a fund manager at Kothari Pioneer Fund, reminds us that even in the US, the P/E ratios of IT stocks are much higher than the market because growth is anticipated in this sector. In the US, software companies that provide the same services like many Indian companies have a peak P/E ratio of 60.

Suhas Naik, manager, Infrastructure Leasing & Financial Services, agrees: ''If you look at software stocks putting the economy in the background, then sustainability of profits in this sector has to be seen to be believed.'' According to NASSCOM, Indian software exports are expected to touch Rs 360 billion by 2002 from the Rs 60 billion recorded in 1997.

But have not the current prices of infotech stocks already factored in growth projections? Sukumar defends his stance. ''I expect the current valuations of Indian IT stocks to hold in the medium-term, though they may contract during periods of pessimism and expand during periods of optimism. If current valuations hold, then the stocks will perform in tune with the earning growth which is very high. In the long term , when the P/E ratios shrink, the high earning should compensate for this and the stocks will appreciate substantially.''

With high margins and relatively modest capital requirements, software companies can expect a high return on capital. Because of this they are also able to achieve high rates of growth from internally generated sources. But surely, with so much appreciation having already taken place, can one expect more? Should they be preferred to other commodity stocks?

Currently, most companies like Reliance, Tata Tea, Gujarat Ambuja dealing in commodities like cements, tea, steel and petrochemicals are facing a rough time as almost all these commodities are in their cyclical downturn period. But once their worst period is over, these stocks are expected to give multiple returns.

Because when investor interest automatically shifts from software to commodity stocks, their scrips which will be at their lowest will record a big jump in comparision to the software stocks. In the current scenario, software stocks are already in a state where they are giving us multiple returns.

But this argument does not cut ice with fund mangers. Tata Asset Management' s recently launched open-ended fund is reallocating 25 to 30 per cent of its funds to this sector. According to the fund's manager, Shyam Bhatt, ''Right now it may not be possible to judge when the software or any sector's cycle will turn, since the problem is no longer with us only, it is a worldwide problem. In such a scenario, one can only invest in what seems the best option. Funds have already burnt their fingers in the past, so to say.''

Alliance Capital's Asian markets chief Sameer Arora says, ''There will be an appreciation in the prices of commodity stocks but it is not as if software stocks will stop moving at all. During those periods the growth in the prices of software stocks will take place in tune with the earnings growth of the company. And growth for software companies cannot be ruled out with the current growth expectations of this sector.''

As the dream run continues, it is becoming increasingly difficult to separate the grain from the chaff. In such circumstances, almost every fund manager and researcher agree on important factors such as company managements and future plans to decide which company to invest in. Obviously it means blind faith in this sector will not translate into more profits even if rising prices seem to be telling another story.

Clearly, the overall winners in this field will be those who have been able to match profits with sales figures. Which would mean increased investments in infrastructure needed to support growing client demands with the industry focus likely to shift from only providing services to developing solutions.

In trying to outline the future winners, there is no other means than to look into the past. Thus, we look at how some of the most-sought-after companies have grown over the past few years and what their present designs could lead to.

Wipro

Its massive size is one reason why it has always been an eye-catcher in the IT industry. But the company has also performed. It has shown a huge jump in its sales and net profit figures every year in the past five years. The company's promoters hold about 75.48 per cent of the equity as on April 9, 1997 and are active in buying their shares from the market.

Which would mean that the promoters have a lot of faith in their own performance. Its current growth is 13 per cent despite only eight per cent of Y2K business, which ensures that growth will not taper off beyond the year 2000. But the company's sustenance in hardware business need to be watched, with Acer, its erstwhile collaborator, breaking off and starting independent Indian operations. It has, however, made substantial investments in software infrastructure of which it expects to get full benefit. It is also working on an American depository receipts issue soon. The following table reflects Wipro's performance in the last few years (figures are in Rs/crore. Rs 10 million = Rs 1 crore; Rs 100 crore = Rs 1 billion):

Year	98/03	97/03	96/03	95/03	94/03
Sales TO	1426.94	1252.47	1157.45	795.76	243.95
Net profit	85.65	63.53	50.37	32.19	6.66

Tata Infotech

Except for the big jumps in net profits and sales in 1998 from 1997, the company has shown a steady upward movement in the past five years. Much of the change occurred since Unisys divested its stake in the company. The company has also been making a conscious effort to move away from the stand-alone hardware business and instead focussing on its systems integration and software services business. The company is currently engaged in software exports, agency and own software products, systems integration and education. It has tied up with SEEC Inc of Pittsburgh, a leading player in Cobol applications, to market its Y2K solution. For training it has tied up with Edexcel of the UK, a leading organisation with courses recognised in 105 countries. Thus, the company has the potential to maintain the momentum of growth.

Year	98/03	97/03	96/03	95/03	94/03
Sales TO	324.95	207.47	171.63	135.78	119.25
Net profit	34.33	21.60	20.07	15.59	13.10

Satyam Computers

This Secunderabad-based company has been recording massive jumps for the last five years. The prime reason is probably the investments it has been making in infrastructure over the years. While the directors hold 21.11 per cent of the equity, foreign investors hold 27.62 per cent reflecting their trust in the company. With the Y2K business growing and diversification into domestic consulting and networking business, the company seems to be on the right track.

Year	98/03	97/03	96/03	95/03	94/03
Sales TO	178.49	89.26	51.97	24.12	7.55
Net profit	39.08	20.43	13.58	9.03	2.83

NIIT Limited

For a company that started with only education, NIIT's report card reads well for the last five years. The company is building up its assets fast at 34 per cent while sales growth is at 42 per cent. The company now has a mix of training, software services and product development but its thrust is still on computer education.

Year	98/03	97/03	96/03	95/03	94/03
Sales TO	324.32	228.42	149.70	90.36	61.78
Net profit	66.97	47.99	33.61	21.46	13.53

Pentafour Software & Exports

The company has recorded high sales and net profits for the last five years. The company directors hold 22.52 per cent of its equity. Foreign collaborators hold 32.31 per cent and 4.97 per cent are held by NRIs. The company has identified multimedia as its niche and is making investments in building up its assets. There have been some doubts about its accounting practices since the company is not very forthcoming about meeting software analysts, but the company claims to be working on this front too.

Year	98/03	97/03	96/03	95/03	94/03
Sales TO	284.56	170.21	112.70	59.58	31.82
Net profit	68.37	46.95	30.38	15.65	8.01

Infosys Technologies

Its uniformly good performance in the last five years might have something to do with the 25.25 per cent (as on May 29, 1998) that foreign institutions have invested in it. The company is being claimed as one of the best in the Indian IT sector. It believes that with increasing price competition, the level of investments into hardware, software and telecommunication infrastructure would become a critical factor for success. Thus it has been a big investor in assets.

Year	98/03	97/03	96/03	95/03	94/03
Sales TO	257.66	139.21	88.55	55.42	28.97
Net profit	60.36	36.98	21.01	13.32	8.09

BFL Software

The company has reported many ups and downs in the past five years. However, under the new management (the Barings group took over the company recently) it is expanding its exports business. It has set up a 100 per cent subsidiary in the US to increase its revenue. Alongwith Y2K, the company is planning to provide Euro conversion services in the future. The company could face competition from China which is also providing talent in the same field .

Year	98/03	97/03	96/03	95/03	94/03
Sales TO	27.88	52.76	18.36	12.62	0.97
Net profit	-13.41	3.79	6.32	4.90	0 .13

R S Software

The company has identified Y2K as its thrust area, with its expertise on the IBM mainframe platform. Along with this, it has entered into Internet based applications and data warehousing. Both these segments have huge potential and will fuel growth after the Y2K problem is solved.

Rolta

The company has recorded a growth of 32.8 per cent in revenues which is lesser than the sector growth of about 55 to 60 per cent but is in line with the CAD/ CAM segment growth. It is increasing its exports in this segment this year.

VisualSoft

It is engaged in providing Internet / intranet services which are growing areas for the next two years.

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