Stock Market Update

The stock market made considerable

gains during the fortnight with an 11% appreciation in the sensex. The bullish sentiment

started early and by December 31, the sensex had already gained 82 points. The new year

too began on a positive note and the bullish sentiments continued for sometime in the new

year, with the sensex gaining 244 points in the first five days of trading. There was

considerable buying by domestic financial institutions who had been absent from the market

for quite a while. The sensex finally closed at 3299 points with a gain of 326 points. The

main reason for this change in the mood of the market has been the early signs of revival

in the economy and the emergence of certain sectors such as pharmaceuticals and IT as

profit making machines.






The Indian IT sector emerged as a major winner during 1999, virtually outperforming all
the other sectors. Lack of demand and rising inventory forced the companies to cut down

production. Almost all the sectors recorded lower growth than the previous year, except

for the IT industry. While the Indian industry managed to stand tall vis-a-vis the

faltering economies of southeast Asia, the economic health of the country remained a cause

of concern. A sharp fall in exports, high inflation rate in the latter part of the year

and the rupee depreciation consequent to the nuclear explosion all affected the country's

economy. Moreover, there has been persistent political uncertainty, forcing the coalition

government to postpone important decisions. These include divestment of PSU shares and

clearance of important bills such as the Patents Bill, Company Law Bill and the Insurance

Bill.






One of the major event that led to this growth was the critical Y2K problem. While India
had an enviable pool of human resources, lack of marketing efforts had in the past limited

its growth. However, the Y2K gave Indian companies the opportunity to penetrate deep into

the US markets and make inroads into Europe and Japan. Moreover, Indian software companies

today are realizing the need to remain focused and move up the value chain by providing

solutions and not just programming skills.






Reflecting the increasing share of Indian companies in the global markets, the stock
markets have been chasing IT stocks like never before. During the year 1999, Hinditron

Informatics, Wipro and HCL Infosystems recorded gains of more than 1000% in one year.

Wipro rewarded its shareholders with a 2:1 bonus issue during the year. The share price of

Wipro was Rs456 at the start of the year whereas the current market price is a whopping

Rs1,839. HCL Infosystems too gained appreciably from Rs25 to Rs294 due to the spectacular

financial performance of its software division. Hinditron Informatics, a loss-making

company, moved up at the end of the year on the announcement of being taken over by

institution investors. The share price at the end of the year was Rs20 as against Rs1 in

January 1997. Out of the 46 IT companies analyzed, 38 recorded gains in the year 1997 with

26 of them gaining more than 100%. Apart from Wipro, Leading Edge Systems issued a 1:1

bonus, NIIT issued 1:2 bonus and at the end of the year Infosys Technologies too announced

a 1:1 bonus. The share price of Infosys crossed the Rs3000-mark on announcement of the

bonus issue, the third since the company's public issue.

During the fortnight, DSI-5 continued its upward journey and gained 12%. The height="103" align="right"> BSE Sensex too recovered and posted an 11% rise. Among the DSI-5 scrips, Tata Infotech and Satyam Computer Services gained with 19%, followed by Digital Compaq India that gained 13%. NIIT gained 11%, whereas Infosys moved 8% on announcement of 1:1 bonus issue. Almost all the IT scrips made gains during the fortnight, barring Leading Edge Systems and Fujitsu-ICIM which led the list of losers. The major gainers were Lee & Nee Software, Pertech Computer and Altos.

COMPANY REVIEW: RS

Software Ltd

The Eastern Star

Over the years, IT industry in

India has spread across different parts of India and today can be called a countrywide

industry except for its token presence in the eastern part of the country. Since the time

of independence, this part of the country has been left behind in the development race.

There are, of course, a number of reasons behind this fact. Starting with the

nationalization of most of the engineering and core sector companies headquartered there,

to the volatile politics of the region, it has been a 'no-no' for most of the new

industries in India.






With opening of the economy and somewhat softening of the leftist stance on privatization,
the negative image of the region among entrepreneurs has reduced to some extent. Some

investments have now come up in the region and there has been a marked improvement in the

infrastructure, especially in West Bengal.



Despite this improvement, IT penetration remains poor in the area. Notwithstanding a large
pool of personnel, software companies in general have shied away from the region. While

the region may have lower real estate and salary costs, the quality and experience of

software professionals, even to this day, remains poor compared to southern and western

regions. At the same time, a beginning has been made with the entry of majors like the JV

between CA and TCG Group, NIIT and Cognizant, among others. Among the first software

companies to set up shop in the region has been the Calcutta-based RS Software.






Background: Sloppy ground, strong base


Calcutta-based RS Software was set up in 1998 by Raj Jain an IT professional himself. The
company has the distinction of being one of the first units in Calcutta where hardly any

software units were planned till recently. The main reason for setting up the unit at

Calcutta, according to the management, was the number of technical institutes like IIT,

Kharagpur, IIM Calcutta and Calcutta University located in close proximity. The assistance

provided by WBEIC (West Bengal Electronic Industrial Corporation) was in no small measure

also instrumental in this decision.



The company invested heavily into computing facilities right from the early stages of its
operations. In the initial years, it worked with a Unix-based DCM Zeus and got its first

contract from Ashisuto of Japan in 1989. While the turnover stood at a modest Rs9.81 lakh

in March 1989, net profits were a minuscule Rs40,000. Thereafter, the company grew in size

as the turnover increased to Rs1.67 crore in March 1992 and Rs26.14 crore in March 1998.

The growth in net profit, however, was slow due to lower operating margins. The company

incurred high overheads of maintaining infrastructure facilities with no additional

revenue streams to compensate it. During this period, it largely worked as an onsite

consultant and its facilities remained largely under utilized. Further, high interest and

depreciation charges due to such investments further eroded the profitability. Another

reason for relatively poor profit margins is that the company was forced to sell cheap to

gain entry into large corporates.






RS Software came out with a public issue at a premium of Rs20 each in March 1994 to
finance its Rs6.40-crore expansion plan. A portion of equity was allotted to TDICI

(Technology Development & Investment Company of India Ltd) and Risk Capital &

Technology Corporation of India (RCTC) as co-promoters of the company. The entire project

cost was funded entirely through equity. Similarly, shares were also allotted to financial

institutions and mutual funds. The issue financed, among others, purchase of hardware,

software and augmentation of long-term working capital requirements.






The promoters were also allotted warrants which can be converted to 5.62 lakh shares at
Rs20 each if exercised before April 1998. These warrants were converted to equity shares

during the period ended March 1998 allowing them to retain a higher stake in the company.

Currently, the promoters hold 33% of the total equity of Rs4.69 crore. The venture capital

firm UTI Offshore fund holds 14%, Body Corporates and NRIs hold 5% and FIIs hold 1%. The

balance 47% is held by the public. The shares of the company are currently traded at Rs136

with a 52-week high of Rs171 and low of Rs17.






Operations: Headstart investment, slower growth


RS Software commenced operations to provide offshore services to its clients. However, the
company has operated mainly in the onsite market despite the excellent infrastructure.

This was possibly due to the lack of marketing efforts and its relatively smaller size. RS

Software achieved a total turnover of Rs27.00 crore out of which exports revenue stood at

Rs23.40 crore. The company achieved 75% of the revenues from onsite activity for the year

ending March 1998.






With a view to expand the business in global market, the company made a series of
alliances in 1994-95. The alliances included many leading international software companies

such as Software AG, for data warehousing and data management, Lotus Development Corp for

systems integration with Lotus Notes, Miles Burke Associates for enterprise systems, and

high-productivity systems for CASE tools. For the year ended March 1998, revenues from its

alliance partners accounted for 15% of its total turnover.






Among the services that RS Software provides include software development, enhancement,
and customization, wherein the company has considerable experience in the areas of

application development, enhancement and customization and has evolved a modular

development process. Under the software conversion and migration area, RS Software

executes data conversion and program language conversion. The company has also developed

process for providing support for migration of applications, minimizing the impact on

existing resources and ongoing activities. Apart from the services mentioned above, RS

Software provides round-the-clock remote maintenance of systems through its offshore

facility at Calcutta. The company also provides Y2K reengineering services that

constituted 20% of its total revenues in 1998. Its Y2K services broadly consist of Impact

analysis, code conversion, unit testing, integration, regression and compliance testing

and data conversion.






RS Software is currently executing several projects for a major credit card company. The
company currently maintains the system that was earlier developed in DOS environment using

COBOL. This is being converted to Windows environment using Visual Basic and C. It is

utilizing its expertise in the mainframe environment to execute the projects.






The company has well-equipped facilities at SaltLec, Calcutta, and a developer base of
more than 325 people. Its hardware facility consists of IBM Mainframe systems and a 64Kbps

satellite link to client systems in the US. The company has two development centers apart

from the corporate office measuring 2,300 sqft. The two development centers measuring

9,000 sqft and 8,600 sqft respectively are located at SaltLec.






In terms of marketing, the company's focus is now on the European and far eastern markets
that will reduce the company's dependence on the US markets. The company also has a 100%

subsidiary in the US, Responsive Solutions Inc, that acts as the marketing and

coordinating arm of the parent company. The various alliances have also helped the company

in achieving orders in the past. Its excellent service to its clients has ensured it

recurring business from its existing clients.






Future: Reaping the benefits


Over the years, RS Software has developed substantial expertise in the IBM mainframe
platform. The continued usage of mainframes and the level of investment made in these

platforms provides the company considerable hope in the future. The company expects to

achieve 95% of the turnover from IBM and AS/400 services and the balance from specialized

offerings such as ERP and internet in the current year. In the next year, business from

IBM mainframes and AS/400-related services are projected at 60% of the total revenues.

Unix and Windows-based offerings are expected to contribute 30% of the total revenues and

the balance is expected to come from specialized offerings. The expertise having been

proven will also help the company to transform itself from an onsite vendor to one that is

able to offer offshore facilities for its clients as well. Revenues from onsite activities

are expected to come down to 75% from 60% in the current year and 45% in the next year.






RS Software expects a 65% jump in the revenues in the current year and approximately 200%
in the next year, largely led by the growth in Y2K services. Y2K revenues are expected to

be around 20% of the total revenues in the current year and rise to 30% for the period

ended March 2000. While the revenues from Y2K will taper off, the company does not see

this as a major concern as it expects the IBM mainframe and AS/400 services to perform

well. The company also plans foray into specialized services such as internet and ERP to

meet its revenue targets. Moreover, the company is also planning to take up euro

conversion projects. It has presence in Europe through some of the projects it executes.

RS Software has entered into an strategic alliance with a leading IT vendor for extending

euro services. It is also in the process of partnering a leading consulting/tool provider

for outsourcing jobs in euro. However, the revenues from this area will not be sufficient

to cover the fall in the Y2K revenues. Consequently, the company will have to grow much

faster in its core area of providing services on the mainframe platform.






The company has currently 375 employees on its payroll which is expected to triple to
approximately 1,200 by the end of the year 2000. It plans an expansion of its facility by

setting up a new building measuring 34,000 sqft. The company's investment plans in

hardware include, enhancing existing satellite link, installing new servers and

replacement of IBM mainframe with S/390 architecture. While the company states that it

plans to finance the expansion through debt, a further dilution in equity is not ruled

out.






While the company's optimism is natural, considering its good first-half results, the
share of Y2K in the company's revenues does cause concern. While the Y2K service rates

should jump substantially as the millennium approaches, the new century will see a sudden

slowdown in Y2K revenues.






Financials: Expanding growth


The company's revenue have grown steadily in the past, recording a CAGR of 32% in the past
three years. The operating margins, however, have not improved due to high costs

associated with huge infrastructure and other expenses such as salaries and marketing

alongwith higher onsite activity. For the year ended March 1998, RS Software reported a

13% jump in total revenue to Rs26.14 crore. The net profits jumped from Rs1.42 crore to

Rs3.03 crore, thanks to a 27% fall in the interest charge and a steady depreciation

provision.






In the current year, RS Software is likely to post better profits due to the jump in Y2K
revenues. Turnover in the first half has risen from Rs8.57 crore to Rs18.49 crore, whereas

net profit leaped 221% to Rs3.02 crore. The Q3 results are also better than the

corresponding previous quarter with an increase in turnover from Rs4.45 crore to Rs8.95

crore and a 96% jump in the net profit to Rs1.47 crore. However, the turnover and the net

profit in the Q3 have declined with respect to the second quarter of the current year.

With the focus on offshore activity and higher Y2K revenues, operating margins should be

higher than reported in the past few years. Consequently, it can easily post a 40% jump in

total revenues and more than 90% jump in the net profit in the current year. Revenues in

the next year will grow much faster than the current year, due to the company's investment

in infrastructure and a further jump in Y2K revenues. While the operating margins in the

year 2000 will be slightly higher than in 1999, these would slightly come down after 2000

due to high overheads on account of expansion. However, the increase in offshore activity

should take care of any steep fall in the operating margins.

Financial: Massive Growth Ahead

(All figures in Rs Crore)

* Projected

Investment potential: Size to drive price


The share price of RS Software is currently traded at Rs136, discounting its March 1999
EPS by 11 times and the year 2000 EPS by five times. Shares of RS Software were trading at

Rs100 in December 1998 and have risen sharply in the past one month. The software stocks

have moved up substantially in the past few weeks and the change in the valuations of the

large software companies has had its impact on the small companies as well. Consequently,

the share price of RS Software has increased 33% in the past one month. Sustaining such

high valuation largely depends upon the growth of the company. With a sharp increase in

the revenues and earning in the next two years, the share price of RS Software is expected

to ride the software stock boom and move up from its current levels. Buy.