Winner Of The Bourses

IT stocks witnessed considerable improvement in valuation in the calen-



dar year 1998. Investors were attracted towards IT stocks after bonus issues by Wipro and NIIT and the turnaround story of HCL Insys. At the same time, some feared if the stocks could sustain its performance in 1999. Whether the stocks would sustain its valuations depends on the growth of the company and the sector. The Y2K phenomenon also led to some slowdown in new development work and with the Y2K projects themselves coming to an end, the future of Indian software growth was in some doubt. 

Yet 1999 was no different from 1998. Y2K was just the launch pad that IT companies were looking for to make inroads into the global IT market. Traditionally, while India’s pool of human resource was leveraged, growth of Indian companies was limited due to lack of marketing efforts. Further, Indian companies were low down in the value chain and were selling primarily programming skills. The size of the Indian software exports industry stood at Rs10,940 crore for the year ended March 1999, representing just 1% of the global market for IT software products and services. Since March, Indian companies have overcome their marketing inertia and have worked hard to improve their share in the global market. 

By the end of the year, the Indian software sector has shown maturity in almost every aspect of the business–valuations on the stock market, financial performance, strategy, innovations and technology development. We look at some of the major events that made the IT sector ‘The Winner of the Bourses’. 

IPO: Public loved the issues



The primary market has been in doldrums since 1996 with only a few banks bringing out public issues. However, Bangalore-based Sonata Software decided to raise funds through its IPO in December 1998. The company offered its shares at a premium of Rs80 per share, which were then listed at a phenomenal premium of 181% to the offer price in January 1999. The listing of shares of Sonata Software not only revived the primary market but also boosted the confidence of many companies waiting to come out with their IPOs. Following Sonata Software was Hyderabad-based Cybermate Infotek, a Rs1.62 crore company. This less well known company offered its shares at par and received an excellent response to its maiden public issue. The shares were listed at the Hyderabad Stock Exchange at Rs20 and are currently traded at Rs120. Pune-based KPIT Systems followed suit with a public issue at a premium of Rs90 per share. Its shares were listed at Rs325 and currently trade at Rs245. 

The success of these issues opened the doors to the capital markets for a number of IT companies. With every successive issue, the over-subscription ratio is widening signifying a huge demand for software stocks. While the public issue of Sonata Software was oversubscribed by just four times, issues following it met with astounding success. Hughes Software, which tapped the capital market with a Rs275 crore issue, attracted investment demand of a whopping Rs6,000 crore in the book building process. While the book building issue by HCL Technologies attracted an investment demand of Rs20,000 crore against the offer size of Rs741 crore. The flow of investment through the IPOs is understandable considering the high valuations of the existing listed companies. Established companies such as SQL Star International, Polaris Software, Polaris Software Labs, Hughes Software and Subex have also created excellent value for subscribers to their issues. SQL was listed at Rs110 and is currently traded at Rs209 against the offer price of Rs55. Polaris Software Labs was listed at Rs580 and is currently traded at Rs735 compared to

the offer price of Rs220 per share. While Hughes Software, which offered its 



shares at Rs630 listed at a whopping Rs1,585 per share. It touched a high of Rs1,839 per share and is currently traded at Rs1,519. 

Private placement: Institutional investors were also keen



While the IPO was the preferred route for closely held companies, the existing listed companies chose the private placement route. A number of listed companies offered the shares on private placement. Prominent among these was Mumbai-based Aptech, the IT education giant, which successfully raised Rs117 crore in the domestic market by placing 13.4 lakh equity shares at a price of Rs875 per share. Chennai-based software education company SSI issued 750,000 shares on preferential allotment at a premium of Rs750 per share to raise Rs56.25 crore. SSI had earlier issued 450,000 shares on preferential allotment at Rs320 per share in early 1998. Mumbai-based Aftek Infosys allotted 15 lakh equity shares to NH Securities at Rs36.50 per share to raise Rs5.48 crore. Aftek’s share is currently traded at Rs731. Some of the other companies that offered shares through this route include Moser Baer India and Maars Software. 

Foreign listings: Even Nasdaq was interested



Bangalore-based Infosys Technologies became the first Indian company to have its shares quoted on Nasdaq. The company offered a total of 20.7 lakh American Depository Shares (ADS) at a price of $34 amounting to a total of $70.38 million or Rs299 crore in March 1999. As two ADS represent one share, the effective offer price per share was $68 (Rs2,890 per share). The ADS, listed at $33.75, immediately touched $50 and ultimately closed at $44.25. The ADS have since zoomed to touch $235 by the end of November. Satyam Infoway, a 70% subsidiary of Satyam Computer Services, made its debut on the Nasdaq offering American Depository Receipts (ADRs) at $18 in October. The ADRs are currently traded at $75, a jump of 316% in less than two months of trading. Following the success of these companies, more Indian companies are queuing up to list their securities in the US market. Some of these are Mastek, Pentafour Software and Silverline Industries.

Acquisitions: Happening



After the worldwide takeover of Digital by Compaq last year, Compaq Computer (India) acquired the computer products and services business of Digital Equipment (India) for a consideration of Rs83 crore. Digital Equipment has realigned its business offerings, becoming a totally software- oriented company. Mumbai-based Cybertech tookover Bangalore-based Equinox, an ecommerce solution provider. Infotech Enterprises, Hyderabad, tookover Cartographic Sciences, a fully-owned Indian subsidiary of US-based Analytical Surveys Inc (ASI). Cartographic Sciences has a data conversion facility at SEEPZ, Mumbai.

Financial Performance: Stellar



The growth in profit of IT companies continued to remain ahead of growth in revenue indicating the improving economies of scale and movement up the value chain. The cumulative revenues of about 35 major software companies jumped 40% during the year ended March 1999. The cumulative net profit on the other hand grew 81% during the same period. Among the leaders, VisualSoft (I) reported a growth in turnover of 222% to touch Rs30.32 crore and an increase in net profit of 310% to touch Rs11.61 crore. Similarly, for the first half ended September 1999, revenues and net profit grew 150% and 202%, respectively. Infotech Enterprises and Satyam Computer Systems reported growth in turnover of more than 100% in March 1999, whereas Infosys Technologies reported a 94% growth in revenues despite a much larger base.

Bonus: And stocks were splitting



Satyam Computer Services achieved the SEI level 5 certification becoming one of the prestigious few in the world to attain this distinction. The company also announced a 1:1 bonus issue. Maars Software too announced a bonus issue in the same ratio in September 1999. 

Stock Markets: No complaints



While the mood in the stock markets changed with the political happenings, IT companies were singing a different tune. The sensex opened at 3,122 in January and moved in a narrow range to touch 3,223 in February. The announcement of the budget in February led to a major jump in the Sensex, which touched a high of 3,750 by mid April. However, the fall of the BJP government pulled the Sensex down to 3,245 by the start of May. Despite the announcement that fresh elections will be held in October, the Sensex begin its northward journey and touched 4,900 by September. It crossed the 5,000 mark for the first time in October but fell due to large-scale divestment by FIIs by the end of October. 

The software sector was one of the two sectors that attracted maximum investment during the year; the other being the pharmaceuticals sector. There were two major reasons for the attraction towards the software sector. First, the growth rate shown by software companies were unheard of in the past. The software companies continued to report growth of more than 50% with some of them even reporting a 100% jump in revenues. Second, traditional sectors such as commodity and infrastructure were in doldrums due to recession. The economic survey for 1999 revealed a deteriorating fiscal situation in India due to a fall in both exports and industrial growth. The software sector witnessed selling pressure during September as the improving signs of the industry led to a shift in investment from IT to certain cyclic stocks. However, the financial results of the cyclic companies failed to cheer the investors, which led to the re-investment in the software sector.

Value for money: The winners on the bourse



While Mumbai-based Aftek Infosys was the clear winner in terms of capital appreciation in the period January to November, Infosys Technologies, at Rs30,391 Crore, excelled Wipro to command the highest market capitalization. The market capitalization of Wipro stood at Rs28,193 Crore, whereas that of Satyam Computer Services stood at Rs18,289 Crore. The combined market capitalization of these companies made up approximately 70% of the total market capitalization of IT companies.

Aftek Infosys provided the maximum returns with the share price zooming from Rs50 to Rs 731. It was followed by Mastek, with a 997% jump in share price–from Rs490 to Rs5,380. Sonata Software, VisualSoft (India) and Transmatic Systems followed Mastek. Notably, Wipro, which was traded at about Rs4,500 in September, decided to go in for a stock split resulting in its share being split into five shares of Rs2 each. While Bangalore-based IT goliath Infosys Technologies split its share into two shares of Rs5 each.

The craze for software stocks can be gauged from the fact that investors fancy any stock that has software appearing somewhere in its name. This led to a number of companies changing their business focus or just their name with the sole intention to pump life in their otherwise dead stocks. A large number of such companies have witnessed excellent demand for their stocks.

Emerging trends: The only way to go is up



Moving up the value chain is no longer just a mantra. Increasing competition and costs have forced companies to focus on a faster move up the value chain. Even smaller companies are now shifting from onsite to offshore. The international IT user industry have shown an increasing level of comfort by setting up offshore development centers. Moreover, an increase in revenue from offshore development centers improves operating margins and consequently cash flows for subsequent expansions.

Despite the increasing costs of salaries and higher provisions for depreciation due to infrastructure enhancements, software companies were able to report excellent performance in each quarter. This was largely due to the increase in dollar rates and the shift to the offshore model, enabling the companies to report high operating margins. While the upcoming software companies garnered funds through private placement and IPOs, established ones like Infosys and NIIT began looking out of the Indian market to supplement their growth. Infosys made an ADR issue and raised $70.38 million with a view to acquire a US-based software company. NIIT too firmed up plans to acquire a company in the US and set aside an estimated $100 million. Neither of the companies having managed to acquire a company yet, but a number of companies are gearing up to raise funds from the US market intending to acquire. However, the possibility of more companies raising funds from the US market will depend on the valuations in the US market. 

Moving ahead on the value addition chain, companies are focusing on providing turnkey services. They are even considering outsourcing certain work elements from other companies in India or elsewhere. Yet, at the higher end of the value chain, where product or technology development is undertaken, Indian companies are yet to make a mark. Apart from a few companies like Infosys, NIIT, Satyam, Visual Soft and Wipro, a majority of companies remain providers of programming skills alone. However, this is changing and in the coming years this could be a major trend among software companies. 

Looking ahead



Post Y2K, the future is challenging for the software sector and even more puzzling for the investors. Some skeptics believe the software sector would die after Y2K. Contrary to this belief, the sector will continue to sustain its growth in the coming years. 

Successful companies: What are they doing



The major challenge for software companies today is the ability to maintain growth rates in revenues and profits. As the Y2K orders taper off and ERP markets remain somewhat dull, software companies have to find ways of maintaining growth. While, NASSCOM predicts a 40% growth in the next 10 years, it’s going to be a lot harder than in the past. The main reasons for this is due to increasing competition from India as well as other emerging software countries. A number of US companies too have in recent times set up centers in India and are able to offer comparable rates to clients. They have an added advantage–a development center in the US as well. These companies have the ability to offer attractive compensation packages. They will also provide US-based jobs more easily to their staff. How do we meet this challenge? Some of the answers can be found among steps being taken by companies like Infosys and NIIT who with their higher staffing costs and overheads are more severely affected. 

One of the trends clearly emerging is acquisition of companies in the US and Europe. This strategy enables companies to quickly penetrate international markets leveraging the targets of marketing resources, instead of a longer and usually less successful independent foray. It also allows the companies to employ locals overseas–people who have greater knowledge of the market and also the ability to understand customer requirements effectively. Moreover, the valuations of software service companies in the US are 0.5 to 3 times the turnover. This seems attractive compared to that of the Indian companies, which is higher. NIIT, Infosys and a number of mid-sized companies are looking at this direction and we expect this trend to emerge as a strong force. 



Another direction of movement is for developing a clear sectoral focus such as finance, retailing and supply chain management as a means of positioning the company at par with consulting companies rather than software developers.

Success here is much harder as companies have to fight established players starting with the ‘Big 5’ firms to small niche players who focus on particular areas such as the internet, ERP and multimedia. However, companies like Satyam, TCS and Infosys, among others, are developing high-end capabilities in specific technology and sectoral areas. This is now a necessity rather than a luxury as the IT user-market matures. 

Human resource management has always been and will continue to be the major challenge to IT companies. An increasing number of companies are moving towards stock options and other incentives to promote retention as well as a profit-oriented workforce. To beat the MNCs in compensation, companies like Infosys have already firmed up plans to issue ADRs against ESOPs to the Indian employees. Similar moves are being contemplated by other companies in the field. 

Investors: Will the honeymoon last?



The investors’ honeymoon with software stocks has now lasted over two years as the appreciation of IT stocks have beaten expectations of most optimistic analysts over and over again. This appreciation can be attributed to a number of reasons, foremost being the excellent performance of software companies. Better understanding of the software sector as well as a continued dull performance of other sectors of the economy has contributed to this change. A similar honeymoon with software services companies in the US has recently ended. The question really is whether this will happen in India?

India has established advantages in software services and individual companies are converting many of these advantages, with help from stock markets, into creating strong barriers to entry. Given this, there will be companies who will be able to sustain and perhaps even improve their growth rates. At the same time, there are companies which are not taking advantage of their intrinsic strengths and are unlikely to be able to sustain growth rates in the coming years. This means that the long-term investor has to be far more cautious in making investment decisions than in the past. The stock markets tend to over-react to situations all the time and clearly, today, software is what they love the most. However, as the Indian economy moves out of recession and if some of the software companies don’t match investor growth objectives, the software sector valuations will surely take a beating.

This will affect the small and mid-sized companies the most and investors would be well advised not to take a long-term view on these stocks. One could move into the primary market where the valuations as well as the level of risk is much lower. Or one could move into stocks of bigger companies which have a secure future. Companies operating in strong niche areas could also be a good long-term strategy. 

Future: What it holds?



In overall terms, while it is difficult to predict the future of the stock markets, we are confident that the Indian software
sector will continue to get investor interest especially in the short term. This means that software prices are likely to move upwards in the short term. This phase could well last for four to six months. In the medium term, we expect some corrections and the investment community will increasingly start differentiating between companies who will continue to grow and those who won’t. This correction will especially hurt those investors who are parking their funds in companies with little or no competitive advantages or of dubious origin. 

The future therefore remains positive but investors need to be cautious in their approach. While in the short term, there are no immediate reasons to start worrying, investment in small and mid sized companies needs to be reviewed. We believe that a majority of software stocks today quote beyond their intrinsic worth and their valuations cannot be sustained over long periods of time. But a number of companies remain attractive buys even at their current valuations. In the final analysis, as long as investors stick to the fundamental strength of companies, there is little to fear.

Susanto Mitra



is a financial consultant with 



Techcap Consultants India