KPIT Infosystems: Where’s the Silver Lining?

The last couple of years have been tough for software services companies,

especially the mid-sized firms. The global slowdown and reduced IT spending

forced software companies to increase market spending and take on onsite

consulting assignments thereby severely impacting their margins. Like majority

of its peers, Pune-based KPIT Infosystems (KPIT) faced similar problems in the

recent past. Realizing the need to grow revenues and profits to a reasonable

size prompted KPIT to take the merger route and acquire Cummins Infotech, a

subsidiary of Cummins Inc, with an aim to enhance its service offerings, ensure

revenue growth and increase its market reach. The merger is expected to enhance

KPIT’s capabilities and generate business from the parent company. This trend

of inorganic growth is expected to gain ground as other mid-market companies

like KPIT also realize that continuous growth in not just good to have but a

necessary factor for the long term survival and prosperity for software services

companies.

KPIT was formed in the year 1990 as K & P Information Technology by

Kirtane and Pandit, a chartered accounting firm to provide onsite software

development services through its alliance partners abroad. The company gradually

revised its model by setting up offshore center in Pune. In early 1999, KPIT

came out with its IPO offering 12.96 lakh shares of Rs 10 each at a premium of

Rs 70 per share to setup a 10,000 sq. ft software development center at

Hinjawade, Pune. The company has a SEI CMM level 4 certification and has

subsidiaries in US, UK and a joint venture in the Middle East.

KPIT provides software services in the area of Internet consulting and

development, re-engineering and migration, software product development and

management, business intelligence solutions, oracle applications, control

automation and engineering solutions. KPIT primarily focuses on the BFSI space

and also provides services to consumer goods and telecom clients. In terms of

revenues, 40% of the company’s revenues came from the BFSI space in the year

ended March 2002, 16% from manufacturing and the balance from other verticals.

KPIT posted revenues of Rs 47.84 crore in the year ended March 2002.

Late last year, KPIT decided to merge Cummins Infotech, a subsidiary of

Cummins Inc, with itself to expand its service offerings. Cummins Infotech has

strengths in the manufacturing industry vertical with a focus on e-business and

Lotus notes based solutions. Cummins Infotech had 65 employees and closed March

2002 with revenues of Rs 6.50 crore. Cummins Infotech was 49% held by US-based

Fortune 500 $ 5.70 billion company, Cummins Inc and 51% held by Cummins India.

Cummins Inc has a 51% stake in Cummins India. Cummins Infotech was one of the

three preferred offshore vendors of Cummins Inc and post merger; KPIT Cummins

Infotech would also become a preferred vendor. The other two preferred vendors

of Cummins Inc are TCS and Mascot Systems. The merged entity started working

together since January 2002 although the Bombay High Court approved the merger

recently. The merged would enable KPIT to build competency in Key Technology and

Practice areas specific to the verticals such as embedded software, e-business,

collaborative computing, databases, and ERP. The merged entity, called KPIT

Cummins Infosystems, aims to achieve revenues of $ 100 mn by 2006-07 based on

the revenue flows from Cummins Inc. The acquisition is also aimed at

substantially enhancing skills in the manufacturing vertical, largely related to

embedded software and e-business solutions. KPIT plans to further enhance its

offerings in the area of infrastructure support and PDM.

The merger is based on stock swap and KPIT would issue 704,000 shares to

Cummins, equivalent to 12% of the merged entity’s capital. KPIT would also

issue 1,933,000 options to Cummins, which can be converted into shares over the

next five years based on the business flow from Cummins to KPIT. In case of full

conversion of the options, Cummins would hold an additional 38% stake in the

company.

KPIT’s revenues for the year ended 1998 at the time of the IPO stood at Rs

15.59 crore and the net profit at Rs 1.90 crore. The company had projected

revenues of Rs 27 crore and net profit of Rs 4.50 crore in the full year ended

June 1999. KPIT failed to meet its bottomline target although its revenues were

only slightly below target. The company reported revenues of Rs 25.01 crore and

net profit of Rs 3.36 crore in the year ended June 1999. The company’s

performance in the year 2000 was also disappointing due to the sharp increase in

the operating costs. While sales went up by 28% to Rs 32.09 crore, the company

reported a loss of Rs 34 lakhs in the year ended June 2000. KPIT improved its

performance in the 9 months ended March 2001 but the results for the year ended

March 2002 were again disappointing. The company reported revenues of Rs 47.84

crore and net profit of Rs 2.14 crore, down by 8% and 53% on annualized basis.

KPIT reported revenues of Rs 26.03 crore and net profit of Rs 1.31 crore in the

first half ended September 2002. In the second quarter ended September 2002, it

reported revenues of Rs 13.74 crore and net profits of Rs 85 lakhs, up by 12%

and 35% over the corresponding quarter of the previous year. Its revenues and

net profit grew 12% and 85% respectively on a sequential basis. KPIT’s

operating margins stood at just 12% largely due to high travel costs,

constituting almost 50% of the total expenditure of Rs 12.15 crore. On a

consolidated basis, KPIT’s half-year revenues stood at Rs 28.46 crore and net

profit at Rs 54 lakhs.

Going ahead, KPIT expects to close fiscal 2003 with consolidated revenues of

around Rs 68 crore to Rs 72 crore and net profit of Rs 4.8 crore to Rs 5.30

crore. It expects March 2004 revenues of around Rs 100 crore and Cummins share

is expected to be around 1/3rd of the total revenues.

KPIT currently trades at Rs 171, discounting the projected March 2003 EPS by

23 times and March 2004 EPS by 15 times. KPIT’s merger with Cummins is

expected to give an impetus to its financial performance in the coming years.

Moreover, the merger would also improve the reach of the company in the global

market. We however feel that growth targets set by the company are optimistic

and it would take a much greater effort to scale its business both from Cummins

and other clients to meet these targets. In terms of valuations, we feel that

the stock price has discounted the impact from the merger and is trading at a

substantial premium to the mid-sized peers operating in the services segment.

KPIT was trading at Rs 42 last year and its share price jumped to touch a high

of Rs 234 in April 2002. KPIT has since stabilized and currently trades in the

range of Rs 160 to Rs 180. While we do not expect a major downside it seems from

the current levels, that a re-rating in the stock would happen if the company

reports a substantial improvement in its performance in the second half. Market

Performer.

Sushanto Mitra is the founder

of Technology Capital Partners

The views reflected here are of the author and not of this publication. No

liability is accepted for losses based on the information presented here