Melstar Information Technologies

One of the most disappointing periods for investors who held
on to infotech stocks started in March 2000. Prices of all the technology stocks
plummeted giving little or no opportunity to the investors to book profits.
Similarly, for companies that were listed during the period, the experience was
no different as they saw their shares listed in a volatile market. And share
prices of some of the companies dipped below the offer prices.

Fact Sheet

Melstar Information Technologies
Melstar House, G-4
MIDC Cross Road ‘A’
Andheri (East)
Mumbai 400 093
Tel: 091 022 8310505
Fax: 091 022 8310520
Website: www.melstar.com 
Offices: Mumbai, Bangalore, San Jose, New York, London, Zurich and Singapore
Listing (Stock Exchanges): Mumbai Stock Exchange and National Stock Exchange
BSE Code: 32307
NSE Code: MELSTAR

Mumbai-based Melstar Information Technologies was listed in
January 2000 and its share price has since been on a steep decline ever since.
Melstar has geared up its operations at a rapid pace and may well throw up a few
surprises in the coming years.

Background: Starting from hardware

Melstar was originally promoted as Sifa India by Sifa GmBH
and the Patel Group of Mumbai in August 1986. In August 1991 the present
promoters–Suresh Bansal, SM Arora, Bharat Ramani and Sattar Shaikh–bought
over the entire stake in the company. The 42-year-old Bansal is the executive
chairman while Arora, ex-IBM, is the managing director.

Melstar’s initial operations involved exporting computer
hardware and hospital equipment. The company entered the software export arena
in 1993 and since then has successfully managed to transform itself into a
software services company. However, its software business has grown only during
the last three years. Melstar’s software revenues have grown from Rs 4.5 crore
for fiscal ended March 1998 to Rs 30.9 crore during fiscal ended March 2000.
Last fiscal the company garnered major revenues from software services.

Melstar went public by offering 2,261,000 equity shares and
an offer for sale by promoters of 889,000 shares at a premium of Rs 62 per
share. The issue was oversubscribed around 80 times. Melstar’s promoters
currently hold 35%, the Usha Martin group holds 15%, financial institutions hold
11%, mutual funds hold 3% whereas the public and employees hold the balance 33%.

Operations: Transiting to software

Melstar’s operations have undergone drastic changes during
the last three fiscals, especially during the 1999-00. Out of the total turnover
of Rs 36.5 crore during fiscal ended March 2000, software sales stood at Rs 30.9
crore, an increase of 72% over the previous year. The company provides software
services mainly to vertical industries such as banking, finance and insurance.
Some of its major clients include Citibank, Standard Chartered Bank and
Informix. Software exports contributed Rs 25.1 crore to the turnover with 70% of
this coming from the US and the balance from Europe. Software exports during the
fiscal ended March 1999 had been Rs 10.5 crore. Revenue from onsite operations
made 45% of total software exports. The top 10 clients of Melstar contribute 50%
to its revenues.

Melstar has six software development centers out of which
four are located in India and one each in the US and the UK. In India the
company has set up a dedicated center for IBM Global Services and Informix. The
IBM Global Center is located at Bangalore having a total area of 4,000 Sq ft
with 55 software professionals currently working on IBM projects. The dedicated
center for Informix is located at SEEPZ, Mumbai. Currently 100 employees have
been deployed at this center, which is spread across 12,000 Sq ft. The company’s
major software development center, Melstar House is located at MIDC spanning
15,000 Sq ft. The center, with 130 software professionals, is engaged in
providing object and component technologies, e-commerce solutions using Oracle
technology, Microsoft technology and Sun Java technology. Melstar has partnered
with Robert Day of Antelope & Partners, UK, for developing object and
component technologies. Some of Melstar’s international clients include HP,
Microsoft, ASPOnline, ITC Consulting and Linkhand, whereas its domestic clients
include RBI, Vyasa Bank, ANZ Grindlays Bank and Standard Chartered Bank.

Apart from the 100% subsidiary in the US, Melstar had two JVs
in the US and the UK. It held a 45% stake in the US-based, Global Systems
Development (GSD), and recently acquired the balance 55% from the Summit group
and ITC Consulting for Rs 8.4 crore.

Similarly, Melstar has also acquired the UK-based Linkhand, a
company engaged in providing software services in the insurance and banking
areas for Rs 34 crore. Linkhand currently holds a 30% stake in Melstar UK with
Ellies Systems holding 4% and Melstar holding the balance 66%. Melstar also
plans to merge Linkhand with Melstar UK, which will become a 100%-subsidiary to
be called Melstar Linkhand. Linkhand is projected to close the current calendar
year with revenues of $6.5 million. In all the deals, 75% of the total
consideration will be provided through Melstar’s equity and the balance by
cash during the year.

Melstar has formed a 100% subsidiary in India called Melstar
India Centric, which would provide net solutions to domestic companies. Melstar’s
total employee strength in September 2000, up from about 300 in March 2000.
Melstar’s processes comply with SEI CMM level 3 for all its projects in India
and abroad.

Future plans: Ambitious expansions

Melstar has identified software exports to be its growth area
in the years to come. The company’s strategy has been to enter new markets
through JVs and tie-ups while capitalizing on the infrastructure and skill sets
available in India. In the software exports market the company currently earn
most of the revenues from the US. However, the company expects Europe to
contribute more than the US in future.

Currently, Melstar has 30 employees in the UK and post
acquisition this should increase to 64. The company plans to increase its
employee strength to 1,000 by March 2001. This is expected to further rise to
more than 2,500 by March 2003. Melstar has also planned a gradual increase in
infrastructure. It plans to set up two software development centers in Bangalore
and Mumbai in the current fiscal with a capacity of 100 software professionals
each. It also plans to set up a massive software development center at Kalva,
near Mumbai, in 20001. The center, to be built in phases, can house 2,000
employees and would cost Rs 25 crore.

In terms of business, Internet is expected to remain in the
forefront of the company’s growth plan. The company also expects to expand its
client list in the banking and insurance areas once the acquisitions are over.

Melstar is increasing the size of its offshore development
centers to provide offshore services to its new clients. It is also in talks
with a software major to set up a dedicated development center similar to
centers set up by IBM and Informix. Apart from entering new areas such as
telecom and manufacturing, Melstar plans to provide e-commerce services to
foreign governments. Melstar’s other plans include a listing in the overseas
market and achieving SEI CMM level 5 by March 2002.

Financial performance: Improving

The company’s financial performance over the years has not
shown any impressive growth. However, this has been largely due to the
transition in its business model from hardware to software services. The company
recorded a 10% increase in turnover to Rs 35.7 crore during fiscal ended March
2000 while net profit stood at Rs 10 crore as against Rs 51 lakh during the
previous fiscal. However, the jump in net profit is mainly due to the Rs 6.8
crore, which came from interest on subscriptions. The adjusted net profit for
March 2000 stood at Rs 4.4 crore. In the first quarter ended June 2000, the
company has reported a turnover of Rs 11.7 crore compared to Rs 5.7 crore in the
corresponding quarter in the previous fiscal, whereas the net profit has jumped
460% to Rs 1.9 crore.

Melstar expects its revenues to increase 125%. Since the
formalities relating to the pricing of stocks for acquisition is yet to be
completed, we have not taken into consideration the effect of such acquisitions
in the projections. Higher overheads and employee costs would put the operating
margins under pressure.

Financials

(All figures in Rs crore)

 

1999

2000

2001*

2002*

Revenues

35.0

36.5

64.6

111.1

Other Income

0.2

7.0

1.0

1.1

Operating Profit

2.4

7.9

11.9

21.0

OPM (%)

8.1

21.7

18.4

18.9

Net Profit

0.7

5.6

9.8

16.2#

Equity Capital

8.6

12.2**

12.2

12.2

EPS (Rs.)

0.8

4.6

8.0

13.4

* Projected. # Net
extraordinary income of Rs 6.8 crore
Year ended March 31
** Equity increased due to public
issue 

On the other hand, the acquisitions would give the company a
strong hold in the European and the US markets. We expect the margins to improve
in the long run as the company executes more projects offshore. It expects to
report a consolidated turnover of Rs 100 crore in the fiscal ended March 2001.

Melstar’s equity is expected to increase on allotment of
shares. Moreover, cash outflow for the acquisitions is expected to be more than
the internal accruals and the company would therefore have to raise funds either
through debt or through further equity dilution. While Melstar has not ruled out
further issue of equity on private placement to raise funds for acquisitions, we
believe that further dilution would have a negative impact on the sentiments.

Investment potential: Attractive valuation

Melstar is currently traded at Rs 100 discounting its
projected March 2001 EPS by 12 times and March 2002 EPS by seven times. We
expect these multiples to change by 25% each once the company issues equity on
acquisitions. The current valuation of the company is comparable to Orient
Information, Sierra Optima and VJIL Consulting. Melstar’s shares were listed
at Rs 300 in March 2000 and touched a high of Rs 368 on the listing day. The
share price has failed to cross Rs 300 since the listing and has slipped to the
current level of Rs 80-100 in line with the trend witnessed among infotech
stocks.

Melstar has successfully shifted from a hardware to a software company in the
past thee years. With the acquisitions, the company would be in a position to
make the shift at a much higher rate than in the past. Its growth plans look
very ambitious considering its current scale of operations and resources at its
disposal. The key is to successfully implement the plans and manage the size,
which the company has planned in the next two years. We believe these two
factors would be crucial for the company to move up the value chain and the
company is geared up on these fronts. On the flip side, the equity dilution
remains a cause for concern. Melstar would have to go for right mix of equity
and debt to finance its acquisitions and investment in infrastructure. We
believe there is minimum downward risk at the current price and a re-rating of
the stock is expected once the formalities relating to acquisitions and
financing plans are completed. Buy

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.

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