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.

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.

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.