TATA ELXSI: The Entertainment Elixir

The outsourced market for animation and other entertainment related services
is a multi billion dollar industry and coupled with the large domestic market,
India’s potential in this sector is huge. Yet, there are only a handful of
Indian companies that have made a mark in this sector.

One of the key reasons for the lack of success in this area is the
significantly higher level of investments required in the animation industry
compared to software and BPO sectors. This is largely due to the longer
gestation period required for these companies to break even as well as the
higher level of IT infrastructure requirements especially for 3D animation and
special effects capabilities. Poor presence of Indian companies in key markets
is also a cause for the lack of penetration into the market.

Until now, few of the established IT players have moved into the sector with
the exception of the Pentafour Group and the Bangalore headquarted Tata Elxsi.
We believe that in the foreseeable future, only the well funded forays into this
sector and only those with a strong market focus are likely to succeed.

Established on March 30, 1989, Tata Elxsi’s business divisions are product
design services, integration and design engineering services and visual
computing labs. The company offers an entire range of services, right from
concept design to engineering, analysis to manufacturing. In the past five
years, the total income has grown at a CAGR of 3% to Rs 110.0 crore whereas its
net profit has risen at a CAGR of 43% to Rs 11.7 crore. The company’s current
equity stands at Rs 31.1 crore with promoters holding 38%, institutional
investors holding 0.5%, Indian public holding 53.93% and others holding 7% of
the stake.

Tata Elxsi has traditionally been a hardware company and still derives a
portion of its revenues from the CAD/CAM/GIS solutions that caters to the needs
of the automotive, aerospace, defense, tooling and engineering industries. The
film, video and broadcast division provides solutions for post-production and
broadcast houses in the areas of editing, composing 2D and 3D animations. The
scientific computing group offers technical computing systems to academic
institutes and research laboratories in addition to providing software tools
from Molecular Simulations Incorporated for basic chemical research in molecular
modeling and reaction simulation in the areas of life science and materials
science. The commercial computing and networking group offers solutions to large
enterprises, ISPs, banks and financial institutions.

There are four design and development centers in India, out of which three
are in Bangalore and the fourth one is in Thiruvananthapuram providing services
like visual computing, network and communication systems, embedded programming,
internet, intranet and groupware.

Over the years, Tata Elxsi has built strong alliances with various industry
leaders. The company has a tie up with Silicon Graphics for distributing its
machines and also provide customization services. Also, it recently tied up with
Hitachi to provide and develop engineering software solutions, for all its
divisions. Some of the other alliance partners include Compaq, Alias Wavefront,
Discreet Logic, Molecular Simulations, Lucent and Cambridge Animation Systems.
The company has several strategic alliances with international companies such as
Compaq and Molecular Simulations to distribute their products in India. In the
CAD/CAM arena, Tata Elxsi has tie-ups with companies like Silicon Graphics and
Matra Datavision. Tata Elxsi also has alliances with Discreet and Cambridge
Animation Systems for film and entertainment markets.

For the financial year ended March 2003, Tata Elxsi’s total revenues
declined 16% amounting to Rs 110 crores as compared to Rs 130 crore earned in
the previous fiscal largely due to the downturn in both domestic and overseas
markets. The company also consciously exited segments of the low margin Indian
market. The company’s net profit for fiscal 2003 amounted to Rs 11.7 crores as
against Rs 16.8 crore earned for the financial year ended 2002, a decline of
30%. The SI business of Tata Elxsi that was historically the larger contributor
to revenues had total sales of Rs 33.1 crores while Rs 76.6 crores came from
software development and services segment comprising 70% of the total revenues.
59% of the total revenues were earned from domestic business activities whereas
41% was earned from overseas.

During the current financial year 2003-04, the company has made significant
progress in the animation special effects business. Tata Elxsi with a background
of systems integration in entertainment markets is now leveraging its
understanding to deliver services in this area. The Visual Computing Labs at
Mumbai, a division of Tata Elxsi provided twenty minutes of effects for the
Bollywood feature ‘Fun2shh’. This division of the company also delivered
about 40 minutes and 36 minutes of special effects for Karan Johar’s ‘Kal Ho
Na Ho’ and Kaizad Gustad’s ‘Boom’ respectively.

The company has also delivered special and animation effects for various
Indian and Hollywood films from its facilities at Bangalore and Mumbai. It also
claims a steady flow of projects from television series, advertisement films,
animation and games development.

Revenues for the quarter ended December 2003 amounted to Rs 38.8 crores, up
7% as compared to Rs 36.3 crores sequentially and was up from Rs 25.2 crores for
the same quarter in the previous year. Net profit for the third quarter of the
fiscal 2003 amounted to Rs 5.6 crores as compared to Rs 4 crores in the
immediate previous quarter, up 43%. Year on year, Tata Elxsi‘s net profit grew
38% as compared to Rs 4 crores. The system integrated and support services
segment contributed 32% of the total revenues for the quarter ended December
2003 amounting to Rs 12.3 crores, down 12% sequentially and up 129% y-o-y as
compared to Rs 14 crores and Rs 5.4 crores respectively. The software
development and services segment contributed the balance 68% that amounted to Rs
26.5 crores, up 19% and 34% sequentially and year on year respectively.

Over the next few quarters, an increase in turnkey product development
projects and royalty revenues from areas such as internet telephony, video
conferencing, multimedia players is likely to boost Tata Elxsi’s growth. The
company has already signed several turnkey projects over the last few months and
expects a jump in royalty revenues for its intellectual property to the tune of
twenty per cent of its earnings in the next few quarters. The company expects to
add two hundred people to the existing work force of 1100. Tata Elxsi is also
expecting a major growth for its division Visual Computing Labs in the coming
years as it seeks to focus on overseas markets.

Tata Elxsi is currently traded at Rs 93 discounting our projected March 2004
EPS by 16 times and March 2005 EPS by 12 times. While the share has already
appreciated by over 50% from its 52 week low, we believe that improving business
from both technology and entertainment verticals is yet to be fully discounted
into the current price. The possible merger of all IT related companies of the
Tata Group further strengthens the chances of appreciation. Outperformer.

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