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Analysis – NIIT Tech

By Rohit Chauhan
In Investment ideas, Uncategorized
April 9, 2008
4 Min read
31 comments
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Note: The analysis below is dated end of march – beginning of april. The stock has had a major jump since I started analysing the company. In interest of disclosure, I have a position in the stock. So please take this as a biased analysis. In addition I do not know if the jump in price is temporary and the price will fall again or it will continue rising. So as usual, please do your own analysis, read my disclaimer below and don’t blame me if your decision is based on my analysis alone. In summary – I am not recommending anyone to buy or sell the stock.

About
NIIT technologies is a 900 Crs company. It is a spinoff from NIIT ltd and is in the business of ITES and BPO. The company has 50% of revenue from Europe, around 30% from US and the rest from Asia, and other parts of the world

The company has a focus on a few key verticals such as BFSI (more in insurance), Transportation and retail services. The company has done a few targeted accquisition (such as ROOM solutions) in the above verticals in the last few years. In addition the company has signed a few JV’s too in the past. The company thus seems to be following an organic and in-organic path to growth

Financials
The company has done well in the past few years with ROE increasing from 17% to 30%+ in 2006. This has been driven by improvement in margins from 6% to around 12-14% in the recent years.
The revenue has also grown from around 500 Crs in 2004 to around 1000 odd crores in 2008 (expected). This translates into a revenue growth of around 18% p.a. The Net profit has grown from 33 Crs to around 110 Crs in 2007.

Positives
The company has a cash balance of almost 250 Crs (2007) which could rise to 350 odd crs (approximate). This would account for more than 60% of the market cap of the company.The company has almost 50% revenue from europe and thus is less exposed to the dollar risk and recession in the US.
In addition the company seems to be growing well, improving margins and increasing scale. At the same time the revenue from top 10 clients as a % of total revenue seems to be coming down, which is a good thing.
The company has a repeat business of almost 89% which shows good stability of revenue.

Risks
The obvious ones – US dollar, global slowdown etc etc.
The non obvious – The company is mid-tier ITES company. It still does not have the scale of the tier I vendor. However if the company focusses on the specific verticals and scales up in those verticals, then this disadvantage could be eliminated
In addition the company is pursuing accquisitions also. This is always a riskier way to grow.

Competitive analysis
The ITES business depends on the following key factors
a) scale : NIIT seems to be building scale in specific verticals. This would be the key to the company’s future
b) Customer lock in: This seems to be working for the company as the repeat business is fairly high

The other factors such cost advantage, overall scale etc is no longer a key differentiator as all ITES companies have this advantage and it is now considered as a minimum requirement in this business.

Valuation
The company sells at 1-2 times Net profit (Net profit is equal to free cash flow here) if you take out cash. The market is pricing NIIT tech with a view that the company will be out of business by 2010.

Conclusion
Short the company shutting down by 2010, it cannot think of any other justification for such valuations.
Dollar depreciation, US slowdown and increase in taxation rate can hurt margins. However ITES companies have some flexibility and control on the net margins through variable pay, utilization etc. So even if the margins drop by 50% to around 6-7%, the company will still sell at 4-5 times PE which is still quite low.

In summary, the market is pricing NIIT tech to be out of business in the next 1-2 years. That is a very low probability event in my view

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Prof Greenwald’s valueinvesting talk

By Rohit Chauhan
In Uncategorized
April 5, 2008
3 Min read
Add comment
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Prof Bakshi co-hosted a valueinvesting talk by Prof greenwald and has uploaded the presentation on his website here

I have read prof greenwald’s book on competitive analysis twice and have found his book very useful. You can see the usage of the concepts in my valuation templates too.

My notes on the presentation

– A lot of analysts consider only equity value in the valuation. Debt is also important
– On valuation basis a number of companies especially midcaps are priced at or below asset value. The market assumes these companies are worth more dead than as a going concern
– Most valuation approaches for PE are based on growth. As prof greenwald rightly points out, PE depends on multiple factors such as cost of capital, cyclical position, management etc too. Important to adopt multiple valuation approaches rather than a single simplistic approach based on PE alone.
– Looking back, my most successful investments were in companies selling below asset value, but having a moderate growth and a certain amount of competitive advantage. The returns were realised when the market revalued the company to reflect the true value (for ex : asian paints, blue star, concor, Guj gas, pidilite, ICICI bank etc)
– Great section on barriers to entry (see here for academic understanding of demand supply curves). I had an idea of the demand supply curves and other concepts of competitive advantage. This is the first time I have been able to get an understanding of how these two concepts interact – great learning.
– Slide 27-33 has great explaination of how competitive advantage concepts can be combined with basic micro-economic theory.
– Slide 36 should be an eyeopener if you expect as a lot of market participants do, that the market should give an average of 25% returns per annum or higher. Even with the drop and shrinkage in PE, the prospective returns look like 10-11%.
– Slide 40 – A number of indian companies such real estate, capital goods are showing high ROE, high growth and hence high valuations. Is the growth and ROE sustainable? The high valuation will be justified only if they are sustainable. With competitive pressures, difficult to see how all companies in a sector can maintain high returns and high growth rates.
– Not able to understand the slide 42 completely. But it is interesting to apply the calculations to companies which are selling at PE’s of 40 or higher. Clearly lot of expectations from such companies.

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Inflation, Rupee-dollar rate and impact on stocks

By Rohit Chauhan
In Uncategorized, Views on news
March 31, 2008
2 Min read
10 comments
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I generally avoid a macro view on stocks. It is quite difficult (for me) to analyse a macro event and then come to a stock specific conclusion.

However there seems to be broad trend of dollar depreciation (that not news 🙂 ) due to variety of reasons – subprime, US current account deficit etc etc. A drop in the dollar does not always translate into a rise in the rupee as ours is a managed currency. However inflation and its impact on elections is a powerful motivation for the government to appreciate the currency (imports such as oil become cheaper).

Recently inflation hit 6%+ and it is quite likely that one of policy decision could be to allow the rupee to appreciate. Sudden or slow appreciation? I don’t know. However an appreciating rupee impacts my stock strategy as follows

– IT stocks could get hit further. I doesn’t matter that some are selling at 2-3 time PE and are being priced for bankruptcy. The market is not rational always. If IT stocks could sell for 100 times earnings, they could drop further.
– Oil companies could benefit ..the key word is could. For all you know, the government could drop the prices and pass the benefit of the rupee appreciation to the consumer.
– Export based industry such as textiles etc could be in for a tough time. Makes sense to find the strongest players and invest only in those companies which can pass some of the currency impact to the customers.

I am not changing my stock specific plan drastically. No moving out of export dependent companies and moving into import driven companies and all that. It is quite diffcult for me to figure out the exact impact of such macro factors in the long run.

I am not a contrarian by nature, but going against convential wisdom has been very profitable for me. So as it becomes an accepted wisdom that IT companies or other export driven companies and their stocks are doomed forever, I plan to look more closely at them (and buy if I find them attractive and oversold). and I will not blame you if you feel I am out of my mind to think of IT or export driven companies. I am now very used to that feedback 🙂

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Mr Simpleton and Mr Hotshot Investor

By Rohit Chauhan
In General thoughts, Uncategorized
March 26, 2008
3 Min read
11 comments
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Simpleton and hotshot investor are close friends. Simpleton is a small time businessman …doesn’t understand stock market much. But he knows cash is king. Hotshot is all into investing. Reads blogs like this, talks of DCF, PE, options, subprime and all that.

So one day Hotshot comes to meet simpleton and both get talking of business and stocks and all that.

Hotshot – how’s business?

Simpleton – ok …not too good though. You know that store I have. Used to do very well, but now with that new mall, business is not so good. Too much competition

Hotshot (all puffed) – So why don’t you sell it and put the money in stock market ? You know I made 5 times my money in the market in the last 3 years!!

Now this gets simpleton thinking ..here I am working hard and barely making 20% return every year and this cool dude is able to make so much money.

Simpleton – you study all this stock and business…you analyse all these big companies. How much should I sell my business for ?

Hotshot (opening his sleek laptop) – You know, I have analysed so many companies. I have this complicated spreadsheet. Just give me the numbers and I will tell you

Simpleton – let me see. Last year, I had sales of around 5,00,000 per month and I made around 50,000 per month after all expenses. I keep around 7,00,000 of inventory and I give some credit also. So I have a debt of around 3,00,000 per month. As of now I am having around 7,00,000 cash also in safe. Store is my own, so I don’t have to pay rent.

Hotshot – those are last year’s numbers. How much did you make year before that and last 5 years. I need all those numbers for my spreadsheet.

Simpleton – Around the same. I told you ..too much competition. But you know, I have some loyal customers, so last 5 years I have been making roughly the same. Maybe 3-4 % increase every year.

Hotshot (shaking his head) – not good, not good. No growth ..bad ..very bad. Why don’t you invest this cash some in high growth business

Simpleton – You know, I have not done any other business and I have been managing this store for last 15 years. So I don’t think I will be good at it. Actually, 5 years back I opened a chicken farm and lost all the money …you know bird flu !! . So whatever profit I make, I keep it as cash.

Hotshot (shaking his head even more now, lets out a sigh) – then you have to sell your business for 7,00,000. At best 10,00,000. See no growth, means no future

Simpleton (completely surprised) – what are you saying ? I have cash of 7,00,000. I have inventory, this store and all this good will !!

Hotshot (shutting down his laptop) – All that doesn’t matter. No growth …means no growth. If you cannot grow ..your business is worthless !! don’t believe me .. I will show big companies selling for peanuts because they cannot grow. I am not saying that …the stock market which has millions of intelligent people are saying that !

Simpleton cannot believe what hotshot is saying. How can it be true ? why should he sell his business for the cash he has in the safe ? If he sold his inventory and the store, he would make more money. But then he thinks ..the stock market must be smarter than him !!

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