Why gung-ho about Persistent Systems IPO?

Firstly, a strategic investor is different from a financial investor. If some has love for product development and cutting edge technologies and want to be invested in Persistent Systems (PS), it is ok. However, a financial investor is quite picky as to what he is getting into and at what price. This piece is for a financial investor.

The question is “Should one be gung-ho about Persistent Systems (PS)?” I am trying to rationalize such optimism.

“We are different”: How clichéd this has become? The company says: “No really! We are different from other listed players?” PS delivers IT services to R&D wings of product companies. At the end of the day, it provides services as do other IT players. More importantly, R&D is discretionary in nature. So, this is the company which would get affected more than diversified IT player.

Revenue per employee: If they are really in a niche space where only the crème de la crème is recruited, why is their revenue per employee low? Assuming they do Rs 580 crores topline with 4500 employees, their revenue for employee is 13 lakhs. Its low compared to its midcap peers like KPIT -15 lakhs, Mindtree -15 lakhs and Sasken – 19 lakhs. It is even lesser than a large cap company like Infosys – 21 lakhs (with an employee strength of 1.1 lakh). PS only fares better compared to Infotech Enterprises which generates 13.3 lakhs per employee. All figures are FY10E. What niche are we talking about?

“Revenue growth CAGR of 40% in 5 years”: I struggled to figure out which five years. It was from FY05 – FY09. What about the recent five years? From FY06-FY10E, PS’s revenue growth is 22% CAGR. A change in one year reduces the impressive figure by almost half. It does only better than Sasken which has a Revenue CAGR of 16%. All others have fared well. KPIT – 23%, Mindtree – 23% and Infotech Enterprises – 35%. Interesting to note that both PS and Infotech Enterprises did sales of Rs 216 cr FY05. While Infotech will clock Rs 960 cr this year, PS will languish at Rs 580 cr.

“Impressive EBITDA & PAT margins”: PS’s EBITDA margin would be at 23% while that of KPIT & Infotech Enterprises are about the same. Mindtree & Sasken are lower at 19%. PAT of PS stands at 19% which is better than KPIT & Infotech which is at 16% and Mindtree & Sasken which is at 12%. The margins are just passable and there’s more story in RoE.

RoE:
KPIT has RoE of 34% which is 7% more than that of Mindtree and 15% more than PS. PS’s RoE is 18.7% which is comparable to 17.8% of Infotech and better than 13.7% of Sasken. The large cap stocks have much better numbers. For instance, Infosys has RoE of 31%.

At upper band, PS is valued at 11.3x FY10E. KPIT and Mindtree which have better RoE are valued at 10.3x and 11.1x FY10E numbers. Infotech has RoE of 12.7x. On a relative valuation basis, PS could have an upside of 12% to catch up with Infotech Enterprises.

Fairly valued at EV/Sales:
On EV/Sales metric, PS is at 2.1x which is same has that of Infotech Enterprises. It is higher than KPIT - 1.4x and Mindtree – 1.8x

According to me the gameplan should be the following:
Due to the salability of the management and the investments bankers, the issue will get a good response for sure. In terms of growth, the diversified players have a better opportunity than PS. Though the grey market premium is to the tune of 40% above the upper band of Rs 310, I think it would list and trade above 20% to upper band at around Rs 370. Better would be to shift to Mindtree or Infotech Enterprises which have better metrics and opportunities among the IT midcap players.

Sip the Brazilian Samba…

When we speak about diversification to international funds, the question most people ask is “why should I when I am making money here in India”? Point noted. But could you not have made more money? For instance, Brazil Index gave a return of 136% in 2009 compared to 80% of Nifty. China also gave a return of 80%.

Consider this: What if there is an event that could shake the Indian markets more? I say “more” because any event that spooks India would shake the global markets. The event could be in the form of anything:
Our neighboring country pokes its nose in the form of a war
An issue causes dissent in ruling coalition and brings the government down
Some random calamity (God forbid!)
Government decides to borrow more which spikes interest rates

So, it’s a good idea to hedge our portfolio. I am not asking to hedge with a Japanese fund or a UK fund. Brazilian and Chinese ones could help. These countries are growing just like ours and have better Debt/GDP ratio and fiscal discipline. More than taking country bets, it is better to take stock bets if it compliments our portfolio. Why not an agri based company in Brazil? a semi conductor company in Taiwan? a bottling company in China? a green energy company in US? Of course, picking up a stock (globally) is a complicated process.

What is easy is choosing a country fund. I would like to high light the Latin America funds here. For a retail investor, ING Latin America fund can be a best bet as it feeds your investments into the Luxemburg based fund. As little as Rs 5000 can be invested in this fund.

If one were rich (super rich actually) and wants to choose the best Latin America funds, she could go for HSBC Brazil fund which is Brazil focused and Blackrock Latin America fund which covers the entire region of Latin America. These funds have a minimum limit of USD 5000 and will come under the USD 200k remittance limit.

The snapshot of the funds is given above.

Strategy for NMDC FPO

There are three mining companies in the world that come close to NMDC for comparisons. Thanks to a CLSA report, I could get the names and valuations of these companies. Add Sesa Goa to the list, we have four comparables.
To make things simple, let us only look at PE & EV/EBITDA multiples. The band of these four companies is so tight that the average of these would be the fair value for NMDC.

At CMP of 435: NMDC will be at 120% premium for both multiples
At 300, the price touted for the FPO: NMDC will be at 50% premium
At 275, the price touted for the FPO for retail: NMDC will be at 40% premium
At 200: NMDC will be at fair value

Looking at these valuation metrics, I would not go for it at Rs 300. Why would I pay 50% premium to the company when it has only 14% output of that of India. Moreover, its performance for FY10 is below average and the bet is for FY11 where we could see a substantial improvement in performance.

Even if I go for it, I would flip it immediately after listing. The retail investors should definitely make use of this opportunity as they would get substantial chunk stocks (due to $3bn issue size) at a 5% discount.

The listing would get done because of some of these factors. It is a Navratna company of India. Everyone, especially the foreign investors want to own it. It is supposed to have a superior ore compared to the others and at the lowest price in the world. It is cash flow positive company which is the most sought after in these markets.

Alternatively, investment in Sesa Goa could see a pop of about 10-15% testing the recent high of Rs. 460 as comparitive valuations with NMDC kicks in.

Even after listing, I would short NMDC and long Sesa Goa to play on relative valuations. I expect contraction of the premium going forward.