Cover Story Monday, March 19, 2001

MARKET CRASH
        
From their highs in Mar 2000... IT stocks are at their lows in Mar 2001
        
   Losses are in line with the fall in the Nasdaq Composite index   
        
 

The Indian software story seems to be written at Nasdaq. While Indian software companies depend on the US for over 60% of their exports, their share prices are almost entirely decided by trends in the US bourses.

During the past one year, software stocks have been moving in line with the Nasdaq. While Nasdaq hit the 52-week high of 5078.9 on 20 Mar 2000, Infy and Sify, the ADRs of Infosys Technologies and Satyam Infoway, also hit the top during the same period. While Infy hit the 52-week high of $ 319 on 13 Mar 2000, Sify’s 52-week high of $ 85.5 was recorded on 20 Mar 2000 (see table: Soft relations)

Importantly, Indian software stocks were also hitting their 52-week highs on the Bombay Stock Exchange (BSE) during the same period. While Infosys recorded its 52-week high of Rs 12,295 on 13 Mar 2000, Satyam posted its 52-week high of Rs 1,160 on 14 Mar 2000. HCL Technologies, Wipro and Silverline hit their 52-week highs on 23, 29 and 30 Mar 2000 respectively. However, the Sensex posted its 52-week high of 5543 on 12 Apr 2000.

Prices have come down significantly since then. Nasdaq hit the 52-week low of 1922.8 on 12 Mar 2001. The Indian software stocks listed on Nasdaq followed suit with Infy, Silverline and Wipro ADRs hitting their 52-week lows on the same day. The Sensex touched its low of 3436 on 13 Mar 2001. Major software stocks hit their 52-week lows the same day on BSE.

Infact, the software services sector was under-performing in line with the Nasdaq. While the Infy ADR lost 79% from its high during the past one year, Infosys listed on BSE lost 65% from the 52-week high.

Satyam lost 82% from its high on BSE and HCL Technologies lost 69% from its high. Wipro shows divergent trends. While its ADR lost 46% from its high, the Wipro scrip lost 78% from its high on BSE. Wipro got listed on NYSE during mid-Oct 2000. At this time, the Nasdaq had lost considerable ground with a 31% fall from its high to around 3483.

Perhaps the biggest loser has been Silverline. While it has lost 87% from its high on Nasdaq, the story is worse on BSE. It lost 92% from its high on BSE. The loss in Silverline’s stock price is in spite of the fact that it is the only Indian software services company to have gone ahead with the acquisition of the US-based Seranova Inc with its ADR funds.

Most of the software scrips are now available at a P/E of less than 12 (as on 13 Mar 2001). The scrips include NIIT (TTM P/E of 11.9), VisualSoft (11.5), Mascot Systems (9.5), Kale Consultants (8.6), SSI (7.8), KPIT Infosystems (6.8), Sonata Software (6), PSI Data systems (5.5), Mastek (5.3), Subex Systems (4.8), Silveline Technologies (4.3), DSQ Software (4.1) and R S Software (2.3).

Even the blue chips are now available at much more reasonable valuations. Wipro is available at a P/E of 59.5 and Infosys trades at a P/E of 53.7. Digital Equipment and Hughes Software, the two MNC siblings, are trading at a P/E of just 30.9 and 25.7 respectively. HCL Technologies (30.6), Satyam Computers (23.2) and Polaris Software (13.5) are also attractively placed.

So can we expect a sustained bull run in software stocks? This is unlikely as Nasdaq, which is the main determining force behind the valuation of software stocks, does not seem to have bottomed out. Unless some sort of stability emerges at Nasdaq, software scrips will continue to remain under pressure. However, they have become good value ‘buys’ as Old Economy plays. There is uncertainty associated with software scrips due to a weak Nasdaq which is not bigger than the uncertainty of Old Economy scrips given the economic slowdown in India and stiff political and labour resistance to PSU disinvestment.

Moreover, a close look at the current valuations of Indian software companies listed on US bourses and some of the big names in the US information technology sector reveals a very interesting picture. Surprisingly, the Indian software giant, Infosys Technologies, still remains the most expensive stock on the Nasdaq amongst the group with a P/E multiple of 78.6 based on the trailing twelve months (TTM) earnings per share (EPS). This is despite the fact that the stock has lost around 82% from its high about a year ago. Wipro is the third expensive stock with a P/E multiple of 67.6 based on TTM EPS. Wipro has lost close to 50% from its high.

IT majors like IBM and Hewlett Packard are available at around 20 times their TTM earnings. In fact, Oracle is available at only 14.2 times its TTM earnings. Although these companies are not directly comparable to Indian software companies for obvious reasons, the underlying truth is that they are available at much lower valuations

Even companies like Diamond Cluster International, Computer Sciences Corp and Sapient are available at 18, 22.4 and 30 times their TTM earnings respectively. Notably, Diamond Cluster and Sapient are operating in the business services segments like e-business and system integration.

Infosys again tops the ranking in terms of the market capitalisation (MC) to sales ratio. While Infosys has a MC/sales ratio of 24.7, Wipro is third in the list with an MC /sales ratio of 13. Veritas and Microsoft are the only other two companies which command a double digit MC/sales ratio in the group.

So what differentiates the Indian software companies from the US IT majors? There are many reasons for Indian software companies to command a premium on the US bourses. First is the superior growth rate. While Infosys has posted a growth of 168.4% in its earnings during the last twelve months, Wipro recorded a growth of 86.3%. Although Silverline Technologies posted a growth of 72.8% it seems lower considering the fact that Infosys and Wipro grew from a much larger base.

The only companies in the group posting better growth than Infosys and Wipro are Oracle (at a huge 368.6%) and Electronic Data Systems at 187.1%. Sun Microsystems grew 64.8%.

The other major factor in favour of Indian software companies is their offshore development centre (ODC) model. This is reflected in their profit margins which are quite high as compared to their peers in the US. While Infosys has a profit margin of 31.3%, Silverline has a profit margin of 21.5%. Wipro has a profit margin of 18.9%. Note that, Wipro has other businesses as well and the profit margin in its software business has been moving up consistently during the past one year.

These are much higher than those achieved by the US-based companies. While Sapient has a profit margin of 9.5%, Diamond Cluster has a profit margin of 8.6%. Viant Corporation has a dismal profit margin of just 4%. The only companies in the group having better profit margins are Oracle and Microsoft with margins of 63.3% and 41.9% respectively. However, Oracle and Microsoft are predominantly product companies and hence have a better profit margin.

The question is whether Indian software companies will continue to command such a high premium on US bourses considering that the US economy is slowing down in spite of rate cuts.. It will have an impact on profitability of US companies as can be gauged by the profit warnings of most of the technology majors.

The present premium of the Indian software companies takes into account the future growth prospects. However, if US companies continue to give further profit warnings, Indian software companies may not be able to continue with their huge growth rates of the past. In fact, the first major Indian casualty on account of the US slowdown is NIIT. The company issued a profit warning citing the US slowdown. In such a scenario, Indian software companies may not command huge premiums over their US counterparts.

        

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