May 25, 2007

Red flags – Aftek infosys

Aftek infosys appeared on my stock screens a few days back. I also had a comment from prem sagar on the company. The company seems to be extremely undervalued. It seems to have almost 400 Crs of cash on the books with a market cap of just around 650-700 Crs. With the last year profits of 98 crs, the company seems to be selling at a PE of 2-3. On the face of it the company seems to be an investors wish come true. My initial scan showed nothing wrong, so I decided to dig deeper and came up with a can of worms.

- the company’s management was penalized by SEBI for participating with Ketan parekh in various behind the scene deals during the 2000 bull market (see
here)

- The company had an investment of almost 46 Crs in a company called Arexera. They have accquired this company this year (the balance portion) for a sum of 56 crs. One would consider this accquisition to be significant. The positives of the acquisition are mentioned all over the report. However the valuation of the deal is not mentioned. The company had a net profit of 1 Crs last year (see page 100 of the annual report). The company was acquired at a valuation of 100 Crs ( PE = 100 !!!). The management has not discussed the valuation anywhere in the report and why they paid so much for it. Finally surprise , surprise – this company was accquired from the promoters !!! . See the cash flow statement on page 83. There is an entry for 54.8 Crs which was paid to promoters to acquire this company. So the management accquires this company and has a related party transaction and does not mention this in the complete report??

- The company has issued 3.96 lac warrants to the promoters. They have received 10% of the price now and the rest can paid by the promoters within 18 months. Why have these warrants been issued if the company is swimming in cash, had some FCCB still open and is making almost 100 Crs per year ?

- Promoter holding is only 12%.

- FCCB issue in the last few years to raise capital. This capital is being used to accquire companies like Arexera from promoters.

The stock may do well (had a jump of 10 % recently). However I have bad feel of the whole thing. All the red flags I have pointed above don’t give me any confidence in the management. I still think the business will do well and the company should make money. But I am not sure if the shareholders will benefit or the promoters would. Their past and current actions don’t give me any confidence. I am definitely giving the stock a pass although there could be some trading gains to be made.

15 comments:

RaviAranke said...

Rohit,

Aftek was on my radar too. As I went through their site and first few pages of annual report (you have done admirably better and gone through the last few pages - which is what I plan to do now onwards), I had to put it under the 'too hard to understand' bin.

I understand the IT business fairly well having worked with ISV vendors of all stripes for more than a decade. Still, I cannot understand aftek's product strategy and why they put so much emphasis on it while they make bulk (all?) of their money from services export.

Search engine? Please give me a break.

Home security and home gateways for Indian market? Sounds like a very small field and no mention of popular brands available on market.

The information given is entirely unconvincing and evasive.

The financial structure is all too complex as you have dug through. What are those deposits of cash doing in overseas accounts?

Better to pass ...

Rohit Chauhan said...

i agree completely with your comments. typically i go through financials and if the company looks good, then i browse through the balance sheet and other annexures for any red flags.

i was comfortable with the over financials, however i saw quite a bit of cash and dilution. once i started tracing that, i got all these above red flags

after that i did not bother to investigate further. i have been burnt in my initial years by SSI where i chose to ignore the red flags due to my greed and paid dearly for it

Ranjit kumar said...

Hi rohit,

Three dumb questions where i am feeling a bit of ambiguousness.

1. Pls can you explain me what is the difference between Consolidated and Non Consolidated results on NSE. And the results in BSE seem to reflect the Non cosolidated numbers on NSE, BSE doesnt have consolidated numbers.
2. What are reserves and surplus are they not the same as cash & equivalents. What is the purpose of resves & surplus
3. I dislike companies doing preferential allotments when the current market price is a bargain, if they do a rights issue or buyback all the shareholders will benefit. What would you recommend when the companies we own are doing preferential allotments.

Pls can you clarify me.

Thanks
Ranjit

Rohit Chauhan said...

Hi ranjit
consolidated numbers represent the combined numbers for the company and its susbsidiary, JV and associates (in proportion to the holding). non-consolidated numbers are the results for only the parent company. i am not sure why nse has consolidated and bse has non-consolidated. look at the annual report and you will find both as it a mandatory requirement

reserve and surplus are liability side entries of balance sheet. they represent the total of all retained profits. cash and equivalents are asset side entries. they represent the assets of the company being held in cash or near holding of the company.they are not same.
A company may have a large reserve and surplus due to continous retaining of profits. but the retained profits may have invested in fixed assets or in the business itself. when a company cannot invest in its business, it may hold the extra funds in the cash or equivalents
i dislike preferential allotments too. clearly shows the management/promoter benefiting over the other shareholders. this is a clear red flag against the quality of the management. if you find a few more such negatives, i would avoid the stock

Shankar said...

A low promoter holdings can be looked from two perspective -

1. A retail investor will face fear over the event that the promoters (who run the management of the company) will embezzle (creatively) resources and most investors will be left with nothing.

A flip-side to this is that, professional companies in India are required to follow corporate governance norms. Also Aftek, has multiple FIIs and domestic investors. The probability of them not keeping a hang on things is low. Also each company has a board whose job is to look at these things and guide management.

2. The other set of people are the Sanjay Bakshi kinds (did that sounds a bit crude, but i was a good student.. he gave me a 26 on 30 in my term submission). An example is GESCO Corporation (2000-01), a company with loads of cash (Rs. 28 crores) and property worth 330 crs and was valued at just 19 crores. The major reason why he was able to buy up the company and delist it was the LOW promoter holding of just 11%. So for many, a low promoter holding is a blessing in disguise.

Now I am working on purely mathematics here, unless what's given in the balance sheet is papaer money .. there is enough margin of safety in the business. Aftek is a 100 ton bridge which is enough for a 15 ton truck to pass through. A crack here or there will not dislodge the truck.

Warm Rgds
Shankar

Rohit Chauhan said...

hi shankar
valid points. i am a big fan of sanjay bakshi and personally i really wish i was his student when i did my mba. i would have gone down the graham style value investing path much earlier

coming back to your points ..i think a low holding and excess cash makes sense in an activist role - which is what sanjay did with GESCO (i have read what he did). however i am a passive investor and with multiple opportunities available i generally avoid managements i am not comfortable with.

also i am not sure i agree with the premise that Fii and domestic shareholders would do much to shake things up other than sell their stock. what sanjay did seems to happen very rarely in the indian context.

again there seems to a margin of safety and i would have been comfortable if it was a non IT business. In IT one can do a lot of foolish deals and blow away the money quickly. most of the times the company one is buying is not backed by hard assets. so if the accquisition is bad, then you have to write of most of the money

btw , on a side note, i found your blog very good and used to visit regularly to grab a few ideas. sad to see that you wont be blogging again. hope to hear from you in the future

RaviAranke said...

Today I was looking at Geodesic information systems.

Great set of numbers - 92 Cr revenue and 41 Cr PAT for year ending March, 2006. This, on a staff strength of 150 is nothing but astonishing. The growth has continued. e.g. the June 15 press release says:

"Geodesic Information Systems Ltd. announced its audited results for the year 06 – 07. Revenues are up from Rs. 100.41 crores to Rs. 177.06 crores while profits are up from Rs. 41.98 crores to Rs. 93.75 crores in the same period."

It claims to be software products company focused on high growth market of IM etc.

When I started digging deeper by going through the annual report (available on their site), I kept getting a sense of 'Deja Vu'.

Total lack of transparency as to what is driving revenue and growth - which products, which customers? There is nothing you could double click and drill down deeper into.
After all, the product they tom-tom most about was still in beta till Dec 2006. That can't be the revenue engine. What is it then?

Various acquisitions are spoken about in glowing terms but again there is 'nothing there' to dig deeper. What do they plan to do with these acquisitions? How much they paid for each? No sir, no information.

The 'Deja vu' turned into 'Aha!' when I looked at management backgrounds. Lo and behold, it is all Aftek gang after all.

I don't intend to walk away from this one - I intend to run!

Rohit Chauhan said...

Hi ravi
your analysis reminds me of the saying - if it sounds too good to be true, it isnt.

better to run from this company and any other this management is associated with

Anonymous said...

hi all,

wow u guys r masters of this game wish i had checked before what if one is working for such a company any chances of aftek or geodesic ending in a worldcom or enron

employee

Rohit Chauhan said...

unlikely that these company will end up a worldcom or enron. they seem to be making money ..except that the money may not flow to the investors.
but to be sure keep tracking the cash flows ..if that starts drying up then you may have to start worrying

Anonymous said...

thanx a lot glad to hear that will keep a watch first sign of low cash flow will run

again thanx for giving peace of mind.

Vishal Mittal said...

Hi,

Just saw this discussion..

I also had looked at the company...2 big red flags - 1% tax rate (10% MAT for other IT companies) and what kind of IT company has employee cost at 5% of revenues (typical is 40-50%)...

Conclusion - Put it in "Do not Touch" category like Teledata and look for good companies...

Regards

Vishal

Rohit Chauhan said...

Hi vishal
yes ..agree with you. aftek has quite a few red flags ..maybe an investor would make money from it ..but personally i prefer to avoid such stocks

regards
rohit

Rohit Chauhan said...

Hi vishal
yes ..agree with you. aftek has quite a few red flags ..maybe an investor would make money from it ..but personally i prefer to avoid such stocks

regards
rohit

Hemant said...

Guys ..I have seen all your comments. now the stock is selling nearly at 16Rs.This price is half the cash asset it has on its balance sheet alone. only bad news has been last year with 13 crore loss and I am still not sure if this makes this a bad investment at this price.

What do you say..