April 9, 2008

Analysis - NIIT Tech

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

31 comments:

$ 0.02 Worth. said...

Hi Rohit,

I agree that its far fetched that NIIT tech will shut down by 2010 and a PE of 4 or less is really attractive. Not many -ve's I can see from your figures..the eps is also promising a 17% at CMP of 124 (yesterday). But given current economic conditions do you not think its poised for a decline? Not a big brand name either, so maybe something like TCS which has a moat and is attractive at this level?

$ 0.02 Worth. said...

Hi,

A related question - is there a source for 10 yr Balance Sheet/income statement in the open domain? Where do you get your data for the valuation templates you have provided links for?

Best.

Rohit Chauhan said...

Hi
agree that tier1 companies have a wider moat than an NIIT.

however i think the competitive advantage beyond just pure scale over a broad scope is now moving to vertical based scale also. tier 2 companies are now rightly focussing on vertical based scale - even tier I companies are doing the same internally

even if you account for the differential, i think tier II companies are being underpriced.

the business environment can get worse, dollar can depreciate ..however NIIT tech is less exposed to dollar due its focus on europe. even if you account all that and consider a 50% drop or more in net profit the company would still be underpriced

as of today NIIT is priced for catastrophe. about the stock - no idea ..it could drop

regarding your other question - some of company AR's have 10 year data. most of the websites however have data going back for 5 years only

regards
rohit

VISHNU said...

Hi Rohit,

If you take the price alone , my personal opinion is that NIIT tech is not a screaming buy.

You can find few other IT / ITES companies are selling less than their Cash balance.

Regards
Vishnu

Anonymous said...

Hi Rohit,

Excuse me for jumping the topics but thought this one might interest you.

please find below a link to a excellent talk given by Seth Klarman at MIT.

http://chattablogs.com/brent/archives/067487.html

regards
venkat

Value Architects said...

IF europe is ur focus, chk Mastek, with better financials and mgmt.

Mastek OWNS its assets/land/buildings (as against Niit where they are leased - see assets in cons. balance sheet)

Plus Mastek has a floor due to pending buyback.

Ur cash figs are not taking into acc debt and ongoing capex for campus they are building.

Anonymous said...

Hi Rohit,

Tata elxsi is one company into product dev. outsourcing and also into animation. the areas in which too few indian cos are present.

it is a debt free co. looks a bit undervalued at present.

definitely worth a look.

regards
venkat

Anonymous said...

Hi Rohit

Cash on the balance sheet is around Rs 240 crores on Dec 07 as per the management. So its not moving to the 350 crore level. Also there is about 80 crores of loan on the balance sheet if I m nor wrong. They have spent money on the Room acquisition and setting up of the new campus.

Last three consolidated quarter numbers are flat for both topline and bottomline. BPO business lost money last year and has been contracting both on topline and bottomline. Revenues from Room have also been lower in the last two quarters on a YOY basis.

I agree its a good value pick but will tend to agree with Vishnu that there might be more compelling ones in the midcap IT space. One will not loose money on this one for sure :-) and that is Rule No 1.

Ninad

Rohit Chauhan said...

Hi
I agree there are a number of companies in the midcap space which look undervalued.

i have two factors to run the initial filter - min revenue of 100-150 Crs and PE.

That gave me a list of 8-10 companies which i have sorted in their order of attractivness.

NIIT tech is just of them. So i agree with points all of you have made. my approach is to pick 3-4 companies in this list and invest equally in them.

vishnu - i have not seen any companies below cash and have a revenue of 100 crs+ ..which companies are you referring to ?

valuearchitects - i have not checked mastek and will do so. you and ninad are right on the cash number. i have made an error in the calculation. the cash end of this year could be around 250 odd crores (without considering impact of ROOM and a few other accquisitions/ jv)

venkat - i have not checked tata elxi. will do so ..however product companies are quite out of circle of competence (even more) and even if i find a good company i am not confident to invest. nothing wrong with the company ..just my own shortcoming

ninad - you are right on the cash amount. I am not sure of the topline and bottomline numbers. the last 2 quarters have seen a slowdown. however YOY there is a small growth in topline and a single digit growth in bottomline


are there specific companies you have in mind which you think are doing better and are valued attractively ?

i have patni, hexaware,aztec and sonata on my list. however other than patni i have not analysed others yet ( i am quite slow :)

regards
rohit

Anonymous said...

Hi Rohit,

Lets look at Patni. Has about Rs 100 of cash on books on a per share basis. Stock is at about 240 now and thats bcos of the run up over the last few days bcos of the buyback commencing.

On a similar platform as NIIT but the buyback makes all the difference. The biggest challenges for a value investor is not figuring out cash on the balance sheet but what will the management do with it ( Ex Kothari products .. something that you have mentioned in the past).

Patni is going to buyback about 5-7% of its equity using the cash on its balance sheet and NIIT, I suspect will scout around for a acquisition to grow. Nothing wrong in it but to be honest I dont feel competent in analysing acquisitions and the price paid for it.

I will go with Patni bcos of the near term certainity of deployment of that cash.

Cheers

Ninad

Anonymous said...

Hi Rohit

Did a lil more research work on NIIT. I think looks like a good bet with a 4-5 % dividend yeild.

The downside is really minimal in the stock. Good pick

Cheers

Ninad

Rohit Chauhan said...

Hi ninad
i have analysed patni and invested in it too. however there negatives in patni too

1. a decent portion of their income this year has come from hedging which is not repeatable
2. they are repricing all the options for their employees

i have done an analysis of the options for both NIIT and patni (which i have not published in the post)

roughly the repricing would hit patni's intrinsic value by 120 crs. post ESOP and repricing the options, the buyback is not as attractive as it looks.

i agree how the cash is used is important. however at these valuation for quite a few IT midcaps, there is very low downside and fair amount of upside.

unless these companies completely blow away the cash completely, i think there is decent value.

ofcourse there must be other IT companies have a better price value equation ...i have not found or analysed them. once i figure them out, maybe i will replace the current ones with them

for NIIT, they have done the ROOM accquisition at 20 times earnings. doesnt look execessive ..but cannot say if it will add value or not

Anonymous said...

Hi Rohit,

Like I said I went back to the drawing board and relooked at the numbers and NIIT Tech looks like a good bet.

BTW the management has made another acquistion in Feb.

Wanted to know how you arrived at the 120 crore cost of options for patni. I have been grappling with working out models on expensing out of options. Also what is the thought process when u say the buyback in Patni is not as attractive.

Cheers

Ninad

Rohit Chauhan said...

Hi ninad

I am using the following approach to look at the impact of options

a) dilution due to options - i do not consider just the granted options alone. consider all options granted and to be granted.
so the adj mcap = current price * (options+issued stock).

b) value lost due to free options to employees
option price is given in balance sheet.
so reduction from intrinsic value = total options to be issued or exercised* option price

net intrisic value = DCF based intrinsic value - cost of options

so based on above i now compare adj mcap with net instrinsic value.


i made a mistake in the comment. cost of current options is 120 crs.

the company is repricing almost 1.02 (net options yet to exercised or issued). roughly the exercise price is 250 to 320. so we are talking of 70-100 Crs of net effect (70 rs * 1.02 crs).

the company plans to take the hit in the next few quarters.

in contrast the company has a buyback of 1.39 crs shares. That kind of nets partly with options which will be exercised in the next few years

So 2-3 years later, after 10% buyback and exercise of options we may have the same no. of issued shares

i will load my options calculations in google groups.

Value Architects said...

I think ur calculations are wrong. Options are excerisable over a period of time, and not immediately in fy08. Decision on all outstanding options would not be taken/accounted for in this yr.

See pg 65 of fy06 AR, Section 24, last 4-5 rows.

The hit would only be on vested and excerisable options. As per the last mgmt call (transcripts at their site), the CFO has mentioned that net impact of reprising would be $4m, out of which $2m would be in fy08 and rest would be over 24-36month period.

For a co generating 500c of cash profits (exc other incs), this is a tiny cost for retaining employees.

Would write more on my blog sometime...

Rohit Chauhan said...

value architects
you are right.i saw the same too. there is time value of money and some other factors such as exercise price etc. however i have done a backof the envelope calculations and have taken a bigger number which is not too off from what the transcript says

so if there is value even after taking a bigger number, i think then that is good sign of value at current prices

regards
rohit

Rohit Chauhan said...

value architects
in continuation of your comment, the account impact of the repricing is only to the exercised options. however the economic impact is for all options (current and future)

for ex: if 100 options can be issued. 50 have already been issued. say the exercise price is 100. this is now reduced to 50

now accounting impact is 50*50 = 2500 on the P/L

however the rest 50 when there issued to employees in future (for free) would at exercise price of 50. Lets assume that the stock price is 150 then. the net benefit to the employee now is not 50 per option but 100

when i calculate intrinsic value, i would prefer to consider the impact of repricing on all options even if it doesnt result in an accounting impact. earlier companies did not have to take repricing into account (unlike now), but that does not mean there was no hit to the shareholder.

so in computations 120 Crs is the hit to intrinsic value at current exercise price and 70-100 crs is the additional hit due to repricing

regards
rohit

Shankar Nath said...

Hi,

A friend had the opportunity of meeting the NIIT Tech management team in Feb 2008. I had a brief conversation around NIIT Tech. His inputs :
I met with NIIT Tech guys.
1. They are sitting on good cash pile - around 160c net of debt,
2. Dont have any major plans to use it, unlike others who are buybacking.
3. Capex requrired is around 90c spread over 08 and fy09 - for new greater noida campus.

The idea was to calculate thire unlevered FCFF and FCFE. The FCF yield seems excellent over present valuations.

I hold a position in NIIT Tech ... albeit bought at higher valuations.

Warm Regards
Shankar

Rohit Chauhan said...

Hi shankar
any subjective feedback on the management quality ? would appreciate if you could share the same ..provided it is sensitive imformation or compromises your friend position

regards

rohit

Value Architects said...

The economic impact on company may be different from the economic impact on the employees - as market is an intermediatory. Co may dole out stocks at 100 to employees, and employes may sell them out at 1000. If the employees make more money based on current stock price, that doesnt mean that u have to account that loss in the p&l - its just an oppurutnitiy loss for co AND employees have worked over last few yrs (since provided options), to create that additional value exhibitied by the current CMP. Ofcourse, thats an "oppurtunity loss" for the cos shareholders.

Secondly, the economic impact would be what u say OVER a period.

Thirdly, as I understand options are accounted on cash basis - which means as and when excerised. We cannot give same treatment to all the ESOPs outstanding, as you have done, because market CMP may be different when outstanding esops become excersisable.. and hence may not need to be repriced.

Munger preaches to have a system-wide view. I think, the possibility that Patni is lossing more by issuing esops vis-a-vis any other IT co is very low. Esops are industry compensatory mechanism. Promotors & compensation committee of Patni would be wise enuf not to give any stupid compensation/repricing to employees at the expense of promotors/shareholders.

Therefore I would rather go by mgmt 's word of $2m hit due to repricing of options.

Rohit Chauhan said...

value architect
i am not arguing for or against ESOP as a compensation tool.
I am just trying to see the impact to valuation process.

A few years back companies were not required to expense options ..that hardly meant they did have a value. So i am not really looking at the price at which the stock is sold. As i indicated earlier, my approach is

- deduct cost of options (given in AR) from instrinsic value. different exercise price are being considered as i am taking options cost from the AR
- consider all the options in the mcap calculation. as you rightly point out, this is over time.

regarding patni i cannot say whether the company is giving options appropriately or not . if i trust the management, i would assume they are doing it intelligently

the $2m number seems to be an immediate hit. i think the transcript says that they will expense additional amounts in the future to the tune of $2 mn. the transcript refers to vested options for this hit.

However i think they will reprice the unvested and other options too. that does impact the shareholder value, even if you dont account for it

Shankar Nath said...

Hi Rohit,

His firm has been purchasing NIIT Tech ever since the meeting. They have over 30000 share in the company.

Rathin Shah said...

Hi Rohit,
Can you elaborate more on "Business scability"...Rakesh JhunJhunwala emphasis on that...
Can you also give one practical example of a company??

Anticipating ur reply,
Thanks
Rathin

Satish said...

Hi Rohit,

Saw the file in which you have the details of NIITTECH. Shouldn't it be a 57% discount instead of the 43%?

So the ideal valuation for NIITTECH in terms of share price should be around Rs.240 right.?

Rohit Chauhan said...

hi satish
you are correct ..the discount was 57% ..ideal valuation would be around 240.

i have taken the ratio of current price / intrinsic value. you can divide the current price by .43 as in spreadsheet to get the same no. of 240

regards
rohit

Satish said...

Hi Rohit

You might be interested in reading this link
http://www.livemint.com/2008/06/14005013/NIIT-Tech-forex-risk-ahead.html

Thanks,

Rohit Chauhan said...

Hi satish
saw the link and the latest results too. did some number crunching ...will post on it soon. in summary my analysis was based on the worst case scenario and rupee appreciation still will not be that bad
i will post soon in detail on it

regards
rohit

tony said...

Hi Rohit:

I hold a position in Niit tech close to current levels. I believe that Niit tech is grossly undervalued.

So, I had a look into your calculation for valuation (1657) for Niit tech. Can you please explain the formula that you used?

Please forgive my naivety. Also, what would be the valuation based on 2007-08 results?

regards
tony

Rohit Chauhan said...

Hi tony

i will cover my analysis of the valuation in a post and will update it based on the latest results too

regards
rohit

Satish said...

Though results turned out bad, looks like there is something cooking in NIITTECH. There was a volume spurt today. Don't know what's cooking though. May be stake sale which has been doing the buzz since time immemorial.

Rohit Chauhan said...

Hi satish
consolidated profits are not great but not terrible too. topline growth is around 8%, operating margins are steady at 19% and net profit has grown by 1-2%.
not exciting results, but then the current valuation dont expect much either
need to analyse further on why the net margins have dropped
no idea on the volume and stake sale as such
regards
rohit