April 14, 2008

NIIT Tech – Few additional points

There has been quite a lot of discussion on this investment idea. You can check the comments for that.

A few key points in the valuation of the company are as follows. I have uploaded the valuation (valuationtemplatev3NIITtemp.xls) based on the factors below in
google groups. Please note that this is a rough back of the envelope calculation (see net impacts section of the spreadsheet) and may be off by 10-20%.

Impact of ESOP – This can be computed and I have detailed my logic in the comments. It is not completely accurate. However considering that ESOP’s account for 6-8% of the company’s current Mcap, a 20% errror would not amount to more 2-3% error in the computation of the intrinsic value. That is an acceptable error for me (although you would flunk a derivatives class for that error) as It would not change my overall conclusions.

Tax impact – I do not have the exact numbers on what the changes are. However for NIIT the current tax rate is around 15%. The average tax rate for Corporate india is around 25%. I have assumed that NIIT would be paying the average rates from 2010 onwards. You can see the impact of the tax changes in valuation excel I have uploaded in google groups.

US slow down and dollar depreciation – cannot really compute the impact. The downside is limited due to the fact that NIIT tech has 30% revenue from US. However that does not mean than Europe and Rest of world are immune from a US recession. I have taken the impact of a slowdown and dollar depreciation by considering that the net margins will drop from 14.5% to around 7.5% in the next two years. It could drop below that too …although the probability is low (my guess is good as anyone else). As a result of this the net profit could drop from around 130 Crs in 2007 to 90 Crs in 2010.

Forex hedge – The company does not have large hedges. So I do not see any open risks from hedges (such as the one which hit hexaware). However one cannot rule out such a risk in the future


ESOP computations – See section ‘options’ in the uploaded excel

Basic logic is as follows (which differs from the text book approach). This approach may have flaws and I think it is overly conservative.

i do not consider just the granted options alone. I consider all options already granted and to be granted. As the options approved by the board will be granted in the future and that would then dilute the shareholder’s equity in the business
a) Adjusted mcap = current price * (all options+issued stock).

Options which lapse can be re-issued to new employees, so lapsed options should not be netted out.b) value lost due to free options to employees – The option price is given in balance sheet (ESOP are not free to shareholders)
so reduction from intrinsic value = total options to be issued or exercised* option pricenet intrisic value = DCF based intrinsic value - cost of optionsso based on above i now compare adj mcap with net instrinsic value. If the adj mcap is 50% or below Net intrinsic value, then it is a buy for me.

Finally a correction – As pointed by others in the comments, I have calculated the net cash incorrectly. Post accquisitions and net of debt the net cash could be around 200-250 Crs (what are a few crores here or there :) ?). Luckily that does not change the final conclusions much for me.

Please feel free to leave a comment for me if you find errors in my valuation.

Please read disclaimer at the bottom of the page. In addition I have a position in the stock.

8 comments:

Anonymous said...

Hi Rohit,

I went thru u r excel sheet. If you could explain how u reached the intrinsic value number. I see 300 + ( 2010Pat * 14 ) - 30.

If you could eaborate on this. I will come back to you with my thoughts on how options can be valued.

Cheers

Ninad

Anonymous said...

Hi Rohit
Can you please explain the reasons why you did not do a DCF for NIIT ?

Thanks

Rohit Chauhan said...

ninad

300 is the expected cash position by 2010 assuming no more accquisition.

-30 is options cost.

14 is the PE multiple - why 14 ..no scientific reason

anonymous -
DCF analysis due to terminal value gives a minimum PE of 10-12+. in case of NIIT the company is much below that ...and i felt the crucial issue in NIIT is predictability of cash flow (difficult to do that) ...and if one can figure that out, then DCF will only confirm the undervaluation.

In short the company appears very undervalued compared to current cash flows and hence figuring out the cash flows is more critical for me than doing DCF (which will only confirm the undervaluation).

In addition as i have done DCF a lot of time, i am able to work out the numbers without actually doing it on paper

Anonymous said...

Hi Rohit

To be honest I was wondering where that 14 PE multiple came from when i looked at your sheet and hence posed the question. And that is the tricky part.

The stock is intrinsically undervalued is beyond question but the PE of 14 on a terminal value as compared to the current PE of 4 ??

On options

My two bits. I agree with you that we look all outstanding options to be deducted and not just the vested one. Lets equate options to either bonus shares issed ( In case they are free ) or as a rights issue at the option vesting price. The only difference is that in this case this benefit is not passed on to the existing shareholders of the company but is passed onto a new set of shareholders at the expense of the existing shareholders.

So how would we price in a rights issue. We will come up with a diluted EPS on a per share basis and look at the NPV on a per share basis and not on a overall market cap basis.

That would factor in the cost of options.

Cheers

Ninad

Vidyanshu said...

Hi Rohit,

I "mostly" agree with your assessment of NIIT Tech. I think you have done pretty conservative estimates and the price is quite undervalued, a value pick indeed. The only thing I would like to point out is the sales pipeline. The jump in revenue YOY is pretty steep almost 400%! This after a -ve growth of -22% for the first YOY! Forget Europe or US (that question is for the longer haul, i.e., 10 yr haul), What are their clients and whether this sales growth is sustainable? (Note the lack of moat)..Which would have implications on EPS and FCF?

Anyways, on a separate note, pls. take a look at Kale Consultants. I think its a deep discount Grahamian Kind of Buy at this price..And its been around for a pretty long time now. Look forward to your thoughts.

Regards.

Rohit Chauhan said...

Hi ninad

the PE of 14 is not scientific, but not entirely without an underlying. i have built various scenarios (uploaded in the excel) for various ROE, CAP and growth assumptions. So for for NIIT tech with the current ROE and a degrowth and CAP of 2-3 years , a PE of 14 or around 9-10 of current FCF is not very optimistic.

however as graham once said , you dont need to know the wieght to know if a person is fat. well NIIT seems to be in that area. however i personally am not too confident of the cash flows in future and hence have been conservative

On the options, i guess both are saying almost the same point

On rights issue, options are similar except that the benefit does not flow to the shareholder.

however where it differs from rights issue is that each option has a value which is being given to the employee. so options in effect are more dilutive to the shareholders.

however i prefer to compute on total basis than mcap basis as i am able to avoid calculation errors in that case. however both approaches should give the same results

vidyanshu - can you tell me where you got the pipeline no. from ? i cannot find them.

i think the revenues are sustainable as they have high repeat business and focus on verticals. however this is not firsthand information and i could be wrong. i think if they continue to focus on key verticals they should do well

i will have a look at kale consultants and let you know

Vidyanshu said...

That was a fast reply.

I used the sales gr% in your spreadsheet and did a rapid %change in YoY of sales gr%. I had two observations there - first lack of a long term track record, which Buffett insists upon. So I could not locate 10-yr Balance Sheet and Income Statements...Secondly, the sales growth zig-zags a bit rapidly. Last point is that I visited their website and tried to have a look at their case studies. I am from the IT industry and have been involved in top-line growth. I can see that Niit-tech has primarily 2-3 major banking client's (Belgian Bank and An european bank). Also from experience, I know that though we all talk about repeats, once a project is over we are fighting for another one with our competitors via RFP or some such route. So there is no guaranteed revenue pipeline. I would give them a couple of more years before I trust them to grow further..My personal view.

Kale Consultants and Mindtree(the other company I am looking at), at least have a track record for us to be able to make some predictions.

I am overawed by the huge volume of posts here and would like to know your opinion.

Regards.

Vidyanshu said...

Rohit,

Continuing from above. I did a bit more research on Niit tech. They do have a certain level of sophistication in their BFSI offerings. The Euro conversion and Basel II implementation are going to lead a massive market in Europe and their expertise on asset origination and SaaS focus should indeed virtually guarantee their revenues.

Also, a look at their case studies makes it look like they have a diversified portfolio of offerings and they are sufficiently mature to sustain a steady growth.

I found an immense variety in your posts here. Looks like you have covered most of the areas of interest for a value investor...

Regards.