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.