March 11, 2013

Value trade: Infinite computer ltd

In an earlier post, I discussed about a new mental construct – value trade. This is basically an investment operation where one buys a super cheap stock in the hope that it will become merely cheap (as my good friend neeraj puts it).

The idea is to buy a stock which is selling at dirt cheap price due to various short term reasons such as selling pressure, unexpected bad results or sheer neglect. The hope is that the market will get over this extreme pessimism (temporary) soon and will price it at slightly more reasonable levels (though still cheap). 

In such cases, I am out as soon as the stock recovers (as I have done with some ideas in the past – Globus spirits).

About
Infinite computers is a 1400 Cr IT services company. The main business segments of the company are application management services, infrastructure management services, Product engineering services and a new division – Mobility solutions.

The application management services involve the usual ADM and other support services. This is the bread and butter of the Indian IT industry. This segment contributed to around 68% of the revenue for the company and is characterized by repeat revenue, moderate levels of margins and high levels of competition

The infrastructure management services contributed around 16% of the revenue and is similar to the application management services in terms of profitability and competitive pressures. These two segments are being commoditized across the industry and the days of fantastic profits are gone.

The product engineering services involves some kind of IP based revenue sharing model. I could not find any revenue data for this segment, but based on the other segments would assume around 14-15% of the total revenue.

The mobility solutions segment is a new segment referred to as Infinite convergence solutions. This is a messaging platform (details here) acquired from Motorola and supports around 100 Mn+ global subscribers.

Financials
The company has grown from around 350 Crs in 2007 to around 1400 Crs for the year 2013 which translates to around 25% CAGR growth.  The net profit for the company has grown from around 3 Crs to around 120-130 Crs for the current year.  The net margins have improved from around 9% to around 11% levels, mainly due to a small reduction in the manpower cost (as % of sales)

The company has been able to deliver an ROE of 20%+ in the last five years. In addition the company been able to maintain receivables at around 25-30% of revenue which seems reasonable for a company of its size.

The company is a debt free company and has around 130 Crs cash on the books (30 % of market cap). The management has been investing capital into the business, has a 30% dividend payout ratio and the rest has been accumulated as cash on the books. In addition, the company also did a small buyback in the last one year.

Positives
The company has a very strong balance sheet and good returns ratio. The management has invested capital sensibly in the past and has a reasonable dividend policy in place. In addition, the top management is a buyer of the stock at the current levels (though one should not read too much into it)

The company has a high level of repeat business, which provides a high level of confidence to the sustainability of the revenues.

Risks
The company has been able to grow the topline and profits since 2007 and now has considerable cash on the books. At the same time, the company was not very profitable from 2005 to 2008 (average 2-4% margins) and had a very low topline growth of around 5% per annum during this period.

The company operates in a highly competitive, global and fragmented industry – IT services. The industry is facing commoditization and is very likely to have lower profitability in the future. The company is focused on the telecom industry which has its own competitive pressures with the additional risk of a very high proportion of revenue from the top 5 clients. This exposes the company to a high level of topline and profit risk, if there is any loss of  business from the top few customers.

Finally, the company is also expanding into the product space which is a high risk, high return kind of a business. The company has invested in excess of 80 Crs on various product related businesses and these intangible assets may incur a write down if these ventures were to prove unsuccessful.

Catalyst
In case of a long term idea, a buy and hold strategy works quite well as the company is growing its intrinsic value. In case of mid cap IT companies, the economics of the industry over the long term is not very clear (atleast to me). As a result, the returns have to come over the next 9-12 months and this is usually driven by a catalyst.

In case of infinite computer solutions, the 2013 profits have been a bit suppressed by the forex losses and once this headwind dies down , we should see a better growth in the net profits. A consistent dividend payout of 30% - growing with the profits should serve as another catalyst.

What can go wrong?  A loss of any of the top 5 customers would hit the topline and profits. A sudden slowdown in north america would impact the company as this region accounts for almost 80% of the revenue. If any of this happens, the stock is likely to drop in the short term

Finally, if the management does an overpriced acquisition or has to write down the intangible assets, the market is not going to like that.

Conclusion
The company sells at a PE of around 4 and an EV/EBDITA of 1.7 (after excluding cash). At these levels, the market believes that the company will soon be out of business. The company does face multiple risks (which company doesn’t), but none of the risks appear to be fatal. In addition, as far as I can tell, the management seems to be doing a good job of managing the business and a fair job of allocating capital.

If one believes that the company is not going out of business, then one does not need any fancy calculations to realize that the stock is cheap.

Why a value trade?
I am not comfortable with the economics of the IT services industry. This industry is commoditizing and the wage arbitrage game is slowly coming to an end. The super high returns on capital are likely to trend down – as has already occurred for several mid cap companies in this space.

At the same time, I cannot resist an undervalued stock which can deliver above average returns in the medium term (9-12 months).

Note: This idea was emailed to me by chaitanyya and it is not an original idea. I have a small starter position and will add or reduce based on the price and performance of the company.  Please do your own due diligence.
Disclaimer : Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

13 comments:

Anonymous said...

Hi Rohit,

A good write up as always.
Hope this one doesn't turn to another geodesic or Zylog?
Where do they park their cash?

Thanks in advance
Excel

Rohit Chauhan said...

Hi excel
I have not seen geodesic ..but what is the issue with zylog. yes the cash flows are weak and there is too much of recievables, but i have yet to see something fishy in their accounts.

but then again even in case of deccan chronicles it was not evident till the whole thing collapsed.

numbers for infinite computers are good ...not out of the ordinary ..but decent. ofcourse its a speculative idea for me. worth a shot, but not a serious idea

rgds
rohit

Rohit Chauhan said...

the company does not give the names of the banks ...around 100 Crs is parked out of india

rgds
rohit

jagan said...

while we are talking about value? i stumbled upon Unity Infrproject. Take a look

Anonymous said...

Hi Rohit,

Cash outside the country is the typical operating procedure of farji companies.
I might be wrong but be extra careful with such companies.

Regards,
Excel

JK said...

Hi Rohit,

Had written about Infinite some time back here-
http://fundoopupil.blogspot.in/2012/08/infinite-comp-value-investors-delight.html

Agree with most of what you wrote..

Would like to know when will you Sell this? At some price (already decided today) or at some PE (say 6) or after a particular time (say 1year)?

Narayanan said...

I took a look and decided to pass because I couldn't answer the following question: “Can Infinite survive a decline in wired telephony revenues from one of its top clients and declining SMS and MMS revenues which is unlikely to be offset by growth in the RCS-e platform?” Given the non-linearity there in the revenue stream, the effect on margins could be higher.

I will stay away from this idea until there is clarity on how the RCS-e vs. OTT battle is going to play out emerges. This stock could be more attractive at even 2x from this price if there is clarity on this. At the moment, this uncertainty is not there in the price. It will be if revenues from this vertical start declining significantly. At that time, I might buy for other verticals. But unfortunately, the company would have lost out in an area in which it has strong domain expertise.
If I get a chance, I might ask the management about their thoughts on my concerns and then take a call.

There is good money to be made here if things go well. But this stock goes in the 'too hard' pile for me.

Rohit Chauhan said...

hi excel
farji companies may keep money abroad, but every company has cash abroad is not fargi. infy has 600+ crs in the US

keeping cash in US is not an indicator of fraud. companies in india like satyam had cash and fudged their accounts

Rohit Chauhan said...

hi jk
this is a short term speculative bet ...just to satisfy an itch. will sell if i am 30% on it or realise that i have made a mistake - whichever happens earlier

rgds
rohit

Rohit Chauhan said...

hi narayana

this company is highly dependent on telecom. if anything goes wrong in that space, there will be a lot of problems.

thats why its a speculation for me ..less than 0.5% of my portfolio, even less

its in the too hard pile for me too ...hence i have a 9-12 month window on it. i will exit by that time anyway or maybe earlier if the undervaluation correct or i realise that i have made a mistake here

rgds
rohit

sudeep said...

I hope infinite computer will be a good pick. Your fundamental knowledge is very strong and i always get profit from it.

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Laxmi kant said...

Hi..
I appreciate the ideas of Investment . This is very nice article and have great information.

Nasir said...

how did this end for you Rohit? Were you able to get out on time?