COMPANY REVIEW: RS Software Ltd
The Eastern Star
Over the years, IT industry in India has spread across different parts of India and today can be called a countrywide industry except for its token presence in the eastern part of the country. Since the time of independence, this part of the country has been left behind in the development race. There are, of course, a number of reasons behind this fact. Starting with the nationalization of most of the engineering and core sector companies headquartered there, to the volatile politics of the region, it has been a 'no-no' for most of the new industries in India.
With opening of the economy and somewhat softening of the leftist stance on privatization, the negative image of the region among entrepreneurs has reduced to some extent. Some investments have now come up in the region and there has been a marked improvement in the infrastructure, especially in West Bengal.
Despite this improvement, IT penetration remains poor in the area. Notwithstanding a large pool of personnel, software companies in general have shied away from the region. While the region may have lower real estate and salary costs, the quality and experience of software professionals, even to this day, remains poor compared to southern and western regions. At the same time, a beginning has been made with the entry of majors like the JV between CA and TCG Group, NIIT and Cognizant, among others. Among the first software companies to set up shop in the region has been the Calcutta-based RS Software.
Background: Sloppy ground, strong base
Calcutta-based RS Software was set up in 1998 by Raj Jain an IT professional himself. The company has the distinction of being one of the first units in Calcutta where hardly any software units were planned till recently. The main reason for setting up the unit at Calcutta, according to the management, was the number of technical institutes like IIT, Kharagpur, IIM Calcutta and Calcutta University located in close proximity. The assistance provided by WBEIC (West Bengal Electronic Industrial Corporation) was in no small measure also instrumental in this decision.
The company invested heavily into computing facilities right from the early stages of its operations. In the initial years, it worked with a Unix-based DCM Zeus and got its first contract from Ashisuto of Japan in 1989. While the turnover stood at a modest Rs9.81 lakh in March 1989, net profits were a minuscule Rs40,000. Thereafter, the company grew in size as the turnover increased to Rs1.67 crore in March 1992 and Rs26.14 crore in March 1998. The growth in net profit, however, was slow due to lower operating margins. The company incurred high overheads of maintaining infrastructure facilities with no additional revenue streams to compensate it. During this period, it largely worked as an onsite consultant and its facilities remained largely under utilized. Further, high interest and depreciation charges due to such investments further eroded the profitability. Another reason for relatively poor profit margins is that the company was forced to sell cheap to gain entry into large corporates.
RS Software came out with a public issue at a premium of Rs20 each in March 1994 to finance its Rs6.40-crore expansion plan. A portion of equity was allotted to TDICI (Technology Development & Investment Company of India Ltd) and Risk Capital & Technology Corporation of India (RCTC) as co-promoters of the company. The entire project cost was funded entirely through equity. Similarly, shares were also allotted to financial institutions and mutual funds. The issue financed, among others, purchase of hardware, software and augmentation of long-term working capital requirements.
The promoters were also allotted warrants which can be converted to 5.62 lakh shares at Rs20 each if exercised before April 1998. These warrants were converted to equity shares during the period ended March 1998 allowing them to retain a higher stake in the company. Currently, the promoters hold 33% of the total equity of Rs4.69 crore. The venture capital firm UTI Offshore fund holds 14%, Body Corporates and NRIs hold 5% and FIIs hold 1%. The balance 47% is held by the public. The shares of the company are currently traded at Rs136 with a 52-week high of Rs171 and low of Rs17.
Operations: Headstart investment, slower growth
RS Software commenced operations to provide offshore services to its clients. However, the company has operated mainly in the onsite market despite the excellent infrastructure. This was possibly due to the lack of marketing efforts and its relatively smaller size. RS Software achieved a total turnover of Rs27.00 crore out of which exports revenue stood at Rs23.40 crore. The company achieved 75% of the revenues from onsite activity for the year ending March 1998.
With a view to expand the business in global market, the company made a series of alliances in 1994-95. The alliances included many leading international software companies such as Software AG, for data warehousing and data management, Lotus Development Corp for systems integration with Lotus Notes, Miles Burke Associates for enterprise systems, and high-productivity systems for CASE tools. For the year ended March 1998, revenues from its alliance partners accounted for 15% of its total turnover.
Among the services that RS Software provides include software development, enhancement, and customization, wherein the company has considerable experience in the areas of application development, enhancement and customization and has evolved a modular development process. Under the software conversion and migration area, RS Software executes data conversion and program language conversion. The company has also developed process for providing support for migration of applications, minimizing the impact on existing resources and ongoing activities. Apart from the services mentioned above, RS Software provides round-the-clock remote maintenance of systems through its offshore facility at Calcutta. The company also provides Y2K reengineering services that constituted 20% of its total revenues in 1998. Its Y2K services broadly consist of Impact analysis, code conversion, unit testing, integration, regression and compliance testing and data conversion.
RS Software is currently executing several projects for a major credit card company. The company currently maintains the system that was earlier developed in DOS environment using COBOL. This is being converted to Windows environment using Visual Basic and C. It is utilizing its expertise in the mainframe environment to execute the projects.
The company has well-equipped facilities at SaltLec, Calcutta, and a developer base of more than 325 people. Its hardware facility consists of IBM Mainframe systems and a 64Kbps satellite link to client systems in the US. The company has two development centers apart from the corporate office measuring 2,300 sqft. The two development centers measuring 9,000 sqft and 8,600 sqft respectively are located at SaltLec.
In terms of marketing, the company's focus is now on the European and far eastern markets that will reduce the company's dependence on the US markets. The company also has a 100% subsidiary in the US, Responsive Solutions Inc, that acts as the marketing and coordinating arm of the parent company. The various alliances have also helped the company in achieving orders in the past. Its excellent service to its clients has ensured it recurring business from its existing clients.
Future: Reaping the benefits
Over the years, RS Software has developed substantial expertise in the IBM mainframe platform. The continued usage of mainframes and the level of investment made in these platforms provides the company considerable hope in the future. The company expects to achieve 95% of the turnover from IBM and AS/400 services and the balance from specialized offerings such as ERP and internet in the current year. In the next year, business from IBM mainframes and AS/400-related services are projected at 60% of the total revenues. Unix and Windows-based offerings are expected to contribute 30% of the total revenues and the balance is expected to come from specialized offerings. The expertise having been proven will also help the company to transform itself from an onsite vendor to one that is able to offer offshore facilities for its clients as well. Revenues from onsite activities are expected to come down to 75% from 60% in the current year and 45% in the next year.
RS Software expects a 65% jump in the revenues in the current year and approximately 200% in the next year, largely led by the growth in Y2K services. Y2K revenues are expected to be around 20% of the total revenues in the current year and rise to 30% for the period ended March 2000. While the revenues from Y2K will taper off, the company does not see this as a major concern as it expects the IBM mainframe and AS/400 services to perform well. The company also plans foray into specialized services such as internet and ERP to meet its revenue targets. Moreover, the company is also planning to take up euro conversion projects. It has presence in Europe through some of the projects it executes. RS Software has entered into an strategic alliance with a leading IT vendor for extending euro services. It is also in the process of partnering a leading consulting/tool provider for outsourcing jobs in euro. However, the revenues from this area will not be sufficient to cover the fall in the Y2K revenues. Consequently, the company will have to grow much faster in its core area of providing services on the mainframe platform.
The company has currently 375 employees on its payroll which is expected to triple to approximately 1,200 by the end of the year 2000. It plans an expansion of its facility by setting up a new building measuring 34,000 sqft. The company's investment plans in hardware include, enhancing existing satellite link, installing new servers and replacement of IBM mainframe with S/390 architecture. While the company states that it plans to finance the expansion through debt, a further dilution in equity is not ruled out.
While the company's optimism is natural, considering its good first-half results, the share of Y2K in the company's revenues does cause concern. While the Y2K service rates should jump substantially as the millennium approaches, the new century will see a sudden slowdown in Y2K revenues.
Financials: Expanding growth
The company's revenue have grown steadily in the past, recording a CAGR of 32% in the past three years. The operating margins, however, have not improved due to high costs associated with huge infrastructure and other expenses such as salaries and marketing alongwith higher onsite activity. For the year ended March 1998, RS Software reported a 13% jump in total revenue to Rs26.14 crore. The net profits jumped from Rs1.42 crore to Rs3.03 crore, thanks to a 27% fall in the interest charge and a steady depreciation provision.
In the current year, RS Software is likely to post better profits due to the jump in Y2K revenues. Turnover in the first half has risen from Rs8.57 crore to Rs18.49 crore, whereas net profit leaped 221% to Rs3.02 crore. The Q3 results are also better than the corresponding previous quarter with an increase in turnover from Rs4.45 crore to Rs8.95 crore and a 96% jump in the net profit to Rs1.47 crore. However, the turnover and the net profit in the Q3 have declined with respect to the second quarter of the current year. With the focus on offshore activity and higher Y2K revenues, operating margins should be higher than reported in the past few years. Consequently, it can easily post a 40% jump in total revenues and more than 90% jump in the net profit in the current year. Revenues in the next year will grow much faster than the current year, due to the company's investment in infrastructure and a further jump in Y2K revenues. While the operating margins in the year 2000 will be slightly higher than in 1999, these would slightly come down after 2000 due to high overheads on account of expansion. However, the increase in offshore activity should take care of any steep fall in the operating margins.
Financial: Massive Growth Ahead
(All figures in Rs Crore)
Year Ended March 31 1997 1998 1999* 2000*
Sales 23.95 26.99 39.75 85.25
Other Income 0.45 1.21 2.00 2.35
OPM (%) 16.03 15.41 18.38 19.24
Operating Profit 3.84 4.16 7.30 16.40
Net Profit 1.42 2.89 6.10 14.15
Equity 4.35 4.69 4.69 4.69
EPS (Rs) 2.97 5.78 12.55 29.70
* Projected
Investment potential: Size to drive price
The share price of RS Software is currently traded at Rs136, discounting its March 1999 EPS by 11 times and the year 2000 EPS by five times. Shares of RS Software were trading at Rs100 in December 1998 and have risen sharply in the past one month. The software stocks have moved up substantially in the past few weeks and the change in the valuations of the large software companies has had its impact on the small companies as well. Consequently, the share price of RS Software has increased 33% in the past one month. Sustaining such high valuation largely depends upon the growth of the company. With a sharp increase in the revenues and earning in the next two years, the share price of RS Software is expected to ride the software stock boom and move up from its current levels. Buy.
Sushanto Mitra
is a financial consultant
with Technology Capital Partners.
sushanto@techcapIndia.com
The views reflected here are not necessarily those of the organization. No liability is accepted for losses based on the authenticity/accuracy of information presented here.
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