On the dull side

BS Compass

The MphasiS BFL group has had a rather lacklustre June quarter, with net profit growing by a meagre 4.1 per cent, despite a 7.7 per cent sequential increase in revenues and a 52 per cent jump in non-operating income.

The culprit was a disproportional (15.7 per cent) jump in cost of revenues, which led to a near 500 basis points drop in gross margins.

Breaking up the results between the software services business (MphasiS) and the call centre business (MsourcE), it's interesting to note that the deterioration in performance is restricted to MphasiS.

MsourcE, on then other hand, showed signs of a turnaround to profitability. Its revenues grew 23.4 per cent sequentially, in line with the 100 per cent y-o-y growth guidance the management has given for the whole of FY04.

More importantly, the operating loss posted last quarter reduced drastically (by over 650 basis points) to 3.8 per cent of sales. This simply means there would at least have to be a similar (650 bp) improvement in operating margin in the next two quarters for the company to achieve its target of a double-digit operating margin in the second half of the fiscal.

The management is not worried about this fact, and has reiterated that it stands by the guidance given at the beginning of the year.

The performance of MphasiS is rather worrying, however, since its revenues have grown a mere 2.4 per cent, while its net profit has actually declined seven per cent.

Interestingly, revenues of the top 10 clients grew seven per cent sequentially, while revenues from other clients declined seven per cent, leading to the flat growth in overall sales.

Gross margins of the business fell 600 basis points, thanks to an appreciating rupee, salary hikes, and a 12.4 per cent increase in workforce. The company's dollar exposure was thankfully hedged, which is reflected in the 32 per cent jump in non-operating income.

Besides, provision for tax fell by over half, which according to the company was on account of the reinstatement of 100 per cent tax exemption (90 per cent last fiscal) on software exports. As a result, the decline in net profit margin was much lower at 2.22 per cent.

The lacklustre performance of the software services business hardly made any dent on the MphasiS stock price, which supports the notion that the company's increasingly becoming a BPO play in the markets.

Wockhardt

Not only will Wockhardt's acquisition of UK-based CP Pharma place the company amongst the top 10 companies in the UK market, but it will also provide the company with a foothold in the European market for generics.

The acquisition will allow Wockhardt to bypass any import barriers into the European Union, since CP Pharma already has a presence in the region. The acquisition will enable the company to leapfrog the process of setting up a network of its own in the countries by around 2-3 years.

Since generics contribute around 40 per cent to Wockhardt's exports, there's a scope for ramping up revenues and operating margins for the consolidated entity if CP Pharma outsources manufacturing of generics to Wockhardt.

The surprising fact about the deal is the considerable discount at which the Wockhardt has bought CP Pharma. The acquisition, done at a discount of 67 per cent to FY2003 (June ended) sales of around Rs 250 crore, can be explained by the outlook of both parties.

According to Wockhardt, while the former promoters of CP Pharma did not see much growth for the company over the next few years, it presented an opportunity for Wockhardt to improve its presence in the region as well as improve its margins.

Further, the company says that there are around 225 product licences which are underutilised. Thus, not only is there potential for outsourcing, there is an upside to revenues from efficient utilisation of the product licences too. Wockhardt appears to have driven a very hard bargain in light of such obvious advantages to the company.

On a consolidated basis, while CP Pharma would contribute around 24 per cent of its revenues, Wockhardt also does not lose much in terms of profitability.

CP Pharma had EBIDTA margins of around 13.5 per cent in 2002 compared to Wockhardt's operating margins of 14 per cent in 2002 (December ended). Therefore there appears to be a definite upside over the longer term with minimal downside to profitability in the near-term.

However, the benefit of the acquisition will likely be reflected only in the second-half of the current year as operations of both companies get integrated.

With contributions from Mobis Philipose and Sameer Ranade