Megasoft: Riding the products wave

PENNY WISE

Megasoft is one of the few Indian companies making the transition from IT services to products, likely to boost its margins even further.

For a market dominated by IT companies, the paucity of good-quality, promising software-product companies in India comes as a surprise.

Despite its small size, the Rs 125 crore Megasoft, a Hyderabad-based hybrid services and products company, is one of the rare companies which seems to be successfully making the products-switch, changing itself from a networks-upkeep service-provider to a telecom and clinical-trials product company.

Going by the company's recent performance and the steady increase of the share of product-revenues in its total turnover and the associated improvement in margins, the stock is likely to be an out-performer over the next one year.

It has climbed steadily from around Rs 90 a year ago to the present Rs 170 levels and currently boasts of an earnings per share of Rs 8.53, up nearly 54 per cent over the last nine-months.

While the current price of nearly 20 times its trailing 12-month earnings may be slightly expensive compared to other pure IT-services companies of its size, it hardly accounts for the rapidly transforming revenue-structure of the Rs 125 crore company, which has the potential to increase its earnings substantially over the coming months.

Over the past one year, the financial performance of Megasoft has lived up to the promise it made a year ago of transforming itself from a low-margin services shop to a R&D led, royalty-driven product company.

From just 23 per cent a year ago, the company now derives nearly 40 per cent of its revenues by selling telecom software such as those used for billing, roaming, call-activation etc and software used by the clinical-trials industry.

"From being a primarily services-driven company, we have shifted gears and moved toward products in mobile telephony and life sciences. We will double our telecom revenues in 2006 and will target bigger, higher value telecom deals in the western markets. For this, we will acquire another US company soon," says the company's

CEO and MD, GV Kumar, referring to the six month old acquisition of a small (Euro 1.4 million) German telecom-consulting firm for 0.53 m Euros.

The company, which has nearly 500 employees in its Chennai and Hyderabad facilities as also offices in USA, UK, Singapore, Malaysia and Germany, derives all of its product revenues from the telecom and clinical-trials industries, mainly from the US, Europe and Middle-east. Of late, it also figures in the vendor lists for nearly all the major telecom companies in India except Airtel and BSNL.

This year, the company's total annual turnover has gone up from Rs 91 crore a year ago to Rs 125 crore for the year ending March, an increase of 37 per cent. While the growth may seem decent or even average for a IT company of its size, the real story lies in where it has come from - the high margin telecom and clinical trial software business.

Most importantly, nearly all of the growth in both the company top-line and bottom-line has come from its rapidly expanding products business

For example, even as its 12-month revenues from its services-business has stubbornly refused to budge from the Rs 75 crore mark, the company has successfully got over the stagnation by focusing on its other two businesses - the telecom and the clinical trial software products.

The two have grown at an astounding 113 per cent over the last four quarters. From 23 per cent a year ago, the telecom division alone has increased its share to nearly 35 per cent of the total revenue in March this year.

Its contribution on a trailing twelve-month basis too was up from 20 to 34 per cent, standing at nearly Rs 42 crore out of the Rs 125 crore total revenue for the four quarters ending March this year.

Assuming that the services-revenues are to remain static over the next year but the company is able to double it telecom revenues during the same period as promised, Megasoft will have more than half of its total revenues coming from the sales of its telecom products at the end of next year. This will significantly alter its profitability due to the high-margin, cost-independent nature of the product-business.

For example, while the company's standard gross profit margin on it services revenue has remained between 13 to 14 per cent for the last two years, the margin on its telecom revenues is 45 per cent, according to the company's March quarter results.

Even a year ago, when the unit was much younger, it still had a margin of 31 per cent. Compare this to the company's overall pre-tax margin of a mere 14 per cent last year, which to 21 per cent this year thanks to the rising telecom revenues.

The improving margin left its impact on the bottomline too as the company's 12-month profit has zoomed 69 per cent in over the last nine months alone and has been showing an average increase of 20 per cent every quarter for the last one-and-a-half years.

The impact of the increasing share of the telecom business will continue to increase in the coming quarters. For example, a doubling of revenues at current margins from the telecom business will add nearly Rs 19 crore to the gross earnings while this year's net earnings is just Rs 24 crore. The revenue, in contrast, would show only a growth of 34 per cent.

But telecom is hardly the end of the story. The company's offering in the clinical-trials market caters to the independent and other clinical trials organisations by supplying them with a software tool to record and analyse the results of their tests and studies. Over the last six months, revenues in this unit has trebled, from Rs 2.6 crore to the present size of 7.1 crore on a trailing-12-month basis.

Though it contributes only 5.7 per cent of its latest 12-month revenue, Kumar says the clinical trails story is just starting. "As of now, we have one pharma company three dedicated clinical trial companies using this product, all from the US," he says.

"But three out of the four came in only in the second half 2005. This is a very nascent market, hardly a few years old and one in which the incumbent (Oracle) has a near monopoly. We believe our product, which integrates a variety of data like X-rays, field and compliance related information, has a significant advantage over the other products. Besides, our product is much cheaper and we expect to the full benefits of the business to start showing this year," he adds.